by Zabihollah Rezaee Ph.D., CPA, CMA,
INTRODUCTION In the past, bank accountants paid little or no attention to the use of managerial accounting concepts in the banking industry. Viewing managerial accounting from the perspective of the banking industry provides a unique opportunity to explore the development of the internal reporting structure. While the use of internal cost and profitabiHty reports is widespread in merchandising, manufacturing, and other service industries, banks have historically focused only on overall profitability. The reason is simple. In the past, interest rates, branch locations, and service offerings were heavily regulated by the government; banks had little incentive or opportunity to consider issues such as pricing, product mix, or market share strategies. Deregulation has put an end to this complacent approach, and bankers are now scurrying to survive in a quickly changing environment. The most obvious result of deregulation is increased competition.' Customers are more aware today of yields on investments and costs of loans. For banks, this means increased pressure on interest spreads, and ultimately, on bottom-line profits. Currently, the traditional business of banking, loans and deposits, is being challenged by outsiders.^ To meet these challenges, banks are adding managerial accounting concepts and techniques to their existing financial reporting structures. Banks are seeking more information regarding the profit contribution of business units, product lines, and customers,. The purposes of this paper are to: (1) discuss the phases of bank profitability reporting; (2) examine the costing methods most commonly used by the banking industry; and (3) discuss the concept of internal funds transfer pricing and a mechanism for measuring and allocating the costs of gathering funds to the users of those funds. 'Associate Professor of Accounting Middle Tennessee State Universitv 1. Jensen, Flemming J., 'Customer and Product Profitabilitv Control in Banks," The World of Banking, May-June 1985, pp. 20-25. 2. Renshaw, William W., "How Profitable Are Your Cash Management Services?' Bank Administration, May 1988, pp. 40-44. ^ THE RELEVANCE OF MANAGERIAL ACCOUNTING C O N C E P T S IN T H E B A N K I N G I N D U S T R Y 3
PHASES OF BANK PROFITABILITY REPORTING
The need for internal measures of profit contribution is clearly evident for financial institutions. The difficulty is establishing and maintaining a reporting system that is comprehensive, reliable, relevant, and useful. Researchers have identified several phases of bank profitability reporting. For example, Roosevelt and Johnson' describe eight phases, while Faletti" presents four, and Chishohn and Duncan* examine only three phases. The differences lie more in degree than in substance. Basically, there are three distinct phases of bank profitability reporting: responsibility and profit center reporting, product profitability reporting, and customer profitability reporting. These phases are built based on the responsibility accounting concept. This concept is based on the premise that an organization is simply a group of individuals working toward common goals. An organization such as a bank usually divides responsibility for specific functions among its employees. Thus, a responsibility center is a particular unit of a bank assigned to a manager who has the proper authorities and responsibihties to make decisions about the center's activities and who is also held accountable for the operations and resources of that center. Phase One: Responsibility and Profit Center Reporting The first step in bank profitability reporting involves dividing the organization into distinct managerial units; distinct in the sense that each unit must be responsible for clearly identifiable income and expense items. Nevertheless, some areas of the organization cannot easily be defined in these terms. For...