Cost Accounting

Cost Accounting

Introduction

·       Cost accounting measures, records, analyzes and reports costs of products/services to help management plan, control and make decisions.

·       In hospitals it identifies costs of patient care activities (inpatient days, surgeries, lab tests), support services, and overheads.

Purpose (hospital):

• Determine cost per bed-day, per surgery, per lab test.
• Control costs (identify waste, improve efficiency).
• Set prices/fee schedules and negotiate with insurers/GOI schemes.
• Budgeting, performance measurement and investment decisions.

Example: Calculating cost per inpatient day to set bed charges or to compare with peer hospitals.

Exam tip: Start with definition → objectives (control, pricing, decision-making) → hospital examples.

Procedure of Cost Accounting (step-by-step)

1. Define objective (e.g., compute unit cost of inpatient day).
2. Identify and classify cost centers (wards, OT, lab, admin).
3. Classify costs by element (material, labour, expenses), behavior (fixed/variable), and function (patient-care vs admin).
4. Measure & record costs (issue vouchers, stock records, time sheets).
5. Allocate/apportion overheads to cost centers.
6. Assign direct costs to services/patients where possible.
7. Accumulate costs by job/process/service.
8. Analyze & report (unit costs, variances, break-even).
9. Use for decision-making & control (budgets, reduction measures).

Example (hospital): To cost a surgery: identify direct consumables (sutures, implants), direct labour (surgeon, anaesthetist), and allocated overheads (OT depreciation, sterilization, housekeeping allocation).

Pitfall: Poor record-keeping (missing consumption data) → wrong unit costs.

Analysis of Cost (ways to break costs down)

• By element: Material, Labour, Expenses.
• By function: Patient care (wards), Diagnostic (labs), Administrative.
• By behavior: Fixed, Variable, Semi-variable.
• By identifiability: Direct (traceable) vs Indirect (needs allocation).
• By time: Historical (actual), Standard (predetermined), Budgeted.

Hospital example: Medicines = variable direct material; nursing salaries = fixed direct labour for ward; electricity = semi-variable overhead.

Overheads

Definition: Indirect costs that cannot be directly charged fully to a single product/service.

Classifications:

• By function: Production (ward), Administrative, Selling, Service.
• By behavior: Fixed (depreciation), Variable (utility bills to some extent), Semi-variable (maintenance).

Allocation methods: Simple proportional apportionment, basis of allocation (floor area, staff numbers, machine hours), step-down, reciprocal.

Worked allocation example (simple proportion by area):
Housekeeping overhead = ₹200,000. Areas: Ward 600 m², Lab 200 m², Admin 200 m² (total 1000 m²).
Ward allocation = 200,000 × (600 / 1000) = ₹120,000.
Lab = ₹40,000. Admin = ₹40,000.
(120,000 + 40,000 + 40,000 = 200,000)

Pitfall: Choosing wrong allocation base (e.g., allocating nursing salary by floor area—use nursing hours instead).

Computation of Unit Cost

Definition: Unit cost = total cost attributable to a unit of output.

General formula:

Unit cost=Total cost (direct + allocated overheads)Number of units of output\text{Unit cost} = \frac{\text{Total cost (direct + allocated overheads)}}{\text{Number of units of output}}

Hospital approaches:

• Service costing (unit/service costing): for ward bed-day, lab test, OP visit.
• Job costing: for a specific complex surgery or transplant.
• Process costing: rarely used but can apply to continuous services.

Worked example (inpatient day):
Total monthly cost = ₹1,250,000; inpatient days in month = 5,000.
Unit cost = 1,250,000 ÷ 5,000 = ₹250 per inpatient day.

(Computation shown: 1250000 ÷ 5000 = 250)

Pitfall: Mixing volumes (using billed cases rather than actual service units).

Departmentalization (Cost Centers)

Concept: Break organisation into cost centres (wards, OT, lab, radiology, kitchen, admin) for better control and allocation.

Types:

• Production/patient-care centres: Wards, OT, ICU.
• Service/support centres: Housekeeping, Sterilization, Laundry.
• Administrative centres: Accounts, HR.

Benefits:

• Responsibility & accountability.
• Easier allocation and control.
• Basis for performance measurement (cost per bed-day per ward).

Example: If ICU is a cost centre, direct nurse salaries in ICU are charged there; sterilization overhead is apportioned to ICU based on instrument usage.

Cost Assignment vs Cost Allocation

• Cost assignment (direct tracing): Putting costs straight to a unit — e.g., implant cost charged to that surgery/patient.
• Cost allocation (apportionment): Distributing indirect costs across multiple units — e.g., admin salaries split across wards based on staffing headcount.

Tip: Wherever possible use direct tracing; only allocate what cannot be traced.

Cost Allocation — Methods & Example

Common methods:

1. Direct method: Service costs directly allocated to production centres; ignores inter-service support.
2. Step-down (sequential) method: Allocates service centre costs to other centres in sequence (partially recognizes inter-service).
3. Reciprocal method: Fully recognizes mutual services using simultaneous equations (most accurate).

Reciprocal method example:
Service A initial cost = ₹100,000; Service B initial cost = ₹50,000.
A supplies 20% of its service to B; B supplies 10% to A. Set equations:

A_cost = 100,000 + 0.10 × B_cost
B_cost = 50,000 + 0.20 × A_cost

Solving gives (approx):
A_cost ≈ ₹107,142.86; B_cost ≈ ₹71,428.57.

(These are the true service centre costs after recognizing mutual servicing.)

Pitfall: Reciprocal method is accurate but computationally heavier.

Measuring Hospital Output

Common measures:

• Inpatient days (bed-days) — basic volume metric.
• Admissions / Discharges.
• Average Length of Stay (ALOS) = total inpatient days / discharges.
• Outpatient visits.
• Surgeries / Procedures.
• Adjusted patient days — combines inpatient + outpatient workload to compare resources use.

Adjusted patient days example (conceptual):
Adjusted patient days = (Total inpatient revenue + total outpatient revenue) ÷ (Average revenue per inpatient day).
Use for allocating overheads across inpatient & outpatient services.

Also useful: Case-mix index, DRG-weighted outputs (for advanced costing and payment systems).

Standard Time (setting time standards)

Purpose: For labour costing, budgeting, staffing and efficiency measurement.

Steps to set standard time:

1. Time study or work measurement (observed time).
2. Apply performance rating → obtain normal time.
3. Add allowances (personal, fatigue, delays) → standard time.

Formula:

Normal time=Observed time×Performance rating

Standard time=Normal time×(1+Allowances)

Worked example:
Observed time = 30 minutes; performance rating = 1.10; allowances = 15% (0.15).
Normal time = 30 × 1.10 = 33.0 minutes.
Standard time = 33.0 × 1.15 = 37.95 minutes (≈ 38 min).

(Computation shown: normal = 30 × 1.1 = 33; standard = 33 × 1.15 = 37.95)

Pitfall: Using unrealistic ratings or ignoring allowance types.

Cost Behaviour

Categories:

• Fixed costs: Don’t change with short-term volume (depreciation, salaried staff).
• Variable costs: Change with activity (drugs, disposable supplies).
• Semi-variable/mixed: Part fixed, part variable (electricity with fixed minimum + usage charge).
• Step costs: Fixed over ranges, increase at steps (adding another full-time nurse when workload crosses threshold).

Concept of relevant range: Behaviour assumptions hold only within certain activity levels.

Hospital examples:

• Fixed: Building depreciation.
• Variable:medicines per patient.
• Semi-variable: Maintenance contract + repairs.

Implication for decision-making: Short term decisions often focus on variable costs and contribution margin.

Types of Cost (detailed)

• Direct vs Indirect: Traceable vs not traceable.
• Prime cost: Direct material + direct labour.
• Conversion cost: Direct labour + manufacturing overhead.
• Fixed/Variable/Semi-variable: (see above).
• Controllable/Uncontrollable: Manager’s ability to influence.
• Sunk cost: Past cost, not relevant for future decisions.
• Opportunity cost: Value of next best alternative foregone.
• Marginal cost: Cost of producing one additional unit.

Hospital examples:

• Sunk: Purchase of obsolete equipment.
• Opportunity: Using a room for dialysis vs renting it out.

Break-even Analysis (Cost-Volume-Profit)

Key formulas (single product/unit):

• Contribution per unit = Selling price − Variable cost.
• Break-even units = Fixed cost ÷ Contribution per unit.
• Break-even revenue = Break-even units × Selling price.
• Margin of Safety = (Actual sales − BE sales) / Actual sales.

Worked example:
Fixed cost = ₹100,000; Price per patient day = ₹400; Variable cost per day = ₹150.
Contribution = 400 − 150 = ₹250 per day.
Break-even units = 100,000 ÷ 250 = 400 patient days.
Break-even revenue = 400 × 400 = ₹160,000.
If actual = 600 patient days → Margin of safety = (600 − 400) ÷ 600 = 200 ÷ 600 = 33.33%.

(Computations shown stepwise: contribution 400−150=250; BE units 100000÷250=400; BE revenue 400×400=160000; MOS% 200/600100 = 33.33%.)*

Pitfalls: Multiple products need weighted contributions; costs must be separated reliably.

Cost Accumulation (Systems)

• Job costing: Costs collected per job/case (e.g., a transplant).
• Process costing: For continuous homogeneous services (less common in hospitals).
• Service costing: Most hospital departments use service costing (ward-day cost, test cost).
• Actual costing: Uses actual rates & quantities.
• Standard costing: Uses pre-set standards for planning/control.

Tip: Use job costing for high-cost episodic treatments (e.g., CABG), service costing for routine services.

Standard Cost Accounting & Variance Analysis

Standard costing: Set standard (expected) costs for materials, labour and overhead. Then analyze variances between actual and standard.

Basic variances (examples):

• Material price (rate) variance = (Actual price − Standard price) × Actual quantity.
• Material usage (quantity) variance = (Actual qty − Standard qty) × Standard price.
• Labour rate variance = (Actual rate − Standard rate) × Actual hours.
• Labour efficiency variance = (Actual hours − Standard hours) × Standard rate.
• Overhead (spending/volume) variances.

Worked labour variance example:
Standard time per patient day = 2 hours; number of patient days = 500 → Standard hours = 2 × 500 = 1000 hrs.
Actual hours worked = 1100 hrs; Standard rate = ₹200/hr; Actual rate = ₹210/hr.
Labour rate variance = (210 − 200) × 1100 = ₹10 × 1100 = ₹11,000 (Unfavourable).
Labour efficiency variance = (1100 − 1000) × 200 = 100 × 200 = ₹20,000 (Unfavourable).

(Interpretation: pay rate higher than standard and more hours used than standard → both unfavourable.)

Pitfall: Overemphasis on minor variances; always investigate root cause (mix, absenteeism, inefficiency).

Effective Use of Resources (practical)

• Capacity planning & utilization: beds, OT slots, diagnostic machines.
• Staffing & skill mix: right number of nurses, technicians per shift.
• Scheduling: block scheduling for ORs, appointment systems for OPD to reduce waiting.
• Inventory management: ABC classification, reorder levels, safety stock.
• Preventive maintenance: reduce downtime of diagnostic equipment.
• Lean and process improvement: reduce non-value activities, shorten patient flow cycles.

Example: Optimize OR schedule by grouping similar cases to reduce set-up time and increase cases per session.

Cost Reduction (methods & examples)

Methods:

• Activity-based costing (ABC): find high-cost activities and redesign them.
• Bulk purchasing & centralized procurement: lower per-unit price on consumables.
• Standard treatment protocols: reduce unnecessary tests/treatments.
• Reduce length of stay (where clinically safe): faster discharge planning.
• Energy efficiency: LED lights, efficient HVAC, timer controls.
• Waste reduction: rationalize just-in-time supplies.

Example: Introducing a clinical pathway for uncomplicated deliveries reduces average length of stay and resource use.

Limiting Factor (Constraint) & Decision Rule

Concept: When a resource (OR hours, ICU beds, specialized staff) is scarce, choose services with highest contribution per unit of the scarce resource.

Worked example (OR hours limiting):
Surgery A: Contribution ₹1,000, OR time 2 hours → Contribution per OR hour = 1,000 / 2 = ₹500/hr.
Surgery B: Contribution ₹1,200, OR time 4 hours → Contribution per OR hour = 1,200 / 4 = ₹300/hr.
With 100 OR hours:

• If all A: 100 ÷ 2 = 50 cases → Contribution = 50 × 1,000 = ₹50,000.
• If all B: 100 ÷ 4 = 25 cases → Contribution = 25 × 1,200 = ₹30,000.
  Choose A because it gives higher contribution per scarce hour.

(Shows how to use contribution per constraint to prioritize.)

Video Description

·        Don’t forget to do these things if you get benefitted from this article

·        Visit our Let’s contribute page https://keedainformation.blogspot.com/p/lets-contribute.html

·        Follow our page

·        Like & comment on our post

·