How To | Costing and Managerial Accounting

The Use of ABC for Indirect Expenses

How To | Costing and Managerial Accounting

The Use of ABC for Indirect Expenses

There is a potential connection between the use of the idea of activities with respect to patient-level costing to activity-based costing (ABC) and its variant time-driven activity-based costing (TDABC).

The use of the idea of activities with respect to patient-level costing suggests a possible connection with activity-based costing (ABC) and its variant time-driven activity-based costing (TDABC). ABC traces and assigns, rather than “allocates,” indirect expenses into calculated costs based on costing’s causality principle. ABC traces costs based on “driver” quantity and volume measures that reflect how much of a work activity, employee, or equipment, was consumed by the cost objects referenced in the article. Not all expenses are direct costs. In a healthcare organization, there will be indirect support expenses that are required by the direct costs. For example, there are expenses associated with the technicians needed for maintenance of equipment (such as diagnostic medical devices and patient beds). Assigning those expenses as costs using averages (e.g., number of beds) introduces cost error. ABC more properly reflects diversity (e.g., different types of equipment or beds). In effect, ABC adds indirect costs to the direct costs while still complying with the costing causality principle. Physicians and department managers are likely to be interested only in the direct costs to patients. That is where they can focus. The addition of ABC for indirect expenses provides a more comprehensive view and opportunities to reduce indirect expenses as well.

ABC modeling enables the expenses to serve each patient to be separated from non-patient-related expenses, such as building, heating, air-conditioning, and insurance. In management accounting, non-patient-related expenses are referred to as “business sustaining costs” needed to operate a healthcare facility. Under such an approach, a patient-level cost does not include any costs that the patient did not cause. ABC also allows the behavior of each resource expense to be classified as sunk, fixed, step-fixed, or variable. These classifications are needed for the predictive future, not historical, view of costs for use in effort such as what-if scenario planning and analysis.

Some have the misperception that ABC is excessively complex and not worth the effort to implement. In reality, ABC is simply cost modeling. The misperception exists because many accountants have over-designed their ABC cost model to be more accurate than necessary. Skilled ABC designers know how to restrict the size and complexity of an ABC model to meet acceptable, or “good enough,” levels of cost accuracy. a

See related article: Patient-Level Costing and Profitability: Making It Work


Footnotes

a. For more information, see Cokins, G., and Scanlon, C. , “Measuring and Managing Patient Profitability,” hfm, April 2017. 

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