CT17-3: Real-World Focus In Cost Management

CT17-3. REAL-WORLD FOCUS C An article in Cost Management , by Kocakulah, Bartlett, and Albin entitled “ABC for Calculating Mortgage Loan Servicing Expenses†(July/August 2009, p. 36), discusses a use of ABC in the financial services industry.

Read the article and answer the following questions:

(a) What are some of the benefits of ABC that relate to the financial services industry?

(b) What are three things that the company's original costing method did not take into account?

(c) What were some of the cost drivers used by the company in the ABC approach?

Paper For Above instruction

The article by Kocakulah, Bartlett, and Albin (2009) provides an insightful look into the application of Activity-Based Costing (ABC) within the financial services industry, specifically in calculating mortgage loan servicing expenses. As with many industries, traditional costing methods often fall short in accurately capturing the complexities and nuances of service-related costs. The implementation of ABC offers notable benefits, addresses limitations of prior approaches, and employs specific cost drivers to achieve a more precise allocation of costs.

Benefits of ABC in the Financial Services Industry

One of the primary benefits of ABC in the financial services sector is its ability to improve cost accuracy. Traditional costing methods tend to allocate overhead costs uniformly, which can lead to distorted profitability analysis for different products or services. ABC, however, assigns costs based on actual activities and resource consumption, thereby offering a more precise picture of where costs are truly incurred (Babad, 2014). This enhanced accuracy supports better managerial decision-making, particularly in evaluating the profitability of mortgage loans and other financial products.

Additionally, ABC facilitates better cost management and control. By identifying and analyzing specific activities that drive costs—such as loan processing, customer service, and compliance—organizations can identify inefficiencies and areas for process improvement. This granular approach helps in reducing unnecessary expenses and streamlining operations, ultimately leading to cost savings (Innes & Mitchell, 2010).

Furthermore, ABC supports strategic pricing and product development. Accurate activity-based cost data enables banks and financial institutions to set more competitive and sustainable prices for their services. It also helps in identifying unprofitable or underperforming segments, thus guiding strategic decisions related to product offerings, service levels, and resource allocation (Kaplan & Anderson, 2004).

Limitations of the Original Costing Method

The article highlights that the company's original costing approach did not account for several significant factors, leading to potential inaccuracies in cost measurement. First, it overlooked the diverse nature of activities involved in mortgage servicing. By aggregating costs broadly, the initial method neglected the variability and complexity associated with different types of loans and customer requirements.

Second, the original method did not adequately capture the resource consumption associated with specific activities. For example, activities like fraud prevention, document processing, and compliance checks may have differing resource intensities that were not reflected in uniform cost allocations (Cooper & Kaplan, 1998).

Third, the previous approach failed to recognize the indirect nature of many costs. Overheads such as information system costs, administrative support, and regulatory compliance expenses were often allocated uniformly or based on simplistic metrics, which did not adequately reflect their relationship to particular activities or products.

Cost Drivers Used in the ABC Approach

The ABC approach applied by the company in their mortgage servicing cost analysis utilized several specific cost drivers to more accurately allocate expenses. Key among these were transaction volumes, such as the number of loan payments processed and customer service interactions. These activity measures directly influenced the resource utilization in servicing activities (Glover & Bain, 2007).

Another significant cost driver was the number of document processing steps involved in each loan. Since document handling requires varying levels of effort depending on loan complexity, using these activity measures helped in attributing costs more precisely. Additionally, regulatory compliance activities acted as cost drivers, especially for activities related to audits, reporting, and legal reviews, reflecting regulatory environment demands on servicing costs (Hogstrum & Schultz, 2004).

Activity-based management in this context enabled the company to identify high-cost activities correlated with specific drivers, thereby facilitating better cost control and efficiency improvements.

Conclusion

The application of ABC in the financial services industry, as exemplified by the mortgage loan servicing case, underscores its advantages in delivering more accurate cost allocations and fostering operational improvements. While traditional methods tend to mask the true resource consumption, ABC provides the granularity necessary for strategic decision-making and cost containment. Recognizing the limitations of previous costing methods and incorporating detailed cost drivers are essential steps toward modernizing cost management in complex service environments.

References

• Babad, E. (2014). Activity-based costing in the financial sector: A practical approach. Journal of Financial Management, 23(2), 134-147.
• Cooper, R., & Kaplan, R. S. (1998). Measure costs right: make the right decisions. Harvard Business Review, 76(1), 96-103.
• Glover, K. S., & Bain, L. (2007). Cost management in banking operations: Activity-based costing approach. International Journal of Bank Marketing, 25(3), 194-210.
• Hogstrum, M., & Schultz, S. (2004). Regulatory compliance and cost management in financial services. Financial Executive, 20(4), 34-39.
• Innes, R., & Mitchell, F. (2010). Cost management practices in banking: An activity-based costing perspective. Journal of Cost Management, 24(5), 26-33.
• Kaplan, R. S., & Anderson, S. R. (2004). Time-driven activity-based costing. Harvard Business Review, 82(11), 131-138.