Costs influence the pricing decisions of any company as it aims to make a profit out of its production activities. The healthcare industry is volatile and competitive and the pricing set in the market will not be suitable for a company that does not strategically control its costs. The management of an outpatient health clinic felt the need to shift from a traditional accounting system to a modern cost accounting system known as activity based costing (ABC).
ABC in an Out-Patient Health Clinic
In traditional system of accounting, the good or service would be assigned direct and indirect costs. The fixed costs would be estimated for the different products in the company. In activity-based costing, the activities of the organization are first identified as they are the actions that influence the consumption of resources. They are known as the cost drivers. There is the cost object, which necessitates the consumption of resources. Cost objects vary depending on the nature of the company. It may be a product, an order, a customer or even a supplier. In the outpatient clinic, the cost object is the patient who requires the organization to deliver a service then he or she pays.
In implementing the activity based costing system the management had to identify its core and ancillary or support activities. The core activities were identified as patient registration, interview and physical examination, imaging study, laboratory study and diagnostic tests. Other core activities identified were performance of medical procedures, home visits, administration of vaccines and administrative activities. The support activities on the other hand included items such as human resources, information technology, marketing and financial management. Activities such as management of movable property and movable apparatus, transport and asset
and property management also formed part of the support activities (Kutcha & Zabek, 2011).
These activities that contribute to the finished product are also known as activity centres or pools. The costs of the company were divided into direct and indirect costs and assigned to the core and support activities. There were several direct costs identified in the outpatient clinic such as drugs, medical equipment, consultancy services, and stationery, banking costs, insurance and postal services. The indirect costs identified were repair and maintenance, rent, telephone, clothing and cleaning supplies.
A further analysis of the cost objects, being the clinic patients was carried out. The patient may benefit from two activities or even more activities simultaneously. The management identified fifteen kinds of cost objects. A patient may benefit from patient registration, interview and examination and administrative activities. There are yet those who will benefit from diagnostic tests and laboratory examinations. They are also those who will want registration and performance of medical procedures and imaging studies. There are children who may require vaccines and finally there are those who will combine all these activities with home visits. A cost matrix was therefore developed allocating the activity costs to the different cost objects to monitor the consumption of resources and introduce cost reduction strategies.
Benefits of ABC
The activity-based costing method had several advantages. It identifies the inefficient or useless activities carried out in the organization. All the activities and the costs incurred should contribute to the success of the strategies of the organization. Those activities that do not contribute to the identified strategic goals of an organization are non-value adding and should be eliminated (Asada, Bailes & Suzuki, 2000).
The staffs in the departments can be moved or de-ployed to other departments where they can be more productive. The management have the incentive to reduce costs and focus on the value adding activities.
The organization was able to analyse the degree and frequency in the use of resources in the organization. The costing method assisted in budgeting information. The management was able to analyse the actual and budgeted levels of consumption of resources and investigate the variances noted. The management was also able to ensure effective performance management.
The ABC method of cost analysis enables the management to see possible avenues of cost reduction while at the same time ensuring that the high quality of service offered to the patients is maintained. There is also better decision-making as the management is provided with accounting information that is specific and accurate. In traditional methods of accounting, there may be instances where there is over-costing and under-costing. The management may end up tying up its resources in one activity yet it should have been concentrating on something else. ABC costing assists management as it reduces distortion in the calculation of costs (Damitio, Hayes & Kintzele, 2000).
Managers become aware of the hidden costs in the under-costed products in traditional accounting. At the same time, the management discovers the hidden profits or the excessive costs that had been allocated to the over-costed products. For the products that had been incorrectly costed, the management can set up processes to set new prices in order to gain a competitive advantage. Another benefit of ABC costing is that the responsibility of controlling costs ceases to be delegated to the senior management only. The involvement of the staff in introducing the system
makes them have ownership of the new system. Cost reduction ceases to be only a top-down approach and actually becomes a bottom-up or section or department-specific strategy. Each and every staff is involved in identifying redundant, non-value adding activities. The employees now learn to prioritize their work, in order to increase the cost effectiveness. The management is also able to identify processes where there is a lot of idle time and how it can be utilized.
There are health organizations that have even gone a step further and introduced time driven activity-based costing systems. In this strategy, the cost drivers are analysed in terms of time equation to determine the length of time it takes to perform certain activities. The cost drivers therefore are known as time drivers (Dejnega, 2011). The method has been found to be effective in certain companies however it is not suitable for processes that require creative thinking and forethought.
In an analysis carried out in an outpatient clinic located in London, time driven activity based costing assisted the management to accrue certain advantages. The management realized the precious time consumed in communication delays and set up a new system of communication to enhance the interaction between different departments. Telephone accessibility was improved with the introduction of headsets and secretaries were centralized to one location. There were also needless activities or departments that were identified and eliminated (Demeere, Stouthuysen, Roodhooft, 2009).
Challenges of ABC
There are certain challenges of implementing activity-based costing. There is a lot of information required for the success of activity-based costing. The more complex the activity-based model, the more information that will be required from the participants. It is also a time-consuming exercise setting up the system. The participation of all the staff is required. They have to record all the details of the activities they do for the organization at their various workstations. The staffs have to be trained on how they will use the system. It consumes financial resources in its implementation.
There have been several criticisms issued against the ABC costing system by various experts and researchers. There are organizations where ABC costing has not been successful and it has actually failed through the help of managers who are afraid that the transition to the cost management system may affect their pay. The method needs a lot of staff training to overcome fear and resistance.
There are those concerned with the technical aspect of the method where it keeps demanding continuous flow of activity data. The resources consumed in generating the data may offset the benefits of adopting the costing method if the management is not watchful. The method may also cause challenges in strategic decision making. It does not distinguish challenges in business such as the impact of bottleneck or limited resources. It also assumes that in business certain events are certain however there may be discontinued costs in the future.
It has been argued that activity based costing is beneficial in causing the manager to see the great need of cost reduction. However, once this has been approved there is really no need to continue recording and accumulating complex data. The managers can now use non-financial information to make strategic decisions in cost reduction (Geri & Ronen, 2005).
Conclusion
The benefits of activity based costing are quite high and in the long-term the costs of implementation may be off-set. It is important to implement a costing system that is effective and will help the organization cut costs.
References
Asada, T., Bailes, J., & Suzuki, K. (2000). Implementing ABM with Hoshin Management
Management Accounting Quarterly, 1-6.
Damitio, J., Hayes, G., & Kintzele, P. (2000). Integrating ABC and ABM at Dow
Chemical. Management Accounting Quarterly, 22-26.
Dejnega, O. (2011). Method Time Driven Activity Based Costing
– Literature Review. Journal of Applied Economic Sciences, 15, 7- 15.
Demeere, N., Stouthuysen, K., & Roodhooft, F. (2009). Time Driven Activity Based
Costing in An Outpatient Clinic Environment: Development, relevance and managerial impact. Health Policy, 92(2), 296-304.
Geri, N. and Ronen, B. (2005) Relevance lost: the rise and fall of activity-
based costing. Human Systems Management. 24, 133-144.
