Acct434 Advanced Cost Management: 5-27 First International Bank (FIB) is examining the profitability

Acct434 Advanced Cost Management
Week 1 Homework

5-27 ABC, product costing at banks, cross-subsidization
First International Bank (FIB) is examining the profitability of its Premier Account, a combined savings and checking account. Depositors receive a 7% annual interest rate on their average deposit. FIB earns an interest rate spread of 3% (the difference between the rate at which it lends money and the rate it pays depositors) by lending money for home loan purposes at 10%. Thus, FIB would gain $60 on the interest spread if a depositor had an average Premier Account balance of $2,000 in 2008 ($2,000 × 3% = $60).
The Premier Account allows depositors unlimited use of services such as deposits, withdrawals, checking accounts, and foreign currency drafts. Depositors with Premier Account balances of $1,000 or more receive unlimited free use of services. Depositors with minimum balances of less than $1,000 pay a $20-a-month service fee for their Premier Account.
FIB recently conducted an activity-based costing study of its services. It assessed the following costs for six individual services. The use of these services in 2008 by three customers is as follows:
Activity-Based Cost per “Transaction” Account Usage
Robinson Skerrett Farrel
Deposit/withdrawal with teller 2.50 40 50 5
Deposit/withdrawal with automatic teller machine (ATM) 0.80 10 20 16
Deposit/withdrawal on prearranged monthly basis 0.50 - 12 60
Bank checks written 8.00 9 3 2
Foreign currency drafts 12.00 4 1 6
Inquiries about account balance 1.50 10 18 9
Average Premier Account balance for 2008 $1,100 $800 $25,000
Assume Robinson and Farrel always maintain a balance above $1,000, whereas Skerrett always has a balance below $1,000.

Required
1. Compute the 2008 profitability of the Robinson, Skerrett, and Farrel Premier Accounts at FIB.
2. What evidence is there of cross-subsidization among the three Premier Accounts? Why might FIB worry about this cross-subsidization if the Premier Account product offering is profitable as a whole?
3. What changes would you recommend for FIB’s Premier Account?
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