12.2.3 Management Ledger Profitability Models

The starting point for most Management Ledger-level profitability solutions is the Financial Accounting data that you import from your General Ledger system. A number of different processes are generally performed to manipulate your initial Financial Accounting data to produce Management Accounting results.

Management Ledger-level models often involve both “top-down” and “bottom-up” kinds of processes. In the Management Ledger context, top-down processes are typically composed of series of allocation rules that operate in a cascading or “waterfall” sequence that begins with your Financial Accounting data.

For example, in constructing Organizational profitability within a Management Ledger, your design might begin with an analysis in which you subdivide all of your Organizational Units (or Responsibility Centers) into either Cost Centers or Profit Centers. Cost Center managers are responsible for managing their expenses and meeting their budgets while Profit Center managers have P & L responsibility. While your General Ledger may support independent P & L's for Divisions, Regions, Lines of Business, or Companies, your objective in a top-down Organizational Profitability solution is to push P & L responsibility down to much lower levels: branches, loan origination centers, an so on.

You might continue your analysis by organizing your Cost Centers into functional groups such as Overhead, Indirect Support, and Direct Support. You might then devise a series of allocation rules that allocate Indirect Support expenses to Direct Support cost centers which in turn allocate their (burdened) expenses to Profit Centers. You might finish by allocating Overhead expenses directly to Profit Centers. In some cases, you might also need to allocate some non-interest revenues. Since interest income and interest expense are typically booked to Profit Centers within your General Ledger, it is less likely that you will need to allocate these balances.

You also might wish to build some balance sheet allocations to move non-financial assets & liabilities (such as cash, fixed assets, goodwill, and equity) to the Profit Centers that rely upon those non-financial assets & liabilities to support their businesses. The rationale here is that you generally want to transfer price the entire balance sheet, not just instrument-level balances. As with your instrument balances, these non-financial balances will generate transfer pricing charges & credits, and these secondary transfer pricing charges & credits need to be assigned to the proper Profit Centers.

Frequently, Management Ledger implementations focus on both Organizational Profitability and Product Profitability. Typically, these kinds of implementation will first complete the Organizational Profitability component and then continue with additional allocation rules to develop Product Profitability. Product Profitability is normally developed using both top-down and bottom-up methods.

The above narrative is meant to be illustrative; there are an enormous variety of methodologies you might choose from in constructing Management Ledger-level models for Organizational Profitability, Product Profitability, or multi-dimensional profitability incorporating additional dimensions.

As mentioned above, Management Ledger-level models typically involve both “top-down” and “bottom-up” kinds of processes. One kind of bottom-up process is matched term funds transfer pricing. In matched term funds transfer pricing, every instrument asset record is assigned a “cost of funds used” and every instrument liability record is assigned a “credit for funds provided”. These instrument-level charges and credits (expenses and revenues) are subsequently aggregated to the Management Ledger. In implementations where activity-based costs (and sometimes revenues) are assigned to each instrument-level record, these charges and credits may also be aggregated to the Management Ledger level.