Improving Financial Institution Performance through Overhead Cost Management

An efficient and effective cost accounting operation is a key factor in the successful performance of a financial institution. Of the numerous factors that contribute to the keen management of an organization, cost accounting techniques serve as a valuable management tool that helps identify organizational strengths and control performance. In this article we examine the role that cost accounting can play in analyzing and managing overhead cost and thereby enhancing the performance of a financial institution.PERFORMANCE MEASUREMENTBefore discussing the application of cost accounting to manage overhead costs, we need to address how to measure the performance of such application. In general, the number and variety of performance measures that can be built into regular reporting are limitless. However, limits must be set to keep the processing costs related to reporting from exceeding their value. There is a large number of quantitative and qualitative issues to investigate when measuring performance. Since we are concerned specifically with financial institutions in this article, our focus will be on customer activity and profitability while providing satisfactory service. A sample quantitative measure could be the financial benefit derived from an average number of customer transactions at a branch per full-time employee. There are several revenue and cost factors which influence the financial outcome of such a measure. Without regard to the pricing of services, the key question that needs to be answered is which costs (direct and indirect) or other expense factors need to be controlled and in what manner, in order to improve financial performance. In performance analysis, the assignment of direct income and expenses is relatively straightforward. However, the assignment and fair measurement of indirect income and expenses present a challenge.For example, if a bank desired to measure the average cost per teller transaction at a branch, there are numerous cost issues which need to be addressed. One must be able to measure the cost factors involved as effectively as possible. Direct costs, including direct materials and direct labor, can be assigned with relative ease. However, indirect costs or overhead, such as utilities, computer usage, space and supplies, must be investigated with respect to accurate and fair allocation. The proper treatment of overhead costs is critical to the measurement of financial institution performance. Improper management of this issue can produce misleading data and the resultant incorrect decisions. There exists a critical need to allocate overhead costs in a manner that is fair and equitable to all parties and provides management with the most meaningful information for decision making. How can this be accomplished?COST ACCOUNTING SYSTEMSThe key to dealing with overhead allocation lies in establishing an effective cost accounting system. Given the primary issue involved, that is, the allocation of costs to enhance performance, a necessary first step is to accurately track all the relevant costs. Cost accounting helps to identify and accumulate costs for proper consideration in decision making by adding structure and clarity to the cost issues. Furthermore, the use of cost accounting makes it possible to plan and control expenditures at their various sources and generate comparable measurements of like activities. Given the availability of meaningful cost information, there develops a greater level of management awareness and involvement in the planning and control process. The proper use of cost and profitability information provided by cost accounting can in turn improve financial institution performance through better cost allocation and decision making.The development of a useful and meaningful cost accounting system requires a team effort and participation at all levels of the organization. Top management must provide its approval. The organizational chart may have to be modified to arrive at an operational cost accounting structure. …