It does so by describing the partial costs and full cost systems in banking institutions. It then looks at the limitations of these approaches to the current competitive conditions and goes on to consider the applicability of the activity based costing system in the allocation of indirect transformation costs to branches, products and customers. Finally, we will look at the findings of a questionnaire to Spanish savings banks in order to evaluate how widespread these systems are and how they are used in savings banks. We found that direct costs systems predominate in customer and products entries whereas full costs systems are much more widespread in the case of branches. Furthermore, we also found that the use of activity based costs systems is very limited.
Keywords: Saving banks Cost structure Management accounting Cost systems Activity based costing. JEL Classification Codes: M41 – Accounting G21 – Banks; Other Depository Institutions.
1. Introduction
Historically, management accounting in banking institutions was introduced considerably later in comparison with companies in other sectors. There are a number of reasons for this limited development. This was due, on the one hand, to external causes. For example, it was not until the 80’s that competitive conditions in the banking sector fostered the development of accounting management planning and control systems. On the other hand, there were also internal conditions that had to do with the nature of the banking business and the operations that these companies carry out, which differ significantly to those of other sectors.
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This hindered the transfer of models that had basically been developed for industrial companies to the financial sector. As regards internal factors, the accounting regulations set down by regulating bodies of the banking system have traditionally been the starting point from which banking institutions have drawn up their accounting information. The purpose of he latter was clearly to address the needs of central banks that used this accounting information in order to supervise and control the solvency of the financial system and to control the relevant variables of monetary policy (Túa and Larriba, 1986, p.37; Cates, 1997, p.51-56; Kimball, 1997, p.24).
Furthermore, the environment in which these companies had traditionally operated had been sufficiently stable in order for them not to see the need to improve their management accounting systems (AECA, 1994a, p.12-13).
On an internal level, Waden-Berghe (1990, p.569) Rouach and Naulleau (1992, p. 101-102) and Carmona (1994, p.210) point out that the characteristic features of the products and the production process of banks hinder the application of management accounting techniques: the intermediation function they carry out, the permanence on the balance sheet of the main sources of income and expenses, the problematic definition of outputs and input, given that there is no difference between the nature of the raw material obtained via financial markets or deposit taking and the final product (loans), the fixed cost and marginal revenue syndrome, the difficulty in allocating indirect costs to cost objects or the diffuse figure of the customer-supplier.
However, the deep transformation of the banking system, and, more specifically, deregulation, disintermediation and innovation processes, have ushered in changes to the competitive behaviour and the information needs of banking institutions. We can therefore assume that the accounting systems of these companies have most probably also evolved and established new conceptual frameworks 1. As a consequence of growing competition in the banking sector and the reduction of financial margins, banking institutions have had to give increasingly greater importance to the planning and control of their non financial costs, which has opened up the debate around the adequacy of the costs systems currently in use in these companies (Scias, 1985, p. 48; Kimball, 1993, p. 5-20; Bos, Bruggink et al., 1994, p.12; Carmona, 1994, p. 213).
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This essay aims to analyse the characteristics of the costs systems of Spanish savings banks which operate in the universal retail banking segment.
In the first place, we will look at the different theoretical models that will enable us to analyse the financial intermediation activity from a microeconomic viewpoint. Secondly, we will go on to describe the characteristics of non financial costs in banking institutions, given that they influence the application of management accounting in these companies. Thirdly, we will put forward a costs classification in savings banks that facilitates the allocation of their non financial costs to different cost objects (centre of responsibility, products, customers and activities).
Based on the above, we can then go on to assess the use of different costing systems, looking at both traditional costing systems (partial and full) as well as activity based costing. The study finishes by presenting the results of a questionnaire given to the heads of management control of Spanish savings banks with the aim of finding out which costing systems are currently in use and how they are likely to evolve in the future.
2. The Production Process in Banking Institutions
This section aims to present an overview of the different theoretical approaches that interpret the productive process of banking institutions. According to Bergés and Soria (1993, p. 17-23) the models that explain the productive process of banking institutions can be grouped into three groups: partial decision models, portfolio theory and services production. Let’s look at these in more detail. 2.1. Partial Decision Models Partial models focus either on the assets and investment decisions (loans versus the treasury) or on the composition of the liability structure (capital versus deposits), considering the other part of the balance sheet as an external or exogenous variable. In these models, the banking institution’s balance sheet is 1
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We can identify various evolution stages in bank accounting and management; for example, Chisholm and Duncan (1985, p.27-33) have divided its historical evolution into three stages, Faletti (1986, p.88-95) refers to four stages, Rezaee (1991, p.26-28) and Roosevelt and Johnson (1986, p.30-31) have established five stages, and Ernst & Young (1995, p.25-31) outline up to 11 phases. Having said this, the different number of stages by different authors reflect differences in nuances but not in fundamental aspects because the evolution of information drawn up by management accounting in banking institutions may be seen as a continuous process rooted in financial accounting that is evolving towards objectives that are more and more related with tactical and strategic decision making. viewed as the key element, because each of its components is modelled individually (Santomero, 2000, p.4).
When loans are regarded as outputs of the banking institution, it is assumed that, given a certain level of exogenously determined deposits, which are not subject to optimization, the company’s management decision is focused on determining what proportion of deposited funds will be allocated to the provision of loans and what proportion will be kept in the treasury. This is due to the fact that the banking institution needs to maintain a certain level of liquid reserves in order to address possible withdrawals of deposits. Obviously, maintenance of this treasury will generate an opportunity cost, so banking institutions will have to minimise this opportunity cost by maintaining the treasury at a minimum level.
However, if the treasury that is kept is insufficient, the company exposes itself to a high liquidity risk (Baltensperger, 1980, p.3; and Swank, 1996, p.176).
When deposits are regarded as outputs, the problem focuses on determining the optimum balance between deposits and equity (Swank, 1996, p.177).
According to this approach, a situation of insolvency could be brought on not only by the mass withdrawal of customer deposits, but also if the value of assets drops below that of liabilities. This scenario is less and less likely the fewer the deposits. It can therefore be minimised by increasing the volume of equity (Baltensperger, 1980, p.1011;
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Swank, 1996, p.177).
However, given that the opportunity cost of equity is greater than the financial cost generated by deposits, in order to maximise profitability the bank need to minimise the bank’s own funds, which increases the possibility of an insolvency scenario and of meeting the ensuing costs associated with it (Baltensperger, 1980, p.13).
2.2. Portfolio Theory Based Models The previous models seek to address the structure of assets or liability management whilst considering the other part of the balance sheet as exogenous. A comprehensive theory of the productive process of banking institutions needs to simultaneously account for the structure of assets and liabilities. The efficient portfolios selection model for banking institutions put forward by Markowitz (1959) and developed by Pyle (1971, p.737-747) concomitantly looks at decisions concerning assets as well as liabilities and gives us a more comprehensive view of the interrelations between assets and liabilities.
Having said this, it must be acknowledged that although portfolio theory overcomes the limitations of partial models by determining optimum treasury, loans and deposits levels together, it still has its drawbacks. The most relevant to this study has to do with the fact that both partial models and portfolio selection theory regard non-financial costs as irrelevant when it comes to estimating the output level and composition of banking institutions (Swank, 1996, p. 194).
2.3. Models Based on the Production of Services and Real Resources The provision of financial services entails transformation costs which are not contemplated in the abovementioned models.
The services production model advocates that the production processes of banking institutions cannot be properly analysed by simply looking at the management of its optimal assets and liabilities structure, but that we also need to take into account the fact that both financial intermediation and the provision of other banking services generate transformation costs, which entail the use of real resources both human and technological (Baltensperger, 1980, p. 27-29).
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The models developed by Pesek, (1970, p. 357-385); Saving (1977, p. 289-303) and Sealey and Lindley (1977, p.1251-1266) are approaches based on production and cost functions, and enable us to study the banking institution’s behaviour from the point of view of profit maximisation.
According to the above models, the activity of banking institutions consists of providing a range of different financial services (both intermediation and other kinds of services), the production of which can be expressed in accordance with a production function. The inputs of this production function are a combination of different types of factors consisting of real resources whereas the outputs are different possible combinations of assets, liabilities and services. Hence the production function, along with the balancing of the accounts between assets, liquidity and liabilities, interest rates that are externally set by the market and legally established coefficients, make up the restrictions under which banking institutions must operate and try to maximise their profits.
These profits will ultimately depend on the difference between revenue generated from the sale of their services on the one hand and the total costs of their inputs both financial and non financial on the other (Sealey and Lindley, 1977, p. 1255; Santomero, 2000, p.3).
The following sections will discuss the problematic of the costing structure of real resources in banking institutions and look at how these are classified for management accounting purposes. This will be followed by an overview of the different costing systems identified in the literature, partial costs, full costs and activity based costing. And finally, we will present the findings of an empirical research study concerning the costing systems used by Spanish savings banks.
3. The Cost Structure of Banking Institutions
Before we proceed to assess the different existing cost systems and their application to banking, we would like to highlight some of the characteristic features of the banking business which influence the cost structure of its costing systems. These characteristic features can be summed up as follows (Sloane, 1991, p.76-79; Sapp, Rebischke et al., 1991, p.56-57): • Variable work load: the volume of operations fluctuates enormously from one moment to the next, which obviates the problem of capacity management, given that at certain times there are “peaks” whilst at other times there are “valleys” which means that these resources are underused. • High fixed costs: resources are usually allocated to covering “peaks” of activity. However, the cost of these resources does not vary with the volume of transactions, because they have a large fixed component. • Predictability of the activity: although the demand for services tends to be highly variable, it is relatively easy to predict, because it follows a cyclic behaviour pattern, which offers the possibility of turning part of fixed costs into variable ones by means of outsourcing.
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• Mass services production activities: a comparison can be drawn between the high volume of repetitive operations in banking institutions and traditional industrial mass commodity manufacturing, which facilitates the use of methodologies that originated in industry and the setting up of a standard costing system. • Joint production and an undefined product: the banking product is physically indefinable which makes it more complex to identify. For example, when a banking institution issues a loan to a customer, the latter must open up a current account to meet the loan payments. If on top of this the customer orders a cheque book on his current account and takes out a life insurance policy, we have four interrelated products.
• Low cost traceability: given that we are dealing with joint production activities with elevated fixed and indirect costs there are many resources that are shared by activities, customers, products and centres of responsibility. As far as we see it, the most significant factors that influence the applicability of different cost systems in banking institutions are on the one hand, the significant weight of indirect costs in relation to cost objects, which makes it difficult to trace them in relation to cost objects. Similarly, given that a large part of the operations carried out by banking institutions are of a repetitive nature and susceptible to standardisation, this makes it feasible to consider calculating the costs of these operations and allocating them to cost objects, and to introduce the use of standard costs as a planning and control instrument.
4. Costs Classification in Banking Institutions
The classification of the non financial costs of banking institutions may prove useful in studying the applicability of different cost systems to banking institutions. Although we can make different classifications of these costs, the most relevant for our purposes is the difference between transformation and overhead costs (AECA, 1994a, p.61-62): “transformation costs are costs that are generated in profit centres and in operational cost or general services centres. In general, the costs of these centres are directly or indirectly related to the consumption of products and services on the part of customers”.
At the same time, transformation costs can be divided into direct and indirect costs, depending on their relation to cost objects (AECA, 1994a, p.61): • Direct costs, are those costs that can be unequivocally and directly allocated to cost objects, in other words their allocation is controlled economically in an individualised fashion. • Indirect costs, are costs that cannot be directly allocated to cost objects because there is no exact allocation of funds that enables us to estimate the consumption of these costs by cost bearers, It should be noted that a significant number of transformation costs of banking institutions are dual in nature when viewed from the previous classification criterion, to the extent that certain transformation costs can be direct with respect to the branches network but indirect in relation to products and customers (De la Cuesta, 1996, p.85-87).
In banking institutions, transformation costs basically correspond to personnel costs, depreciations and other general costs, which although they are difficult to allocate to customers and products, are generally easier to allocate to responsibility centres (Cole, 1995, p.152).
The second costs category corresponds to overhead costs, which are generated in the bank’s organisational centres. These costs are generated by the various functions related to management, administration, organisation and control. In general, these are indirect in relation to all the cost objects. These costs are treated as costs assigned to support all the company’s functions, and as such they are independent of production volume, the existing product lines and of the markets they serve (AECA, 1994b, p.58).
