Heartland Bank & Trust Operates in a Very Competitive Marketplace

question 8

Essay

Heartland Bank & Trust operates in a very competitive marketplace, using a traditional labour-hour-based system to determine the cost of processing its mortgage loans. Recently, the firm explored a switch to activity-based costing to determine the wisdom of its previous ways. The following information is available: $\begin{array}{ll}\underline {\text {Activity}}&\underline {\text {Cost}}&\underline {\text {Driver}}&\underline {\text {Driver Units}}\\ \text { Application}&\$ 900,000 & \text { Applications } &4,000\\ \text { processing}&\\ \text { Loan underwriting}&800,000 & \text { Underwriting }&16,000 \\ & \text { hours } \\ \text { Loan closure}& \underline {800,000}& \text { Legal hours } &8,000\\ \text { Total}&\underline {\$ 2.580 .000 }\end{array}$ Two loan applications, among many others, were originated and closed during the year. No. 7439 consumed 3.5 hours in loan underwriting and 1.5 hours in loan closure, for a total of 5.0 hours. No. 7809 also required 5.0 hours of time, subdivided as follows: 2.0 hours in loan underwriting and 3.0 hours in loan closure. Conversations with management found that, on average, each application took nine labour hours of processing time, excluding underwriting and closure.
Required:
A. Use an activity-based-costing system and determine the cost of processing, underwriting, and closing the two loan applications.
B. Determine the cost of processing the two loans if Heartland uses the traditional labour-hour-based system.
C. Is Heartland making a mistake by continuing to use a traditional system that is based on an average labour cost per hour? Why?

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Definitions:

Externalities

Economic side effects or by-products that affect an uninvolved third party; can be positive or negative.

Pollution Abatement

Measures and processes undertaken to reduce, control, or eliminate pollution from various sources.

Optimal Amount

The quantity of a good or service that yields the highest utility or benefits under specific conditions.

Moral Hazard

A situation in economics where one party is more likely to take risks because another party bears the costs of those risks.