A LONGITUDINAL CASE STUDY OF PROFITABILITY REPORTING IN A BANK

British Accounting Review (2002) 34, 27–53
doi:10.1006/bare.2001.0180, available online at http://www.idealibrary.com on
A LONGITUDINAL CASE STUDY OF
PROFITABILITY REPORTING IN A BANK
CHRISTINE HELLIAR, IAN COBB AND JOHN INNES
University of Dundee
This project involved a seven-year longitudinal case study of a Bank monitoring
over time the changes in profit measurement and overhead allocation, product
group profitability, benchmarking, customer profitability, budgeting and profitabil-
ity/performance measures such as return on risk adjusted capital. The overall finding
is that the Bank’s profitability reporting (particularly its product group and customer
profitability) changed considerably during this seven-year period. The main factors that
accountants and managers identified as influencing such changes were four external
factors and two internal factors. The four external factors were changes in technol-
ogy (computers and telecommunications), regulatory change, increasingly competitive
global markets and a greater difficulty in attracting customers. The two internal factors
were the development of new products leading to a wider product range and a chang-
ing management accounting culture. The historical and organizational context of the
Bank was also critical in this process of change, and a dynamic contingency model
is proposed. This longitudinal case study indicates that more changes are occurring
in management accounting practices (such as profitability reporting) than the current
evidence from questionnaire surveys and ‘snapshot’ case studies reveals. An area for
future research that this study highlights is that although accountants and managers
talk in terms of long-term planning and control, the norm is short-term management
accounting solutions and managerial reaction to new external developments.
 2002 Elsevier Science Ltd. All rights reserved.
INTRODUCTION
Since the 1980s many studies have been conducted that examine the
various features of management accounting systems (MAS) in organizations
(Ferreira & Merchant, 1992; Shields, 1997). Some of these studies examine
We are grateful to the accountants and managers in the bank for all their time and assistance during
this seven-year research project. We would also like to acknowledge all the helpful comments of
participants at the Management Accounting Research Group Conference, the Scottish Accounting
Group Conference, the British Accounting Association Conference, colleagues at the University of
Dundee and the useful comments of two anonymous referees.
Please address all correspondence to: Christine Helliar Department of Accountancy and Business
Finance University of Dundee DUNDEE DD1 4HN
Received September 1998; revised July 1999 and May 2000; accepted November 2001
0890–8389/02/$—See front matter  2002 Elsevier Science Ltd. All rights reserved.

28 C. HELLIAR ET AL.
certain features of a MAS such as the budgeting or costing system, while
others look at the adoption of new management accounting practices such
as Activity-Based Costing (ABC) or the change in practices brought about
by the adoption of JIT. Some studies have been in the form of case studies,
in which researchers have visited a number of sites and interviewed several
people in different functions and at different levels of the organization. Other
studies have used a questionnaire survey method. Most of these studies have
identified the features of the MAS at a single point in time and have not
followed the development of the systems over time.
Generally, these studies have found that change is fairly infrequent, very
hard to implement and that new systems and practices that are implemented
often do not succeed as well as expected. For example, Drury & Tayles
(1995, p. 276), referring to their 1993 survey of management accounting
practices in UK manufacturing firms, found that:
‘Apart from the implementation of ABC by 4% of the organisations and
the greater use of non-financial measures, the responses suggested that most
of the organisations have not made any significant changes. Similar findings
were reported in the UK, USA and Sweden.’
This finding was based on a questionnaire survey that was undertaken
at a single point in time. However, studies conducted over a longer period
of time may reveal findings that are different from those conducted over
a relatively short period. A case study conducted over a number of years
allows the researcher to stand back and look at the cumulative effect of
changes over a period, rather than focusing on one or two changes that
often seem to be unsuccessful (Cobb et al., 1995).
This study of changes in a bank’s profitability reporting uses a longitudinal
case study research method (Yin, 1994) where the aims of the research are
both exploratory and explanatory (Scapens, 1990). In the management
accounting literature, there have been very few longitudinal cases (although
Friedman & Lyne, 1999 is a notable exception) that have allowed researchers
to monitor changes over time rather than rely on the memories of
participants.
Many studies have been conducted looking at the process of change
in organizations (Bruns, 1987; Dent, 1987; Hertenstein, 1987). Factors
that have been related to organizational change include technology, the
environment, the organizational structure, intensity of competition, pricing
policies, marketing or product mix (Woodward, 1965; Thompson, 1967;
Leifer & Huber, 1977; Waterhouse & Tiessen, 1978; Otley, 1980; Merchant,
1984; Jones, 1985; Fisher, 1995). In this study, the researchers did not have
any preconceived hypotheses about change factors, and any factors that
seemed to relate to change were to be derived inductively from the study
and not from a priori hypotheses. However, exposure to the contingency
literature undoubtedly sensitized the researchers to such change factors, and
this may possibly have influenced the findings. A quasi-grounded theory

PROFITABILITY REPORTING IN A BANK 29
approach was adopted, but without the formal detailed coding and analysis
that ‘pure’ grounded theory implies.
Over the last two decades there has been a great deal of research into
the management accounting practices of industrial organizations. However,
management accounting practices in the service sector in general, or the
financial services sector in particular—especially in banks—have been largely
ignored (see, e.g. Drury, 1994). This paper therefore not only promotes the
advantages of longitudinal research but also goes some way to rectify the
dearth of studies in the banking industry.
The paper is structured as follows. A short discussion of the case
study method is followed by a summary of banking processes and a
discussion of the Bank’s costs. Changes in the Bank’s profitability reporting
between 1989 and 1996 are then discussed under a number of headings:
profit measurement and overhead allocation, product group profitability,
benchmarking, customer profitability, profitability budgeting and return on
risk adjusted capital. The factors influencing these changes in the Bank’s
management accounting practices are analysed, and a dynamic contingency
model is proposed and finally conclusions drawn.
RESEARCH METHOD
The case study reported here examines the changes in a Bank’s profitability
reporting over a period of seven years with particular emphasis on its
cost allocation process. The longitudinal nature of the case allowed the
researchers to observe change without relying solely upon the memories
of organizational staff or upon staff who had only recently been appointed
to their jobs. The project started with the Bank’s decision to implement
ABC. The study therefore started with the ‘expectation’ (Lee, 1997) that
the management accounting practices would change and the focus was to
identify any factors that influenced any changes that were made. When the
case started, it was not envisaged that it would last for as long as seven
years. However, as the case unfolded, the focus switched from ABC to the
changes in the Bank’s profitability reporting, and the opportunity was taken
to examine the factors influencing such changes.
This case study used many data sources, such as the Bank’s internal
documentation including confidential budgets and more than 60 reports.
There were a number of day-visits by at least two individuals at the
beginning of the case to familiarize the researchers with the organization
and its management accounting system. Thereafter, the case study involved
regular full-day visits by at least two of the researchers about every six
months. Over the seven years of the case, 10 visits were made (although
visits were more irregular at the beginning and end of the case) and interviews
were conducted with both accountants and managers. These regular visits
enabled the researchers to observe any changes in the operations of the

Bank. Telephone calls, which lasted for about 30 minutes each, were made
on a conference phone by all three researchers to the Financial Controller
between visits. During the visits a semi-structured interview approach was
adopted, supplemented by open-ended discussions on topics raised both
by the interviewers and the interviewees. During these interviews and
phone discussions, one researcher concentrated on the interviewing and the
others on taking notes. These notes were written up and discussed by all
three researchers within a few days of the interview or phone discussion.
Summaries of the findings (including a draft of this article) were submitted
to the Financial Controller for his comments.
A SUMMARY OF BANKING PROCESSES
The Bank differs from a retail bank (Fitzgerald et al., 1991) in that it deals
with other banks and corporate clients in financial products, such as foreign
exchange, and does not have an extensive branch network. The main activity
of the Bank is to act as an intermediary between its clients and the financial
markets for a wide range of financial products.
The activities of the Bank are similar to those of other investment banks.
In particular, the Bank is one of the top-ranked institutions for foreign
exchange–related deals and these comprise a large part of its business.
It is common practice in the banking industry for revenue to be used
as a measure of activity where trades are valued in millions of pounds
and sales revenue tends to be large. The foreign exchange market turns
over nearly one trillion Dollars per day, and roughly one-third of this is
traded in London (Bank of England Quarterly Bulletin, 1995). The Bank’s
conversion process is that of intermediation between its corporate clients and
the financial markets, and its processes are classified into two groupings,
the front office (the dealing room) and the back office. The front office
(shown in Figure 1) designs and sells the Bank’s products. The dealers (also
known as the traders or market makers) design financial products (such as
foreign exchange forward contracts and interest rate swaps) by the use of
sophisticated telecommunications and computer systems that link them to
the financial markets.
Products are sold by the sales team in the front office to the Bank’s
clients, such as multinational companies. The sales team respond to calls
from their clients and also contact clients to promote the Bank’s products.
A client may deal with one sales person in the Bank for a whole range
of products. Transactions between clients and the Bank, and between the
Bank and financial markets, are normally referred to as deals or trades, and
most of these deals are conducted by telephone. Those who deal with the
Bank, whether corporate clients or other financial institutions, are known as
counterparties.

Figure 1. Front Office Intermediation process
Once a deal has been agreed by the dealer or sales person, either a sales
ticket is created or the details are input directly into the Bank’s computer
system by the dealer. The back office is responsible for the inspection,
delivery and payment functions, known as trade confirmation, delivery
and settlement. The back office communicates with the counterparty and
confirms all the details of the trade, such as price, total amount and date of
settlement, before the deal is due to be settled. The settlement date is the
day when the terms of a deal are actually carried out, such as exchanging
US dollars for pounds.
Market prices, such as exchange rates and interest rates, are determined
by market conditions and involve many factors such as the relative economic
fundamentals of countries, the levels of interest rates and inflation rates,
general market sentiment, the actions of central banks and governments
and the businesses of multinational companies. Prices move constantly
and fluctuations can be significant, and are an inherent feature of the
Bank’s markets. However, it is not the absolute selling prices that are of
importance to the Bank so much as the volatility of prices and the spread
between the bid and offer price. Dealers quote a bid and offer price,
and the difference between the two, the spread, is the dealer’s profit.1
However, both bid and offer prices change constantly and the spread itself

may also fluctuate. Thus, dealers earn profits for the Bank by their ability
to anticipate price movements and to move quickly as market sentiment
changes.
THE BANK’S COSTS
Front office costs
The activity of the dealers and sales staff is driven by the number of
deals or trades, not their value. Trading volumes can be very volatile and
are subject to the vagaries of interventions by Governments and Central
Banks, the activities of speculators, and general ‘market sentiment’. For
example, on ‘Black Wednesday’ in September 1992, the United Kingdom
left the Exchange Rate Mechanism (ERM) and the Bank of England
spent over $160 billion trying to stabilize the pound. In normal trading
conditions, daily market volumes may vary and the exchange rate itself
may change, for example, sterling dropped from a rate of $1Ð94 in
August 1992 to $1Ð52 in November 1992 (The Treasurer’s Handbook,
1993). Thus, dealer and sales staff activity is driven by the volume of
deals, but cost incidence is in terms of the number of staff, and the
front office labour cost is a step function of deal volume. In 1989, when
the study was initiated, these front office costs were treated as overhead
costs.
Technology costs for the Bank exhibit a behaviour that is similar to
staff costs. Software and hardware are continually upgraded to state-of-
the-art levels as the computer industry develops better and more advanced
products. Some financial products would not exist without the use of
sophisticated IT equipment. Many of the markets require sophisticated
pricing programs; many banks price options using updated versions
of the original 1973 model of Black and Scholes. In addition to its
own hardware and software, the front office of the Bank hires market
information services from Reuters and Bloomberg, using terminals for
which there is an annual charge. The number of terminals and other
computers is dependent on the number of dealers that in turn is a
step function of the volume of deals. Thus, IT costs for the Bank
have a fixed element together with a deal-volume-related step function
component.
The other costs of the front office include light and power and occupancy
costs, although a City of London location means that for the Bank the
latter costs are high. In general, the front office costs of the Bank are
not directly variable with throughput volume; most of the costs exhibit
deal-volume-related step functions. For example, no matter how many
hours staff work, they do not get paid any overtime. However, their
contribution to the Bank will be reflected in the annual bonuses paid
after the year-end.

Back office costs
The Bank classifies its back office costs as indirect, even though the back
office activities are a necessary part of the completion of any particular
transaction and the work of the back office is directly related to the processing
of products. The conventional use of the term ‘indirect’ is to classify those
costs that cannot be directly identified with a cost object. However, in the
Bank, the back office costs can be identified with specific deals and hence
specific products, although the administrative overhead involved in such
an allocation process is often not justified. The functions of confirmation
and settlement are mainly transaction orientated and are driven by deal
volumes. For each deal a similar procedure has to be conducted, and trading
volumes therefore directly affect back office activity. These unpredictable
deal volumes cause a problem for back office capacity planning. As with the
front office, most of these back office costs are step functions of deal volume.
However, there are two costs that vary directly with the volume of deals,
namely, the cost of SWIFT (an electronic global communication network
comparable to Electronic Data Interchange (EDI) for relaying data) and
facsimile costs incurred in arranging the settlement of transactions.
CHANGES IN PROFITABILITY REPORTING 1989–1996
The above sections highlighted some of the key features of the Bank’s costs
and processes. These features are now discussed in the context of the Bank’s
profitability reporting and the changes that occurred over the seven-year
period of this study.
Profit measurement and overhead allocation
One of the major reasons for overhead allocation in many business
organizations is the need to value stock. However, it is a securities industry
convention that the stocks, or ‘own account’ positions, of banks are always
held at market value, or the amount that could currently be obtained
in the market. Thus, the Bank, in common with its securities industry
counterparts, did not need a costing system for stock valuation purposes,
and this, combined with relatively easy trading conditions, meant that the
Bank had rarely considered its costs at all prior to the mid-1980s. In
1989, the Bank simply analysed its overhead costs by broad ‘general ledger’
categories such as payroll costs, rent and IT costs. Monthly statements
with a profit and loss account and balance sheet were produced, mainly for
financial accounting and regulatory reporting purposes. However, in 1991,
the Bank installed a new computer system (not related to the new dealing
room mentioned later) so that the Bank could monitor daily profit and loss
reports to monitor each day’s trading and to enhance the risk reporting of
the Bank’s activities.

Also, in 1991 the Bank developed a budget using, for the first time, an
overhead allocation ‘methodology’, an overview of which is given in Figure 2
in which front office costs for each product group were traced directly to
the product groups. This was an important change. Back office or service
costs were also traced to product groups using about 20 different bases or
drivers, some of which are shown in Figure 2.
Figure 2. Overhead allocation methodology

In the Bank, many of the activities were human paced, though driven
by a variety of factors. This variety was reflected in the types of allocation
methods used that ranged from the relatively arbitrary, such as revenue,
to the very specific, such as the number of reports prepared on particular
products. These bases gave the Bank’s system an ABC ‘feel’. ABC had been
discussed at various times in the Bank, moving from a high priority to a low
priority depending on the current strategy of the Bank, which changed fairly
frequently (see Cobb et al., 1995). The overhead costing system in 1996
was ‘quasi-ABC’.
In summary, the important changes to profit measurement and overhead
allocation over this seven-year period were:
1. Daily profit and loss account
2. Front office costs traced directly to product groups
3. Back office costs allocated to product groups on the basis of 20 ‘cost
drivers’
This new cost allocation methodology also led to the reporting of product
group profitability within the Bank.
Product group profitability
The allocation of overheads and the consequent determination of product
profitability has been the focus of a large body of research including
Zimmerman (1979), Kaplan (1984), Cooper (1990), Shank & Govindarajan
(1988) and Innes & Mitchell (1993). Drury & Tayles (1995 p. 268),
suggest that:
‘it is apparent from all of the surveys that full costs are widely used for
decision-making’.
Most organizations have divisions or subsidiaries responsible for different
product lines and the management accounting system produces tailored
reports for these product areas. The Bank also had separate departments
responsible for different product lines, but did not have a management
accounting system that reflected this structure. There were two main product
groups in the Bank; foreign exchange products and interest rate products,
but within these two categories there was an increasing plethora of sub-
product types. At the beginning of this study product specifications were
not available in the Bank and thus no attempt was made at detailed product
costing or capacity planning. Until the late 1980s, the Bank had little
awareness of, or apparent concern for, costs of products or product groups
and, therefore, had not been concerned about such cost classifications, and
variable or incremental costs were not identified at all for decision-making
purposes. However, they were increasingly used in the 1990s; new reports
were introduced and distributed to middle- and lower-level managers to raise
cost awareness within the Bank (as noted by a number of the interviewees).

The new overhead allocation methodology was an important step in the
development of product-type profitability reporting in the Bank. From
1991 the Bank began to prepare departmental budgets for sub-product
group profitability. Reports on actual product group profitability were also
produced on a monthly basis with comparisons against the budget.
At the beginning of the study, departmental managers responsible for a
product group either did not receive a copy of the monthly statements or did
not find the monthly management reports very informative. However, when
the new product group profitability reports were produced, the management
accountants started to visit the product group managers to explain and
discuss these reports. This was a conscious result of a new management
culture that was being introduced (see later), recognizing that accountants
should become part of the management team and be able to discuss their
respective businesses with dealers. The managers began to take a very real
interest in the management reports, to understand them and even suggested
changes to the format, and these reports enabled the managers to assess
their performance against other departments. This detailed analysis of the
Bank’s costs further enabled it to participate in a benchmarking survey
starting in late 1991.
Benchmarking
The Bank is a service provider and in such industries it is not normally
possible to buy a competitor’s products and strip them down to determine
the production processes and resource consumption involved. The Bank
therefore participated in a benchmarking exercise in 1991, organized by
an accountancy firm. This involved about a dozen banks, and gave some
indication of how the Bank’s cost structure compared with that of other
banks in the industry. This benchmarking exercise raised a number of
questions for the Bank’s managers and it was considered sufficiently
worthwhile for the Bank to participate in an annual benchmarking exercise
throughout the remaining case study period.
Customer profitability
The new overhead allocation methodology introduced in 1991 enabled the
Bank to assess product group profitability but it was not until 1995 when
a new matrix structure was announced that the Bank began to analyse
customer profitability. The matrix structure analysed profit by product
group and by customer type within geographical areas and at group level.
Figure 3 gives a simplified version of the matrix report to illustrate the
analysis by product group and customer. The actual matrix report was
more complex with both more product groups and more customer groups.
The consolidation of this report at Group level highlighted the key profit-
producing areas and those areas that needed to be reviewed. The matrix

Figure
3.
Group
Matrix
Report

structure was complex as individual customers frequently dealt with not only
the many different product groups within the Bank but also with the other
subsidiary companies of the Group around the world. Thus a consolidation
on a worldwide level was required to assess which customers were important
on a global basis. This was essential, as a customer might be a loss leader to
one division but earn considerable profits for the Group on other activities.
The new reporting structure enabled management to identify loss leaders
and to review them in the light of profits earned by other parts of the Group.
The Risk Manager stated:
‘We are now focusing on products and customers. The Bank has further
down the road to go to look at the split of the functional compared with
the geographical business—the matrix structure. . . On the matrix report each
column represents a product group and the rows represent customer types such
as local corporates, multinationals, global corporates etc. Global corporates
are MNCs where we deal with them at a minimum of 3 points of contact.
The group is managed at a total level. There is a head of treasury, personal
banking and each of the product groups and there are also managers of each
customer category. We look at the contribution of each to the group, although
it’s easier said than done. . . The matrix reporting is good for motivation. . .
Wages and salaries, IT costs etc are included if they are specific to that area.
Any shared function is treated as a support cost. We have therefore come full
circle. . . Thus there is functional [product group] management, geographical
management and customer management—a three dimensional structure. As a
result. . . there will be a much greater demand for information’.
For example, the head of the foreign exchange product group became
concerned with the loss leaders:
‘My area does a lot of good for the rest of the Bank. Inter-group deals—some
are loss leaders. We should increase the margin or spread if loss leaders don’t
bring in other benefits’.
However, there was still some way to go as the head of operations clarified
‘some individual products are loss leaders—but we don’t know which they
are!’ As the case study was ending, the Bank had just endeavoured to try
and formulate a coherent policy on this issue of individual product types
(such as £/$ exchange), although it was satisfied with its information on
product groups (such as foreign exchange or interest rate products).
Profitability budgeting
The Bank had a research department of economists, obtained market
intelligence and subscribed to various information services that were used
for budgetary purposes. However, formal market research or statistical
forecasts were not obtained and the subjective estimates of staff were used
for forecasting sales. In 1989, the profitability budgeting process in the
Bank was completely ‘top-down’ with budget holders having no say in
the final budget. The departmental managers did not see the budget, had

no idea about the profitability of their part of the Bank and received no
information about their budgeted or actual costs. The only information
that departmental managers received in 1989 was on their market share
and gross revenues. The interviews with both management accountants and
managers confirmed that by the end of the seven-year case the budgeting
process had changed to a mixture of top-down and bottom-up involving
departmental managers, top management and management accountants. By
1996, the departmental managers received detailed departmental budgets
(including costs and profitability) that distinguished between controllable
and non-controllable costs at the departmental level. It was essentially a
process of negotiation where budget holders were allowed to influence the
setting of the budget. As one manager said towards the end of the study,
‘I feel committed to achieving my budget. I have been fully consulted and
view it as my budget’.
In 1994, the Bank introduced its Budgeted Product Program comparable
with a new product launch proposal in other organizations. The Product
Program was used to assess a proposed new product, with details of how the
product was put together, the trading limits and stop loss limits2
applicable
to the product, risk components for counterparty limits and country limits,
the potential customer base, the confirmation and settlement procedures,
the tax implications and a detailed schedule showing all the accounting
entries on trade date and settlement date. The expectation was that these
Product Programs would also be written for existing products, but this had
not happened when the study terminated in 1996.
In summary, the important changes in the profitability budgeting process
from 1989 to 1996 were as follows:
1. From top-down budgeting in 1989 to a combination of bottom-up and
top-down negotiation.
2. From no profitability budget reports for departmental managers in 1989
to budgeted profitability reports distinguishing between controllable and
non-controllable costs for departmental managers.
3. From no detailed budgets for new products in 1989 to Budgeted Product
Programs for new products.
Return on risk-adjusted capital
Some of the most important performance indicators used by organizations
today are return on capital employed and target profit (Drury et al., 1993). In
the Bank these indicators were not used prior to the 1990s when market share
was the only important performance indicator regularly reported. However,
in response to its changing environment, the Bank began to introduce
profitability performance indicators during the 1990s. By far the most
important of these was the return on risk-adjusted capital, which calculated
the risk that was incurred in generating the profit of each product group.

The calculations were very detailed, but essentially recognized that riskier
business should earn a higher return than less risky business. Depending
upon the type of business, the capital was given a weighting of anywhere
between 0% and 100%. Thus a lower-risk business might attract a 20%
weighting so that if the unadjusted return had been 5%, the risk-adjusted
return would be 25%. A risky business with a 100% weighting offering a 5%
return would have a risk adjusted return of only 5%. Thus, it was not the
simple return that was important, but the return adjusted for the risk that had
been taken. In other industries, product profitability was generally viewed in
absolute terms and the risks taken to achieve those profits were apparently
rarely considered at that time. In the Bank the management of risk was of
major concern to top management and, therefore, an indicator of the risks
taken to generate the profit of various product groups was considered to be
a key performance measure.
The Bank’s interest in the risk-adjusted return was evidenced by the head
of strategic foreign exchange who argued that:
‘The bottom line is the prime measure [of dealers’ performance] but this
has to be compared to the risk in the markets and a risk weighted return is an
important measure. The success criteria is the return to shareholders. Thus a
gross return for an operation has to be adjusted for risk and tax’.
The assessment of risk and the risk-adjusted return is perhaps one area
where other industries might be able to learn from the Bank. For example,
the earnings on sales to some developing countries may be required to show
a higher return for the greater risk taken than sales to the United States of
America, or alternatively, revenue from long-term contracts may require a
higher return than those of short-term contracts.
Summary of changes 1989–1996
The Bank had dramatically changed its profitability reporting over the seven-
year period 1989 to 1996 (Table 1). In 1989, it had virtually no management
information or detailed profitability reporting. By 1996 it had developed a
daily profit and loss account, an overhead allocation methodology (quasi-
ABC system), product group profitability, annual benchmarking, customer
profitability, a profitability matrix reporting structure, a participatory
budget-setting process with managers receiving budgeted profitability
reports and a return on risk-adjusted capital performance measure. During
this period of change, the Bank faced a very significant increase in
competition and also experienced several key changes to both management
and management accountants (Cobb et al., 1995). It is these external
and internal changes and their impact on the cost and management
accounting system of the Bank that will be explored in the following
two sections.

TABLE 1
Summary of profitability reporting changes from 1989 to 1996
Topic 1989 1996
Daily P & L No Yes
Overhead allocation:
Front office costs No allocation Traced directly to product groups
Back office costs No allocation About 20 different bases including
volume, revenue, headcount and
time (quasi-ABC)
Product group profitability No Matrix analysis of profitability by
product group
Benchmarking No Comparison with 12 other banks on
annual basis
Customer profitability No Matrix analysis of profitability by
customer type
Budget setting Completely
‘Top-Down’
Mixture of ‘Bottom-Up’ and
‘Top-Down’
Budgeted departmental
profitability reports
No Controllable and non-controllable costs
separated in departmental budgeted
Budgets for new products No Product programs in use
Profitability performance
measures
No Return on risk-adjusted capital
EXTERNAL FACTORS INFLUENCING CHANGES
Research that adopts a contingency theory approach attempts to demon-
strate a match between factors specific to the organization and the design of
the organization’s management accounting system (Otley, 1980). Although
this study did not attempt to quantify any specific groups of contingent
variables, it sought to examine whether accountants and managers consid-
ered that certain variables might have affected changes in the profitability
reporting system of the Bank. Thus, these factors were derived inductively
from the study and not from a priori hypotheses. Interviews with both
accountants and managers suggested that the profitability reporting system
in the Bank had been affected by changes in technology, including comput-
ers and telecommunications, regulatory change, increasingly competitive
global markets and a greater difficulty in attracting customers.
Changes in technology
The effect of technology on organizational features has been known to
influence the structure of organizations (Woodward, 1965; Thompson,
1967) and Levich (1989) had argued that the advances in computing
and technology had led to a dramatic fall in the cost of gathering,
storing, analysing and transmitting information. The Bank was dependent

on developments in technology (computers and telecommunications) in
enabling new products to be developed and in lowering costs, but these
technological developments also increased competition. This increase in
competition in itself resulted in an even greater demand for higher levels
of technical development, resulting in an ever-upward spiral. Sophisticated
computer-based technology was used by the Bank for pricing (such as option
pricing programs), processing deals, monitoring positions, calculating risks
and providing analytic tools such as chartist trend analysis and historical
spread profiles. Many of these products would not have existed without such
advanced technology. During the course of this case study, a number of new
IT systems were implemented including a new dealing room system costing
millions of pounds. Thus, the Bank appeared receptive to new technologies.
The head of foreign exchange stated that:
‘To some extent the systems are being held up because the company is now
thinking globally on IT, trying to move away from the current situation of five
different systems being used.’
Another manager stated that:
‘Justification for the new dealing room is that the dealers said that they were
losing a lot of opportunities because the technology was so old.’
The new dealing room, with all its latest technology, was planned to
enhance the Bank’s competitiveness and attract customers, but at the same
time it was designed to provide data that enabled a better analysis of costs,
performance measurement and control. Changes in technology also affected
the Bank’s profitability reporting system indirectly through a widening of
the Bank’s product range that contributed to the need for a more complex
matrix profitability reporting system.
Regulatory change
In the 1980s, the Bank for International Settlements (BIS) and the Central
Banks became worried about the potential illiquidity and insolvency of
banks. This led, in 1988, to the introduction of the Basle Capital Adequacy
ratio requirement that attempted to strengthen banks’ balance sheets by
requiring them to maintain at least 8% of their asset value as core capital,
of which at least half had to be Tier 1, such as equity. The calculation of
the asset side of the balance sheet depended on the nature of the asset and
formulae were set by the BIS on the basis of their assessment of the riskiness
of the asset. For example, commercial loans had a 100% weighting, but
residential mortgages had a much lower risk weighting of only 50%.
This regulatory change led the Bank to change its internal profitability
reporting and it introduced its return on risk-adjusted capital performance
measure. However, during the 1990s this performance measure further
developed and the Risk Manager referred to the risk appraisal project with
which he was involved in 1996:

‘Banks have normally assessed risk in a way which satisfies the regulatory
requirements such as the Capital Adequacy Guidelines. This project is
considering the measurement of the riskiness of the Bank’s relationships
with all parties. A set of statistical techniques is being developed from portfolio
theory. A number of specialist staff are working on this project.’
Regulatory change also had an indirect influence on the Bank’s
profitability reporting. The indirect influence was that regulations were
relaxed to allow foreign banks to establish subsidiaries in most OECD
countries leading to increased competition for this Bank.
Increasingly competitive global markets
In his study of contingency theory, Jones (1985) considered both exter-
nal and internal variables. One of the external variables was competi-
tion—similar to the competitive strategy variable noted by Fisher (1995).
The Bank considered its business environment to be very competitive with
decreasing barriers to entry (Bank of England Quarterly Bulletin, 1992;
Bank of England quarterly Bulletin, 1993).
The very competitive nature of the banking industry may be partly
explained by the nature of banking product life cycles. In the banking
industry, there is virtually no product obsolescence because although there
is a great deal of financial innovation, new products often complement rather
than displace existing products. A new product may give the Bank a market
niche for a while, but competitors will soon introduce similar products, and
the market will expand. The nature of this product life cycle means that
there is intense competition in many of the Bank’s product markets. For
example, when the head of the strategic foreign exchange department was
asked what he saw as the main pressure on the Bank he replied:
‘A more competitive environment, with pressure on margins and the need
to introduce more new products more frequently. Fifteen years ago a product
market’s life was 5 to 8 years, now it is only 2 to 3. There is a need to constantly
seek out new niches.’
The increase in the number of new products being launched was an
important reason for the introduction of budgeted product programs for
new products in 1994, as well as peer pressure. The cost accountant
recognized that:
‘If other banks are doing it. . . we must too. Front office should have an idea
of volume range and should share it with the back office. We need to gear up
the organisational structure to cope’.
Greater difficulty in attracting customers
Prior to the mid-1980s, the Bank, in common with the banking industry,
had been very profitable and the main focus had been on market share

and sales revenue, not on the profitability of individual customers. Because
banks do not have sales ledgers, as all transactions are cash on delivery,
the Bank did not even know the total business conducted worldwide
with each of its multinational clients. During the 1980s and the 1990s
with the increased difficulty in attracting customers, the Bank became
more customer-focused and had much more contact with its customers,
and this influenced the development of the Bank’s profitability reporting
system. As discussed above, it developed a matrix analysis of profitability by
customers and product types, which enabled it to target specific customers
in the 1990s. This accords with Leifer & Huber (1977) who found an
association between an organization’s structure, the perceived uncertainty
of its environment and the frequency of its boundary-spanning activity,
where the greater the contact with those outside the organization, the more
the organization adapted to outside influences.
INTERNAL FACTORS INFLUENCING CHANGES
In addition to the above external factors that influenced developments in
the Bank’s profitability reporting system, interviews with both accountants
and managers also suggested that the Bank’s profitability reporting system
had been affected by the development of new products (leading to a wider
product range) and a change in the management accounting culture within
the Bank.
Widening product range
In response to the increasingly competitive environment and IT devel-
opments, in the mid-1980s the Bank began to develop and market new
products such as interest rate and currency swaps (Helliar, 1997). As the
Bank’s product range widened, costs increased, profit margins suffered and
product profitability became an issue, whereby overhead allocation and
charging service costs to products became problematic. The development
of new products was one of the driving forces behind the introduction of
product group profitability information for managers and the introduction
of budgeted product programs for new products.
Changing management accounting culture
Another contingent variable identified by Jones (1985) was the culture
within an organization. During the study, the culture of the Bank
changed and, in particular, the management accountants in the Bank
became proactive, involving themselves in the new dealing room project
and visiting other departments to discuss and explain the format and
content of the profitability reports to managers. The accountants had

become more involved in the management of the business with, for
example, the financial controller becoming part of the decision-making
management team. At the start of the case study the Bank’s staff
did not appear to function as a team and the management did not
appear to have generated a corporate culture. The Financial Controller
commented:
‘The management has never been a team—it’s really a collection of
individuals. There is a lot of friction between. . . and. . .it’s all personal
experience. If different people had been brought in, different things would
have happened. These individuals and personalities have had a behavioural
impact.’
Some years later in the case, the same accountant was explaining about
a post audit of a value-for-money review. The purpose of the review had
been to:
‘Look at the business at a high level—not a VFM exercise again-and ask
whether they have achieved what they set out to do, how well, and ask what
is still outstanding and why. They also looked at whether the culture of the
organisation had changed. To see if culture had changed is difficult. They
[senior management] therefore asked whether the culture they found was what
they would expect in a forward looking organisation.’
The exercise demonstrated that the culture of the Bank in 1989 was not
one that reflected a forward, outgoing organization and top management
began to make changes to bring about a change. For example, at
the beginning of the case the Bank started to recruit accountants and
managers from outside the banking sector and this influenced the significant
changes that occurred to the profitability reporting of the Bank. The
financial controller had worked in a motoring organization and senior
managers were being recruited from sectors as diverse as supermarkets
and the Civil Service. This resonated with the findings of Hoskin &
Macve (1988) who noted that developments in certain organizations in
the United States in the nineteenth century could be traced back to
the recruitment of key personnel who had all trained at an outside
organization—West Point military academy. In the Bank, the hiring of
key people from outside the industry brought a different perspective and
influenced the change in profitability reporting that was occurring in the
organization.
The changing management accounting culture was evidenced by a
willingness to participate in the annual benchmarking survey and to change
the budgeting system. In general, the change in culture resulted in a change
in emphasis from financial accounting and reporting in 1989 to management
accounting and management control in 1996. The changes in the Bank’s
profitability reporting in relation to these four external and two internal
contingent variables are summarized in Table 2.

TABLE 2
Profitability reporting changes and contingent variables
Profitability reporting
change
External variables Internal variables
Daily P & L Changes in technology
Overhead allocation Increasingly competitive global
markets
Product group profitability Changes in technology Widening product range
Increasingly competitive global
markets
Benchmarking Increasingly competitive global
markets
Changing management
accounting culture
Customer profitability Changes in technology
Increasingly competitive global
markets
Difficulty in attracting customers
Budget setting Changing management
accounting culture
Budgeted departmental
Changing management
accounting culture
Budgets for new products Difficulty in attracting customers Widening product range
Profitability performance
measures
Regulatory change
A PROPOSED DYNAMIC CONTINGENCY MODEL
Our interviews with accountants and managers identified the above four
external and two internal factors that influenced changes in the profitability
reporting system of the Bank. However, a further dimension that emerged
from the interviews was the historical and organizational context of the
Bank as a critical factor in the process of change. The historical and socio-
economic development of the Bank, and the banking industry, has generally
been different from that of other organizations and may help to explain why
the Bank’s profitability reporting system had developed differently from
other industries and, in particular, why the Bank’s systems showed a surge
of development in the 1990s.
Historical and organizational context
Accounting historians have explored the development of cost accounting,
standard costing and budgeting in various organizations (Solomons, 1968;
De Roover, 1968; Miller & O’Leary, 1987; Mepham, 1988; Hoskin &
Macve, 1988; Hoong, 1989; Hopper & Armstrong, 1991; Fleischman
et al., 1995). From these studies it appears that a management accounting
system’s historical, social and organizational contexts are major influences

on its design. Hopwood (1987, p. 230) suggested that accounting could
create:
‘residues of organisational consequences that can change the preconditions
for subsequent organisational change’.
Hopper & Armstrong (1991) claimed that:
‘management accounting history neglected to explore the important linkages
between phases of accounting development and their socio-economic context’.
Contemporary cost accounting and cost management practices in many
industries today can be traced back to the second half of the nineteenth
century and the early part of the twentieth century (Solomons, 1968;
Miller & O’Leary, 1987). There is, however, evidence of much earlier
developments in cost accounting that were not generally adopted at that
time (De Roover, 1968; Mepham, 1988; Hoong, 1989). Solomons (1968)
suggests that the main impetus to developments in the nineteenth century
was the increase in competition, such as in the engineering industry in the
second half of the nineteenth century. At that time sales prices were based
on cost estimates, and the increased competition in the industry resulted in
a need to improve the accuracy of cost estimates upon which the tendered
prices were to be based. In their study of the development of uniform
costing in the UK printing industry in the early part of the twentieth century,
Mitchell & Walker (1997, p. 97) reported that ‘. . . the market environment
was prominent as the contingency underlying costing development’. They
suggested that problems such as poor financial performance resulting from
competitive market conditions could ‘quickly stimulate cost accounting
changes’ (p. 98).
Solomons (1968) also identified that industry in the nineteenth century
experienced an increase in the scale, complexity and capital intensity of
business, and this resulted in additional overhead costs. The banking
industry did not experience such factors to the same extent in the
nineteenth century. It was only in the 1980s that the Bank experienced more
competition and increasingly complex products as the burgeoning advances
in technology led to global markets for a multiplicity of financial products.
Fleischman et al. (1995) in their historical analysis of cost accounting
developments in the United States and United Kingdom analysed the
response to the change in conditions that faced companies in the nineteenth
century. They claimed that the major emphasis was on technological
efficiency and costs, and concluded that this was an appropriate response
for companies to make. The Bank, a century later, also appeared to adopt
this route and focused on cost cutting and technological developments.
In other organizations, standard costing and individual product profitabil-
ity play a major role, but these were absent from the Bank. The development
of standard costing in the early decades of the twentieth century was heav-
ily influenced by industrial engineering and the ‘scientific management’

movement (Solomons (1968), p. 36–37). At this time engineers became
heavily involved in designing and developing production processes within
organizations. Financial engineering did not develop in the banking industry
until the 1980s (Finnerty, 1988) when so-called ‘rocket scientists’ became
involved in designing and developing new products. However, even today,
the Bank has yet to subject its processes to the same degree of analysis
as has been common in other industries for decades. In 1996, the Bank
had budgeted product programs for new products but still did not have
individual product profitability information.
Dynamic contingency approach
Figure 4 summarizes a number of factors that appear to have influenced
the changes observed in the design and operation of the Bank’s profitability
reporting system over a seven-year period. The four external and two
internal contingent factors are developed from Table 2. The four external
contingent variables were (i) changes in technology, (ii) regulatory change,
(iii) increasingly competitive global markets and (iv) the difficulty in
attracting customers, and the two internal variables were (i) a widening
product range and (ii) a changing management accounting culture. These
all created pressures for change on the existing profitability reporting system
that had developed in the historical and organizational context specific
to the Bank. The ‘dotted’ lines in the model emphazise the suggestion
that the factors have influenced, not determined, the design of the Bank’s
profitability reporting system. This influence would have been moderated by
a number of factors, in particular, the historical and organizational context
of the Bank.
Figure 4 gives an indication of the complexity of the situation but does
not convey the dynamic nature of the situation. After the first three years
of this case study, an interesting finding began to emerge; although the
accountants and managers talked in terms of planning and controlling,
the reality was that they were reacting to external developments and
trying to cope with a very complex and dynamic situation. This finding
emerged because of the longitudinal nature of this case study and can be
illustrated by examining the reason why this case first started in 1989. The
Bank was planning to implement an activity-based costing system but its
implementation was delayed year after year because of other developments,
and by 1996, when the case ended, only a quasi-activity-based system had
been implemented, not through formal planning, but by a reactive approach
to various developments, with more and different overhead allocation bases
being used. This reactive approach applied to most of the changes that
occurred in the profitability reporting. Table 2 shows the links between
the profitability reporting changes and the four external and two internal
contingent variables in Figure 4.

Figure 4. Factors influencing the Bank’s profitability reporting system
During the second year of this case, it was thought that the Bank was
just going through a very unusual period of change. However, by the
seventh year it had become clear, not only to the researchers but also to
the accountants and managers in the Bank, that this state of change and
uncertainty coupled with dynamic complexity was the norm rather than the
exception. Obviously this is only one case study and it may be that the seven-
year period of this case was unusual or that this Bank had certain features
peculiar to it. However, an interesting hypothesis suitable for testing in other

organizations is whether accountants and managers talk in terms of planning
and controlling but in reality are reacting to new external developments and
trying to survive through a very complex and changing situation. Managers
make decisions on the basis of management accounting information, but the
norm may be short-term accounting and managerial reaction rather than
long-term accounting and managerial planning and control.
Similarly, during the seven-year period of this case study, the profitability
reporting of the Bank has changed significantly (see Table 1). Again these
changes may reflect the relatively underdeveloped state of the Bank’s
management accounting in 1989. Certainly almost all the existing evidence
(such as Drury & Tayles, 1995) suggests that most organizations do not
make such significant changes to their management accounting practices.
However, almost all the existing evidence is either questionnaire-based or
‘snap-shot’ case studies. Another area for further research is to examine the
developments in management accounting practices over a period of several
years in other organisations. For example, the accounting personnel in
the Bank changed completely between 1989 and 1996—although some
accountants employed by the Bank in 1989 were in non-accounting
functions in 1996. When the accountants in 1996 were asked about past
changes in the profitability reporting system, they gave a very restricted
list. It is possible that more changes are actually occurring in management
accounting practices than the current evidence reveals because of the
research methods generally used.
CONCLUSION
This case study reviewed the changes in the profitability reporting in
one Bank and found that the profitability reporting of the Bank changed
considerably over the period of this study as summarized in Table 1.
During this study, four external factors emerged inductively as the key
influences on the changes that took place. The first factor was the change in
banking technology, both computers and telecommunications; the second
was regulatory change; the third was increasingly global competitive markets
and the fourth was the difficulty in attracting customers. Two internal
factors were also key to influencing the changes in the profitability reporting
system; the development of new products leading to a wider product range
and the changing management accounting culture (influenced particularly
by accountants and managers from a non-banking background). These
external and internal contingent factors need to be considered in the light
of the historical and organizational context of the Bank. The influence of
these six external and internal factors on profitability reporting changes in
the Bank are summarized in Table 2 and the dynamic contingency model is
summarized in Figure 4. Similar contingent factors have also been reported
by Woodward (1965), Leifer & Huber (1977), Jones (1985) and Fisher

(1995). The pace of change in both external and internal factors increased
dramatically during the 1980s and 1990s, and this had both a direct and
indirect impact on the Bank’s need for better information about its business
processes in order to maintain its financial viability. Changes that had taken
place in the management accounting systems of other industries decades
earlier began to occur in the Bank in the 1990s and it appeared that
the Bank’s systems were converging with those of other industries. The
change in environmental uncertainty and the fact that there was increasing
contact with others outside the organization probably encouraged more
‘organicness’ in the organization that enabled the Bank to change (Leifer &
Huber, 1977).
Two areas for further research are firstly, whether short-term management
accounting and managerial reaction to new external developments are the
norm in organizations rather than long-term accounting, planning and
control. Secondly, whether more changes are occurring in management
accounting practices than the current evidence from questionnaire surveys
and ‘snapshot’ case studies reveals. One important lesson from this case
study is the usefulness of a relatively long-term longitudinal case study as
a research method. Such a longitudinal case study enables researchers to
gain a longer-term picture of the organization than many of the current staff
in an organization would have. This view enables researchers to consider
change in a longer-term context. In particular, a longitudinal case study
allows researchers to ask about plans at a point in time and then follow
them through over a period to investigate what actually happens. In our
case study such plans were generally either not fulfilled or delayed. It would
be difficult to have such a finding without using a longitudinal case study as
the research method.
NOTES
1. The dealer quotes a price to buy and a price to sell products. The difference between the
buy and sell price is known as the spread.
2. A dealer must close a position (reduce it to zero) once a certain loss threshold has been
reached.
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