Author Question: The account, ___________, represents amounts earned by a business. a. cash b. expenses c. ... (Read 102 times)

cnetterville · **on:** Jul 6, 2018

The account, ___________, represents amounts earned by a business.
a. cash
b. expenses
c. accounts receivable
d. revenue

Question 2

ABC, product-costing at banks, cross-subsidization.

United Savings Bank (USB) 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. USB 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, USB would gain 60 on the interest spread if a depositor had an average Premier Account balance of 2,000 in 2014 (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 22-a-month service fee for their Premier Account.
USB 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 2014 by three customers is as follows:

Assume Lindell and Colston always maintain a balance above 1,000, whereas Welker always has a balance below 1,000.

Required:
1. Compute the 2014 profitability of the Lindell, Welker, and Colston Premier Accounts at USB.
2. Why might USB worry about the profitability of individual customers if the Premier Account product offering is profitable as a whole?
3. What changes would you recommend for USB's Premier Account?

matt · **Reply #1 on:** Jul 6, 2018

Answer to Question 1

D

Answer to Question 2

1.
Lindell Welker Colston Total
Revenues
Spread revenue on annual basis
(3 ; 1,200, 700, 24,900)
Monthly fee charges
(22 ; 0, 12, 0)
Total revenues

36.00

0.00
36.00

21.00

264.00
285.00

747.00

0.00
747.00

804.00

264.00
1,068.00
Costs
Deposit/withdrawal with teller
2.50 44; 49; 4
Deposit/withdrawal with ATM
0.80 12; 24; 13
Deposit/withdrawal on prearranged basis
0.50 0; 14; 58
Bank checks written
8.20 8; 2; 3
Foreign currency drafts
12.10 6; 1; 5
Inquiries
1.70 7; 16; 6
Total costs
Operating income (loss)

110.00

9.60

0.00

65.60

72.60

11.90
269.70
(233.70)

122.50

19.20

7.00

16.40

12.10

27.20
204.40
80.60

10.00

10.40

29.00

24.60

60.50

10.20
144.70
602.30

242.50

39.20

36.00

106.60

145.20

49.30
618.80
449.20

The assumption that the Lindell and Colston accounts exceed 1,000 every month and the Welker account is less than 1,000 each month means the monthly charges apply only to Welker.
One student with a banking background noted that in this solution 100 of the spread is attributed to the depositor side of the bank. He noted that often the spread is divided between the depositor side and the lending side of the bank.

2. Cross-subsidization across individual Premier Accounts occurs when profits made on some accounts are offset by losses on other accounts. The aggregate profitability on the three customers is 449.20. The Colston account is highly profitable, 602.30, while the Lindell account is sizably unprofitable. The Welker account shows a small profit but only because of the 264 monthly fees. It is unlikely that Welker will keep paying these high fees and that USB would want Welker to pay such high fees from a customer relationship standpoint.
The facts also suggest that the customers do not use the bank services uniformly. For example, Lindell and Welker have a lot of transactions with the teller and also inquire about their account balances more often than Colston. This suggests cross-subsidization. USB should be very concerned about the cross-subsidization. Competition likely would understand that high-balance low-activity type accounts (such as Colston) are highly profitable. Offering free services to these customers is not likely to retain these accounts if other banks offer higher interest rates. Competition likely will reduce the interest rate spread USB can earn on the high-balance low-activity accounts they are able to retain.
3. Possible changes USB could make are:
a. Offer higher interest rates on high-balance accounts to increase USB's competitiveness in attracting and retaining these accounts.
b. Introduce charges for individual services. The ABC study reports the cost of each service. USB has to decide if it wants to price each service at cost, below cost, or above cost. If it prices above cost, it may use advertising and other means to encourage additional use of those services by customers. Of course, in determining its pricing strategy, USB would need to consider how other competing banks are pricing their products and services.