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ABC, it’s easy as 123
Katie Collins takes you on a step-by-step journey through the world of activity based costing – a topic you really must know
Management accounting is discretionary for the UK’s organisations, yet most feel the need to employ techniques in order to survive. The costing area of management accounting is one that appears to be an old-school technique, one that is hard to conceptualise. This article focuses on this area and with particular reference to activity based costing, better known as ABC.
Traditional management accounting scenarios have used widgets as examples, but who really knows what a widget is? Costing isn’t only employed by manufacturing organisations and, in the 21st century, many service-based organisations also use activity-based costing to work out how much to charge for their services.
The NHS, for example, would work out the cost of an inpatient stay for someone with a broken leg or the cost of an initial consultation with a doctor, particularly vital within today’s cash-strapped NHS.
If we think about the terminology that is seen within costing studies and think about applying it to the NHS, we get the example here.
1) Identify the major activities: This first step would look at what the organisation does. In the case of the NHS, we could have a look at the major costs – ward costs, drugs, central office costs, staff costs, theatre time. The list is endless. The costing accountant would need to decide which of the activities will be the major ones.
2) Group the activities into cost pools: Cost pools are a holding pot for the costs. Think of this where the accounts payable team will be coding all of the costs into these major activities. For example, Ward One in the hospital will have costs such as nurses, porters, laundry, etc. All of these will be grouped together and coded for that particular ward. For example, the cost of Ward One is £200,000 a week.
3) Identify the cost drivers: Cost drivers are the activities that cause the cost to happen. For staff time it could be the number of beds within their ward or average patient appointment time. For example, Ward One has 20 beds.
4) Work out the cost driver rate: This would involve working out the amount per driver to charge back to an individual patient.This could be done for Ward One as the amount per day that a patient spends. This would involve taking the total cost pool and dividing it by the total drivers to give you an amount. Taking Ward One this would mean £200,000/20, giving a cost of £10,000 per bed per week, or by dividing it by seven this would give £1,428.57 a day.
5) Charge the cost drivers back to a patient: This could be based on their length of stay in each area or the amount of resource they consume. Patient XYZ spends three days in Ward One, meaning that they would incur costs of (£1,428.57 x 3) £4,285.71.
This would give the cost of a patient that could be used for budgeting and pricing purposes. Within the NHS, tariffs are set for payment from Clinical Commissioning Groups, who allocate funding on behalf of the government. Costing and budgeting is vital in today’s environment as the NHS needs to become increasingly more competitive. Getting these tariffs and pricing principles correct will be a fundamental job of the costing and management accountants.
I’m hoping this has helped to give some context to ABC. ABC is not an old-school costing technique – it is a useful one to help with accurate costing and pricing.
Although it will take time and effort, the advantages will far outweigh the disadvantages and will help with accurate decision making. Once a few examples have been worked through, the principles will become easier. If you don’t believe me, take a note from the Jackson 5. “ABC, it’s as easy as 1,2,3....”
• Katie Collins is a tutor with Kaplan Financial
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