Activity-Based Costing and Management-Citibank
Activity-based costing and management is a contemporary management technique that involves assigning indirect costs to activities and to the final output on the basis of how the activities were used in the production of the final output. Activity based costing is based on the idea that products are as a result of activities and that these activities consume resources (Hossain & Mahal, 2015). The contemporary management technique offers numerous benefits to organizations especially when it comes to providing more accurate costing and operating information. Citibank could also benefit from activity based costing and management in terms of capturing overhead costs and costs of products and customers. However, the management technique is not currently being implemented in the organization’s retail segment. This research paper discusses activity-based costing and management and how it could be implemented in Citibank’s retail segment to aid in achieving its critical success factors (CSFs).
Activity-Based Costing and Management
Activity-based costing and management is a modern management accounting tool that was developed and designed to overcome the challenges of the traditional costing method. While the traditional costing method reports on the amount of resources spent on each department, it fails to report the cost of different activities involved in the production of the final output. Activity based costing (ABC) is defined as a costing system that traces resource consumption to the final output by assigning costs to activities while activity based management (ABM) is when ABC is put into action whereby an organization designs products and services that meet customer expectations, identifies where improvements in quality and efficiency are needed, and improves the value of products and services (Cokins, 2006). ABC costing helps to trace the indirect costs or overhead costs to products and services by ascertaining the type and amount of resources used, the cost of these resources, the set of activities that consume these resources, and how these activities result in the final output. Some of the resource expenses discoverable through ABC include operating supplies, utility consumption, salaries or even equipment depreciation.
A critical element of ABC is activity analysis that involves assessing the type of activities performed by each department, the number of employees performing these activities, the resources and time used to perform the activities, and the value of these activities to an organization (Cokins, 2006). The contemporary management technique also involves the use of resource drivers to trace resources to activities thereby enabling an organization to calculate the cost of each activity. Further, activity drivers are used to trace activity costs to each product, service or customer that consumes a particular activity. An organization can also be able to know the number of activity output units that each cost object used up for a given reporting period.
ABC implementation process
Since ABC and ABM are relatively new management techniques, their implementation require several characteristics at the organizational level. These include: an effective management process to ensure the support of the techniques at all organizational levels, proper planning, initial design and the steps of implementation.
- Change management
Implementation of the ABC technique requires behavioral change management as well as support from the top management. According to Cokins (2016), the top management should demonstrate support for the new costing system by championing the initiative. Lower level managers should also accept the new system to demonstrate that the old costing system provides inaccurate and distorted information therefore requires changing. Change management also helps to address any form of resistance by different people across the organization by ensuring commitment from all level of managers and address the impact that the new costing system might have on performance management and compensation system. Another item that the top management needs to address is communication whereby employees need to be informed about the faults of the current or old system and the need to implement the new costing system. Other items to communicate across the organization include how the ABC system can be used to develop more useful information, how the management will support the implementation process and how the new system will affect employee performance and the reward system (Cokins, 2006). Lastly, a cost benefit analysis might be required to justify the need to shift to the ABC system.
- Proper planning
For any new initiative to be successful, proper planning is necessary to identify the expected outcome and how the specific needs will be met. While implementing the ABC system, organizations should plan ahead on the approach to use to implement the system and the revenues and resources to be used and the design of the system. For instance, an organization should plan on whether to fully implement the new costing system across the entire organization or conducting a pilot study on a single department. In some instances, the full implementation approach is preferable as it could lead to more commitment from managers and a rapid adoption of the systems. On the other hand, a pilot study is necessary when testing the ease of implementation and potential outcome of the system on a single department before considering full implementation. An organization might also consider having a budget or planning resources for the implementation process or just use actual revenues and resources. Other items to consider while planning for implementation include the type of ABC system to use, which vendor to source from, the ownership of the system and the complexity of the system. An organization might also need to decide whether to integrate the ABC system with its financial accounting system.
- Initial design
The ABC system could have two designs: the cost assignment view and the process view (Cokins, 2016). In the cost assignment view, an organization might decide to define resources, activities and cost objects for the purpose of assigning expenses to resources and assigning the costs of activities to the final output. In the process view, an organization identifies operational information and processes and the activities that are involved in these processes by sequencing the work activities. An organization should also be able to identify all its cost objects (drivers) and the activities that they consume to identify the ABC design to use. There are different types of cost drivers that organizations should identify including resource drivers, activity drivers and cost drivers to assess the usage of an activity to produce the final output.
- Steps of implementation
The implementation process for an ABC system involves the following steps:
Step 1: identifying and defining activities and their cost pools. These include supporting activities that are involved in the production of a product or service.
Step 2: tracing overhead and indirect costs to cost objects and activities. This involves identifying the processes that are involved in producing the end product.
Step 3: assigning costs to activities. For instance, operational costs could be assigned to indirect management costs.
Step 4: calculating the activity rate. This involves assigning value to these activities.
Step 5: assigning activity costs to cost objects. This is done by assigning costs to products, services and customers.
Step 6: preparing the management report that contain cost objects and cost owners (Hossain & Mahal, 2015).
ABC application by other organizations
ABC is a system that has been extensively used in the manufacturing sector; however, in the past few years, the costing system has been implemented in the service sector, particularly the financial institutions and banks. Whereas the service sector is significantly different from the manufacturing sector, the ABC management technique can be effectively applied in both sectors to realize the benefits of ABC system that include more accurate tracing of costs. The banking industry needs activity based costing because of two main reasons: profitability and compounding problems. Every bank strives to become profitable and this is the main reason why banks come up with numerous financial products and services. However, many banks still have no idea of the costs incurred to provide these products and services and ABC system could be crucial in accurately identifying the activities involved in offering these products and services and their exact costs. When it comes to compounding problems, banks are designed in such a way that they encourage customers to purchase financial products and services or maintain account balances (Hossain & Mahal, 2015). For instance, an account maintaining a balance of $100,000 was considered to be more profitable for a bank than 10 accounts each carrying $10,000. However, most of the expenses of banks are fixed creating the need for an ABC system that will help to get more accurate cost and expense estimates of offering different financial products and services.
Some of the financial institutions that have used the ABC system include:
- Refah bank Iran
According to Sarokolaei, Ebrati, Khanghah and Ebrati, (2012), Refah bank uses both the traditional costing method and the ABC method to calculate its direct and indirect costs of providing financial products and services. In the traditional costing method, the bank categorizes the overhead costs of deposits intro different classes including saving, long term, current and other deposits depending on the proportion of these deposits as well as the overhead costs related to them. To get the total cost of delivering products and services, the bank gets the sum of both direct and indirect costs. To calculate profits, the bank subtracts the total costs from the revenue. For Refah bank, the main problem with the traditional costing method is that it fails to accurately assign cost to each product, service or activity. Further, the overhead costs of each category of deposit are just an estimate. Refah bank is also implementing the ABC costing system whereby the bank has designed an ABC system and identified the activities of line units to get the costs or resources they consume. The new costing method also identifies organizational units’ activities and categorizes indirect costs according to a suitable cost stimulus. The result of the ABC costing system is that it has helped the bank to get more accurate ratios of the indirect costs associated with different types of deposits. The table below summarizes the percentage of costs using the traditional costing method and the ABC method at Refah bank:
|Deposit type||Cost percentage using the traditional costing system||Cost percentage using the ABC system|
This suggests that the use of ABC system leads to more accurate and meaningful calculation of indirect costs consumed by different activities, products and services.
- ‘Banco Lusitano’ Portuguese Bank
The bank is a family owned business that was nationalized in 1976 and privatized in early 1990s. The bank has been using the traditional costing approach until 1992 when the bank engaged several initiatives to reduce head count and improve the cost to income ratio (Vieira & Hoskin, 2005). Determined to cut costs and increase revenue, the Portuguese Bank engaged several restructuring systems and has adopted new management information system including the ABC system. The bank started implementing the ABC system in 1998 to enhance efficiency and effectiveness of delivering financial products and services. Some of the challenges that the bank faced in implementing the ABC system included the lack of product cost information, lack of comparability of information from multiple sources and delays in providing data. The ABC system was adopted by the bank to help the organization provide more accurate costs to manage the profitability of financial products offered by the bank and to reengineer business processes at the bank that add no customer value. Since the implementation of ABC, the Portuguese bank has managed to accurately calculate its costs of providing products and services, identified new areas of profitability and eliminated processes and activities that do not add value to the bank and its customers. However, the implementation of the ABC system was not without problems but with enough support from the management and better understanding of what information technology can deliver, the bank was successful in implementing the new costing system and has realized its numerous benefits.
The applicability of ABC to Citibank’s retail segment
Citibank’s Global Consumer Bank is the retail segment of Citibank and it serves more than 100 million customers in more than 19 countries. Citibank’s Global Consumer Bank focuses on three key markets: the US, Asia and Mexico (Citigroup, 2018a). In these regions, the bank offers global scale products and services most of which are digital products or are products that customers can access without having to visit the bank. The bank has been shifting its retail customer management to digital channels especially through mobile as a large number of customers are using the Citibank mobile app and other digital services to access financial products and services. The retail segment currently operates more than 2,400 branches that generated more than $32.7 billion in revenues and $7.2 billion in pre-tax earnings in 2017 and this makes it a critical part in the success of the entire Citibank Corporation (Citigroup, 2018b).
Current costing system
Currently, Citibank uses the traditional costing method whereby all the indirect and overhead costs are pooled together. The total cost of delivering financial products and services are calculated as the sum of the direct and indirect costs and these are pooled together as total operating expenses or costs. While this costing method has been used by the company to calculate its operational costs for years, the bank needs a more accurate costing system that will help to accurately determine indirect and overhead costs of providing financial services and tying these costs to the final products and consumers. ABC system could be implemented at the bank to help in accurately determining operating expenses and costs, identifying the most costly products and services in terms of the resources they use and identifying and eliminating activities or processes that add no value to the company (Vieira & Hoskin, 2005). Further, the ABC system could help the company to identify its key cost drivers and focus on processes or products and services that use little resources yet bring significant revenues and income. The ABC system can be implemented as follows:
Implementing ABC at Citibank
- Step 1
This should involve design an ABC system that addresses the needs of the bank and helps the bank to achieve its desired outcome. Different approaches could be used while designing the ABC system including conducting a pilot project or doing a full implementation across the entire organization. In this case, a pilot project could be implemented on the global consumer segment and then the costing system be implemented in other departments and segments. A pilot project could also be helpful in identifying and addressing challenges in implementation before the company could consider full implementation of the costing system. On the other hand, the company could consider full implementation of ABC costing whereby segment and department managers will lead the design and implementation of the costing system.
- Step 2
This will involve identifying and defining activities and their cost pools. For the bank, this could be done by breaking down the bank activities into different categories. For instance, since Citibank offers different retail financial products and services including retail banking, commercial banking and credit cards, the activities could be categorized as:
- Accumulating deposits – these should include all the activities related to managing customer deposits including administering customer accounts, providing statements, processing deposits and withdrawals and any other activity related to supporting the customer deposits (Sarokolaei, et al., 2012).
- Giving loans – these include all the activities related to using the accumulated funds and customer deposits to earn the bank profits. Some of these activities might include giving loans, identifying who to give loans, monitoring the performance of these potential customers, approving loans and processing payments.
- Supporting activities for customers – these include activities related to marketing financial products to depositors and borrowers. They might also involve marketing activities meant to attract retail establishments or even large corporate customers.
- Supporting products and services – these might involve the activities of developing and supporting its key retail bank products including commercial banking, retail banking and credit cards.
- Managing the whole global consumer segment – this segment might need general and administrative support activities such as general accounting, management and administration, marketing, human resource management and regulatory reporting.
- Step 3
This will involve tracing overhead and indirect costs to cost objects and activities. In this step, Citibank will need to assign costs to different activities. For instance, wages, benefits, travel expenses, employee training and other related costs might be assigned to human resources costs.
- Step 4
This step will involve categorizing direct costs, indirect costs and overhead costs. Since direct costs can be easily traced to financial products and services, indirect costs like labor costs, building and equipment costs and indirect material costs must be allocated to activities that consume resources. For instance, the indirect labor costs can be determined by estimating the number of workers for the consumer segment and the payroll for each activity. The activity rate can be determined by assigning values to the different activities.
- Step 5
This involves assigning activity costs to cost objects. This is done by assigning costs to products, services and customers whereby the activity cost pools are assigned to final products, services and consumers. For example, the human resource costs can be assigned to consumer loans or deposits for a certain reporting period.
- Step 6
This should be the final step of the ABC implementation process for Citibank and will involve preparing the management report that contains different cost objects, the activities that consume resources and the costs of these activities (Hossain & Mahal, 2015). The bank can use this report to compare with the cost values of the traditional costing system that the bank currently uses.
Evaluating ABC results
Once the new ABC system has been implemented, Citibank can evaluate its results by comparing the amount and proportion of costs for different cost categories using the traditional costing system and the ABC system. Another way of evaluating the results of the ABC system is by comparing the gross profit margins when the bank uses the traditional costing method versus when the bank uses the ABC costing method (Hossain & Mahal, 2015). The ABC system could help to identify activities and processes that add no value to the final products and services offered by Citibank and the bank can therefore eliminate these business processes. However, the most important and challenging process would be designing an ABC system that specifically meets the needs of the bank. The bank should also commit the necessary resources and the organizational change needed to effectively implement the ABC system.
With the ABC system, Citibank should expect to achieve its critical success factors (CSF) including financial factors, customer factors, internal business processes and learning and growth by accurately identifying the overhead costs of different activities based on their actual consumption of resources. This would make it easier for the bank to increase its operational performance by assigning more time and resources to activities and processes that need more resources and those that are tied to the most profitable products. The ABC system could also help the bank to identify the interdependencies of different cost drivers thereby making it easy to improve operational performance. Another advantage that Citibank is likely to benefit from implementing the ABC system is identifying weak product and service lines as well as their costs. The bank can therefore identify what products to improve to become more profitable and what products to completely eliminate. Once the ABC system has been successfully implemented in the Citibank’s consumer segment, the bank could consider implementing the costing system across the entire organization.
In conclusion, the ABC system is a relatively new costing system that involves assigning costs to activities. Compared to the traditional costing system, the ABC system helps to generate more accurate information in regards to indirect and overhead costs and how they are tied to the final products and services. Citibank could implement this new costing system through a pilot project in its global consumer segment to attain more accurate cost estimates of different activities and cost drivers. A successful implementation of the costing system would enable the bank to increase its operational performance and better control its costs.