Activity Based Costing and Financial Institutions: Old Wine in New Bottles or Corporate Panacea?

"Activity-based costing (ABC) is one of two or three most important management innovations in the twentieth century and arguably the most written and talked about management accounting topic since 1985"2 A. INTRODUCTION Archimedes said that given a proper lever, he could move the world. Given sufficient sponsorship, a sound game plan and practical implementation, Activity Based Costing ("ABC") can do the same for any financial institution. ABC has recently returned to the corporate toolkit as a remedy for many problems that organisations are facing in the current economic downturn. The inherent value and simplicity of ABC lies in its unparalleled ability to provide the most critical of all inputs in corporate decision making today - data (information). While the need for data is paramount; acquiring good data becomes akin to the search for the Holy Grail! The building blocks and robustness of any sound strategic, management or business policy for any organisation rests on this simple yet most elusive of phenomenon. Data allows analysis to be carried out; it allows objective decisionmaking to prosper; and above all, it provides an objective and direct measure of the impact of the decision-making. With good data, strategic policy and operational performance are intertwined and organisational objectives can be achieved. Its catalyst properties can be fundamental to the success of any business. ABC, is at its best revolutionary, and at its worst, misunderstood. Although the usage of ABC is becoming more prevalent, ABC has yet to become standard industry practice, let alone the norm for the financial services sector. A general industry survey found that 27-44% of corporations were using ABC3. It remains an approach that although intuitively simple, has been traditionally difficult to implement. It does require more effort and maintenance than simple cost accounting - but the trade-off is not an issue. While there is a linear effort, the benefit in the quality and the magnitude of data increases exponentially; the additional benefit far outweighs the marginal effort. Financial institutions have recently been at the forefront for implementing ABC. Even though the use of ABC has evolved from the original users, manufacturing companies, to services companies, the financial sector remains virgin territory. Here it is an even more elusive beast: the new frontier. While the use of ABC within financial institutions poses new and different challenges to ABC practitioners, little knowledge or information of the experiences of implementing ABC in financial institutions has seeped into the public domain. This paper seeks to highlight and discuss some issues which are particular to financial institutions, and some which are more generic but have not been otherwise highlighted. These issues can effectively be segregated into three categories: 1) The rationale for implementing ABC and other pre-implementation issues such as effective sponsorship and practical determination of the requirements of the ABC model; 2) Implementation issues include consideration of time-tracking, cost accounting, and model build actions; and 3) Post-implementation issues include costing transactions, care and maintenance policies and decision analytics. We will seek to explain these issues from a non-technical perspective, and to elucidate using real-life examples from our experiences wherever possible. B. PRE-IMPLEMENTATION ISSUES 1) The Rationale to Implement ABC Why ABC? This is the key question that must be addressed by any financial institution as it helps set realistic aspirations and feasible targets. ABC must not be considered as the ubiquitous panacea. It is and always will be simply data communicating the rate at which resources are being consumed and how they are being consumed. From its genesis at the Harvard Business School (due to Kaplan and Cooper), ABC has significantly improved on the deficiencies of traditional product costing techniques caused by the misallocation of overhead costs. …