Application of Activity Based Costing in Healthcare Industries

By Vijayalakshmi.S Fourth Year MBA PTech

Activity-based costing is a costing methodology which identifies activities within an organization and assigns costs to each of the activities based on the actual consumption, which includes indirect costs into direct costs compared to conventional costing. It focuses on allocation of costs in the operational management and helps to single out the fixed cost, variable cost and the overhead cost. ABC analysis has proved to be applicable beyond the academic discussion and thus has been introduced in many companies for financing, costing and accounting purposes. In this era of intense competition, there has been a shift from standardization to customisation of products and services since price and quality have become more necessary over other characteristics. Traditional methods of costing tend to bury overhead in product costs through very general allocations. In contrast, the Activity Based Costing attempts to tie the areas of overhead to their own activity measure thus revealing all the activities contributing to cost and allowing the managers to eliminate those activities which do not add value thereby relating to the costs of the activity drivers rather than just including the fixed and variable costs. Hence ABC offers advantages over the traditional costing. Health care institutions operate in conditions of high volatility environment. The present trend has led to an increase in competitiveness of the healthcare industry, increase in the health care needs and rise of expectations of patients and payers. The basic objectives of any healthcare industry are : 1) Promoting cost efficiency 2) Maximization of resources by managing the services that it offers to its patients, 3) Highlight the opportunities for continuous improvement of operations. Situation on global markets has been changing dynamically, especially in the field of medical services. There has been a rapid increase in healthcare costs which resulted in healthcare providers facing increased pressures in providing services to their patients in a more effective and efficient manner. The traditional costing systems used by healthcare organizations failed to meet the above mentioned objectives, hence to meet these economic challenges faced by the industry and to provide low-cost high-quality services, healthcare organizations had to develop stringent control over their operations and cost accounting systems. Moreover, they had to face challenges in maintaining their revenues. This has forced the managers to constantly seek new and effective methods and management of tools. Basic knowledge of the management provides cost information but it is very important for one to apply such a costing model. Hence ABC would help hospitals in the promotion of cost-efficient operations and in the management of product and service lines.

Fig; represents the cost allocation in healthcare industry (Activity-based costing for health care
institutions; pg 305)

APPLICATION OF ABC IN HEALTHCARE INDUSTRY:

Todays healthcare sector has been implementing ABC in various of its departments. Incase of clinical decision making, the monitoring of serum levels of the antibiotic given to a patient, the various adverse reactions that might trigger and all of which contributes more cost than the antibiotic itself. On the other hand the costing procedures in ancillary departments like radiology where there is a use of advanced procedures like nuclear medicine, computer assisted tomographic scanning and magnetic resonance imagining, follow the activity based costing to enhance or optimise the operations. There are two forms for treating renal dialysis: Haemodialysis (HD) and Peritoneal dialysis (PD). HD is administered at the clinic and requires three visits a week, while PD can be administered by the patients at home and requires seven treatments per week. The problem that emerged while choosing one of these treatments was which of the two were more cost effective. By applying ABC to the dialysis clinic study it was seen that HD was twice as profitable as than PD hence the providers inclined in promoting HD over PD. ABC plays a crucial role in calculating costs more accurately thereby ensuring customer and product profitability. It evaluates and justifies the investments in new technologies and provides necessary changes that are to be brought about in the existing products quality like better product and process design.

Since it helps in managing costs and creates a cost consciousness among all the employees it has led to an increase in competitiveness in the healthcare industry. Improvement in budget plan, performance measurement, responding to increase in overheads and pressure from regulators at the same time supporting various management innovations like Total Quality Management and Just In Time, have brought about a necessity of adopting activity based costing amongst the industries. Moreover it is very much necessary for the hospitals to maintain a record of the actual unit of cost incurred in: treating a patient, the number of patients admitted, the number of patients treated by various procedures, number of tests that were conducted, number of hours of surgery etc and this could be maintained by activity based costing. STEPS INVOLVED TO IMPLEMENT ABC 1. Identifying and assessing the ABC needs which includes the determination of viabilities of ABC within the organization 2. Training requirements Trainings for all employees and workshop sessions for senior managers. 3. Defining the project scope Evaluate mission and objectives for the project. 4. Identifying activities and drivers - Determine what drives what activity. 5. Creating a cost and operational flow diagram How resources and activities are related to products and services. 6. Collecting data Collecting data which shows operational relationship. 7. Building a software model, validate and reconcile. 8. Interpreting results and preparing management reports. 9. Integrating data collection and reporting. CONCLUSION The health care costs climb and effective financial tracing is also very much essential. Cost management in healthcare thus is beneficial if costs are linked to the various care activities where they are incurred. The ABC hence provides a useful approach and can be applied to other departments in the hospital. Likewise as the ability to access to the information increases, the hospital could increase their value in the global competitive environment. Thus a cause and effect concept is introduced which improves the communication between the health oriented staffs and the management oriented administrators i.e. the people executing the activities and the ones measuring these activities would form a cooperation and also a common language. For that reason ABC goes beyond just a costing system to being a strategic management tool. Reference: West, T. D. and D. A. West. 1997. Applying ABC to healthcare. Management Accounting (February): 22, 24-26, 28-30, 32-33. The management accountant journal September 2011 Vol 46. No.9 Activity based costing in healthcare industry : 760-762 Ralph,H :Activity based costing for hospital (1994): 385-396 Cinquini L., Miolo Vitali P., Pitzalis A., Campanale C. (2009), Process view and cost management of a new surgery technique in hospital, Business Process Management, Vol. 15, No. 6, pp. 897-898.