Table of Contents

Executive Summary .................................................................................... 2

Key Terms ............................................................................................... 3

Introduction ............................................................................................ 5

Background Research .................................................................................. 6

Objectives .............................................................................................. 9

Importance of Health Care Costing ............................................................... 10

Costing Problem in Health Care Industry ......................................................... 11

Setting Up a Costing System in Health Care Industry ........................................... 12

Various Methods Used In Health Care Costing ................................................... 13

Suggestions ........................................................................................... 15

Limitation ............................................................................................. 16

Learning from Project ............................................................................... 17

Conclusion ............................................................................................ 18

References ............................................................................................ 19

Appendix 1: Cost Sheet ............................................................................. 20

Appendix 2: Illustration 1 ........................................................................... 21

Appendix 3: Illustration 2 ........................................................................... 23

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Key Terms

1. Cost:
CIMA defines Cost as the amount of expenditure incurred or attributed on a given thing.
More simply, it can be defined as that which is given or scarified to obtain something.

2. Costing:
Costing is defined as the technique and process of ascertaining cost. Thus, costing means
such an analysis of information as to enable management to know the cost of producing
and selling, i.e. the total cost of various products and services. And, also to know how the
total cost is constituted.

3. Cost Accounting:
The process of accounting for cost from the point at which expenditure is incurred or
committed to establishment of its ultimate relationship with Cost Centres and Cost Units.
It is a formal mechanism by means of which costs of products or services are ascertained
and controlled. It is concerned with accumulation, classification, analysis and
interpretation of cost data for three major purposes-
a. Ascertainment of Cost
b. Operational Planning & Control
c. Decision Making

4. Cost Centres:
According to CIMA, Cost Centre means a location, person or item of equipment (or group
of these) for which costs may be ascertained and used for the purpose of cost control.
Thus, cost centre refers to one of the convenient units into which the whole factory or an
organization has been appropriately divided for costing purposes.

Cost Centres may be classified as follows-

i. Production Cost Centres Engaged in manufacturing or processing the products
(Assembly Area).
ii. Service Cost Centres Aids and provides services to other cost centres (Canteen).
iii. Mixed Cost Centres Sometimes produce and sometimes provide services (Tool
Shop).
iv. Personal & Impersonal Cost Centres Impersonal cost centres consists of
departments, plants or an item of equipment. Whereas, personal cost centres
consists of people.
v. Operation Cost Centres Cost centres which consists of machines or people
carrying out same operations.
vi. Process Cost Centres Cost centres which consists of a continuous sequence of
operations.

5. Cost Unit:
While preparing cost accounts, it becomes necessary to select a unit with which
expenditure may be identified. The quantity upon which cost can be conveniently
allocated is called cost unit. CIMA defines cost unit as a unit of quantity of product,
service or time in relation to which costs may be ascertained.

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 Unit selected must be unambiguous, simple and commonly used. Examples-
a. Brick Work : per 1000 bricks made
b. Transport Companies : per passenger km
c. Textile Mills : per yard of cloth manufactured or yarn spun
d. Electricity Companies : per unit of electricity generated

6. Cost Control:
It is the practice of identifying and reducing business expenses to increase profits, and it
starts with the budgeting process. A business owner compares actual results to the budget
expectations, and if actual costs are higher than planned, management takes action.

7. Cost Accountancy:
CIMA has defined Cost Accountancy as the application of costing and Cost Accounting
principles, methods and techniques to the science, art and practice of cost and the
ascertainment of profitability. It includes the presentation of information derived there
from for the purpose of management decision-making.
Cost Accountancy is, thus the science, art and the practice of cost accountant.

Introduction
Beware of little expenses. A small leak will sink a great ship - Benjamin Franklin.

Last few decades has seen a rapid growth in the service sector. Though secondary sector is the
lifeline for the economic growth of a country and it is the largest and fastest growing sector
globally today. The real reason for the growth of the secondary sector is due to the increase in
the demand for intermediate and final consumer services. Availability of quality services is vital
for the well-being of the economy. The growth in the secondary sectors is directly dependent on
the growth of services like banking, insurance, trade, commerce, entertainment, social, personal,
etc.

The increasing importance (dependence) of service industry had led to the emergence of Service
Costing whereas the rapid growth in this industry as led to shifting from traditional methods of
costing to modern methods of costing.

The best care at the cheapest cost is a challenge to hospitals over the past few decades. The
rising cost of healthcare is a globally pressing concern. This makes detailed attention to the way
in which costing is carried out of central importance. This report discusses about various terms
related to costing, overview of service costing, costing in health care industry and why it is
necessary to shift from traditional methods of costing to modern methods of costing.

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Background Research
1. Service Costing

Service sector companies provide their customers with services or intangible products. The
activities of service sector may be used for both

a. Services to outside customers

b. Services to other departments within the organization.

The types of services provided, by service sector are of diverse nature and have their own
peculiarities and requirements in respect of the cost accounting treatment, however, the
general principles of costing relating to manufacturing sector also apply to service sector.

Characteristics of Service Sector

a. Labour Intensive: Due to its inherent nature, the activities of service sector are
generally labour intensive. The direct material cost is either small or non-existent.
The labour cost (i.e. salary and wages) constitutes a significant portion of the total
operating costs of a service sector entity. For example, cost of stationary used by a
consultant is negligible or non-existent if the advice is given orally. Whereas, the
direct labour cost (consultation fee of the consultant) constitutes a significant
portion of the total operating cost as compared to material cost.

b. Cost Unit is difficult to define: The selection of cost unit for service sector is
relatively difficult to ascertain as compared to the selection of cost unit for
manufacturing sector.

External Customer Cost Unit

a. Hotel Bed Nights Available/Occupied

b. School Student Hours, Full Time Students

c. Hospital Patient per Day, Room per Day

d. Accounting Firm Client Hour

Internal Services Cost Unit

a. Staff Canteen Meals Provided, No. of Employees

b. Machine Maintenance Machine Hours Provided

c. Computer Department Computer Times (Hours Used)

c. Product cost in service sector: Costs are classified as product costs or period costs
in manufacturing sector for various reasons. The only difference between
manufacturing and service sector is that in service sector all the products are
intangible, products cannot be stored, assembled and valued. Services are rendered
and not stored. Therefore in this sector for computing the cost unit, labour cost is

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 of most significance. In addition to labour cost, there are overheads incurred which
shall be appropriately allocated or apportioned.

Collection of Costing Data-

Costs are accumulated under various heads for control purposes and decision making.
Costs thus, collected are usually grouped as fixed and variable costs. The format of
preparing cost data is based on the nature of business and the requirement of the
management. The cost units used are mostly composite like per passenger per km. For
preparation of cost sheets, costs are accumulated for a specific period month, quarter,
yearly, etc.

Since there is no direct relation between the costs and level of services, there is a
tendency in service sector to view all the costs as overheads. And in such a situation cost
control is almost negligible. Thus, arises the need of modern costing techniques like
Activity Based Costing.

Costing Methods Used-

Commonly used methods of costing in service sector are stated below:

a. Job Costing Method

b. Process Costing Method
c. Hybrid Costing Method
d. Traditional or Product Costing
e. Recently companies are adopting Marginal Costing, Activity Based Costing and
Time Driven Activity Based Costing.

2. Costing in Health Care Industry

Modern day hospitals provide a variety of services to patients under one roof. It is akin to
a large service organization considering the number of personnel involved and the capital-
intensive nature of the business be it the civil structures, operation theatres and
equipment, diagnostic and therapeutic equipment, resuscitation equipment, gas lines,
surgical instruments, consumables, and so on. Moreover, it is a 247 operations with
people playing a vital role in the well-being of the patients in the hospital.

There are various complexities that necessitate the hospital management to put in place
robust costing systems. However, traditional hospital managements have not given serious
thought to the same. The corporate world has adopted and benefited from good costing
systems, since the early 1930s. The same holds true of modern day corporate hospitals,
who believe in providing cost effective services to patients and ensuring patient loyalty to
the healthcare provider.

Traditionally, hospitals used bed occupancy as the yardstick of measurement of

performance. With the advancements in medical technology, the average length of stay
(ALOS) is reducing and hence, bed occupancy is not the main performance measure any
longer.

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 The increased utilization of costly resources, e.g. equipment in operating theatres, ICUs,
Cath-Lab, Pathology Lab etc. in addition to doctors times are the key to success in
hospitals.

Note:
1. Cost Centre

Patient Care
Intermediate
Overhead: These cost centres provide overhead support services to both Patient Care and
Intermediaries. E.g.: Finance, Dietetics, Security, etc.

2. Cost Unit

per bed per patient

per room per patient
customized as per services availed per patient

Objectives

1. To learn the basic terminologies and methods related to Costing.

2. To understand how costing is done in Service Sector.

3. To understand various methods of costing in Health Care Industry.

4. To study the importance of costing in Health Care Industry.

5. To study the costing problem in the Heath Care Industry.

6. To understand how is the costing system setup in the Health Care Industry.

Importance of Health Care Costing

Also the advent of health insurance companies has also queered the pitch. With the costs of
treatment going up and the privatization of the insurance industry, the hospitals are forced to
give quality service at highly competitive prices as the insurance companies will pay only for the
services that are desired and will also monitor the services that are rendered closely. This leads
to deductibles, co-payments and all claims by hospitals do not get settled hundred percent. There
is also a time element involved as costs are incurred upfront and outstanding amount is received
only after a couple of months.

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It is therefore imperative for hospitals to have a system to control the costs, while at the same
time providing high quality service to the patients.

Costing Problem in Health Care Industry

Patients undergoing treatment receive services of varied nature from different departments. The
hospital has to recover the expenses of the direct departments as also of the support
departments from the patients availing these services.

Nowadays, any composite hospital with latest facilities for advanced medical/surgical procedures
in the various areas of treatment will have nearly 50 or more revenue centres and about 10 to 15
supporting service centres. Furthermore, most of the revenue centres, particularly, in-patient
wards, will have classification depending on the level of services for different class of patients
according to their monetary or other needs. Again, each department, other than wards,
undertakes several types of procedures/operations etc.

All these make the list of procedures and classification of services quite large. It is for this reason
that ascertaining true costs of various services and fixing of the Schedule of Charges becomes
extremely complex. Costing needs to be done after careful analysis of past data, comparative
data from other hospitals, study of utilization of capacities. Costing techniques shall be applied
to provide acceptable costs and charges, enabling optimization of capacity utilization, which, in
turn, result in better overall revenues and leave adequate funds for growth and development of
newer and advanced facilities.

Various Methods Used In Health Care Costing

1. Absorption & Marginal Costing

Absorption Costing is a method of building up a full product cost which adds direct costs and a
proportion of production overhead costs by means of one or a number of overhead absorption
rates.
Marginal Costing is the accounting system in which variable costs are charged to cost units
and fixed costs of the period are written off in full against the aggregate contribution.

2. Top-Down & Bottom-Up Costing Methods

Two main methods used in health care industries are top-down and bottom-up.

Top-Down method starts with targeted overall cost which is then split further and allocated
downwards to various groups or departments.

This method essentially take the operating expenses of the hospital and seek to attribute
them to service lines, departments and eventually individual events; these are prone to error
because of assumptions made while using this approach.

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 The bottom-up approach provides a greater level of granularity than the top-down method. It
involves identifying all of the resources that are used to provide a service and assigning a
value to each of those resources. These values are summed and linked to a unit of activity to
derive a total unit cost this provides a basis for assessment of which costs can be avoided.

3. Flexi Budget

A flexible budget is a budget that adjusts or flexes for changes in the volume of activity.
The flexible budget is more sophisticated and useful than a static budget, which remains at
one amount regardless of the volume of activity.

In this industry the flexi budgets are used to provide customized services to patients and also
to for departmental budgeting.

4. Activity Based Costing

ABC involves identification of both volume sensitive and non - volume sensitive overhead cost
drivers and tracing indirect costs to each driver. This is followed by setting the percentage of
drivers consumed by each service product.

To apply ABC method generally first the hospital units were divided into three main
departments: administrative, diagnostic, and hospitalized. Second the activity centres were
defined by the activity analysis method. Third the costs of administrative activity centres
were allocated into diagnostic and operational departments based on the cost driver. And
finally with regard to the usage of cost objectives from services of activity centres, the cost
price of medical services was calculated.

Suggestions
The health care industry should shift from

1. Absorption Costing to Marginal Costing

2. Fixed Budget to Flexi Budget
3. Top-Down to Bottom-Up Approach
4. Traditional Costing to ABC
5. ABC to Time Driven TBC

Conclusion
Service Sector Costing is very crucial and so is the costing for Health Care Industry, in order to
provide best services at cheapest price.

Hospital cost information is derived by relating the inputs of resources in monetary terms to the
outputs of services provided by the hospital. Cost information is part of the basic information
needed by managers and policy makers for making decisions about how to improve the
performance of a hospital, where to allocate the resources within or among hospitals, or to
compare the performance of different hospitals to one another. Some of the basic reasons for

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wanting cost information are to improve efficiency, increase effectiveness, enhance
sustainability, and improve quality.

Lastly the methods that the industry should adopt to be Marginal Costing, ABC or Time Driven
ABC and also it should adopt to accrual based accounting.

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