Health Care Activity Based Costing and Cost Accounting

Activity-based costing also referred to as ABC is an accounting method that identifies and assigns costs to overhead activities and then assigns those costs to products. Health Care Activity Based Costing is when a healthcare organization accounting system recognizes the relationship between it’s costs. This includes its, overhead activities (such as utility), and manufactured products. By identifying this relationship, it assigns indirect costs to products that are less arbitrary than traditional methods

Activity Based Costing

The Charter Institute of Management Accountants defines activity based accounting as,

“an approach to the costing and monitoring of activities which involves tracing resource consumption and costing final outputs, resources assigned to activities, and activities to cost objects based on consumption estimates. The latter utilize cost drivers to attach activity costs to outputs.”

Activity based costing accumulates the overhead costs  from each department and assigns them to specific cost objects like services, customers, or products. The way these costs are assigned to cost objects are first decided in an activity analysis, where appropriate output measures are cost drivers. As a result, activity based costing tends to be much more accurate and helpful when it comes to helping managers understand the cost and profitability of their company’s specific services or products. Accountants using activity based costing will pass out a survey to employees who will then account for the amount of time they spend on different tasks. This gives management a better idea of where their time and money is being spent.

Cost Accounting

Cost accounting is another common method of accounting that also allocates overhead costs to products. The method of cost accounting is different from the method of activity based costing but the pretty much achieve the same thing.

Cost accounting examines the cost structure of a business by collecting information about the costs incurred by the activities carried out by the company. It assigns selected costs to products and services and other cost objects and evaluates the efficiency of cost usage.

Cost accounting is mostly concerned with developing an understanding of where a company earns and loses money, and providing input into decisions to generate profits in the future. It does so by collecting information about the costs incurred by a company’s activities,  assigning selected costs to products and services and other cost objects, and evaluating the efficiency of cost usage.

The Key activities of Cost Accounting are:

  • Defining costs as direct materials, direct labor, fixed overhead, variable overhead, and period costs
  • Assisting the engineering and procurement departments in generating standard costs, if a company uses a standard costing system
  • Using an allocation methodology to assign all costs except period costs to products and services and other cost objects
  • Defining the transfer prices at which components and parts are sold from one subsidiary of a parent company to another subsidiary
  • Examining costs incurred in relation to activities conducted, to see if the company is using its resources effectively
  • Highlighting any changes in the trend of various costs incurred
  • Analyzing costs that will change as the result of a business decision
  • Evaluating the need for capital expenditures
  • Building a budget model that forecasts changes in costs based on expected activity levels
  • Determining whether costs can be reduced
  • Providing cost reports to management, so they can better operate the business
  • Participating in the calculation of costs that will be required to manufacture a new product design
  • Analyzing the system of production to understand where bottlenecks are positioned, and how they impact the throughput generated by the entire manufacturing system

The History of Cost Accounting

Many scholars attest that cost accounting was first developed during the industrial revolution. The emerging economics of industrial supply and demand caused manufacturers to start tracking whether to decrease the price of their overstocked goods or decrease the quantity they produced.  By the beginning of the 20th century, cost accounting had become a widely covered topic in the literature of business management.

The Different Types of Cost Accounting

Standard Cost Accounting

Standard cost accounting uses ratios to compare efficient uses of labor and materials that are used to produce goods or services under shared and standard conditions. In standard cost accounting, this difference are assessed through a process called variance analysis.

Traditional cost accounting essentially allocates cost based on one measure, labor or machine hours.  Allocating overhead cost as an overall cost has generally ended up with misleading insights because overhead cost rises in proportion to labor costs.

This kind of accounting is not necessarily the best choice for modern companies especially in the age of technological advancements. Some of the issues associated with cost accounting is that this type of accounting emphasizes labor efficiency despite the fact that it makes up a comparatively small amount of the costs for modern companies.

Lean Accounting

Lean accounting is part of the philosophy of lean manufacturing which is widely practiced. Lean manufacturing is a concept that was developed by japanese companies in the 1980s.

Instead of using standard costing, activity based costing, cost-plus pricing, or other management accounting systems, when using lean accounting those methods are replaced by value-based pricing and lean-focused performance measurements. Most accounting practices for manufacturing work off the assumption that whatever is being produced is done in a large scale.

Marginal Costing

Marginal costing is a simplified model of cost accounting. It is sometimes referred to as the cost-volume-profit analysis.Marginal costing is an analysis of the relationship between a product’s or service’s sales price, the volume of sales, the amount produced, expenses, costs, and profits. That specific relationship is called the contribution margin. The contribution margin is calculated by dividing revenue minus variable cost by revenue. This type of analysis can be used by management to gain insight on potential profits as impacted by changing costs, what types of sales prices to establish, and types of marketing campaigns.