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Activity Based Costing & The NHS

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Activity Based Costing & The NHS Financial Analysis - (MN2007) Assignment 2 1. Introduction As the Management Accountant of a local NHS hospital I am going to write a report for the senior management team at the hospital that analyses the issues raised in the view attributed to Gordon Brown. It is difficult to assume which allocation approach the hospitals have used, but I am going to describe the Traditional Costing approach and the Activity Based Costing approach, which I will describe in more detail. 2. The Definition of Activity Based Costing Activity Based Costing (ABC) is a 'costing method' (Fleming & McKinstry, 1998: 216), which recognises that costs are incurred by the activities, which take place within the organisation, and for each activity a cost driver may be identified. Those costs, which are incurred or driven by the same cost drivers, are grouped together into cost pools and the cost drivers are then used as a basis for changing the costs of each activity to the product. 2.1 Cost Pools A cost pool is a collection of costs, which maybe 'charged to products' (Bendry, Hussey & West, 2001: 465) by the use of a common cost driver. Examples of costs pools are the power, material handling, material receipt, and production planning, sales administration, get-up cost and buying. 2.2 Cost Drivers A cost driver is any activity or series of activities, which take place within an organisation, which cause costs to be incurred. Costs drivers are not restricted to departments or sections, as more than one activity may be identified within a department. ...read more.


Systems for gathering information on patient admissions, theatre information and general ledger records can be inefficient to capture and report reliable and complete information for the costing exercise. The problems, which could occur, are: costs data from the general ledger could be incomplete; activity data could be inconsistent and incomplete; and measures of cost-driving activities within hospitals could rely on poor information systems. 5 Advantages and Disadvantages of activity-based costing 5.1 The main advantages of activity-based costing are as follows: * A 'more equitable method of charging costs to products' (Bendry, Hussey & West, 2001: 447) - The products that use the activities, which cause the costs to be incurred bear, those costs associated with those activities in a more equitable manner. This overcomes the drawback in absorption costing where general overheads are spread over the product range in using methods largely unrelated to the way costs are generated. * Takes into consideration product complexity - 'The costs charged to products relate to the production circumstances' (Glautier & Underdown, 2001: 525) in which those products are produced, Under ABC, short runs and complex products might attract consequently higher levels of unit cost compared to long runs and simple products. This aspect would have considerable impact, therefore, in the measurement of relative product profitability compared to the absorption costing approach. * Costs are more closely related to activity levels - Those costs, which under absorption and marginal costing approaches are traditionally regarded as fixed in total, 'may be treated as variable in the longer term under ABC' (Atrill & Mclaney, 2001:223). ...read more.


+ (�20 x 13, 000)] / 2,000 �[(�100 x 1,000) + (�20 x 12, 000)] / 1,000 (Hansen & Moven, 1995) This shows Activity Based Costing can produce considerable product costing improvements in hospitals as they experience product diversity. 8 Conclusion From a managerial perspective an ABC system offers more than just more accurate cost information. It also provides information about the cost and performance of activities and resources. Knowing the cost of activities, their importance to the organisation and how efficiently they are performed allows you to focus on those activities that might offer opportunities for cost savings. If activities are linked across departments forming 'cross-functional processes' (Fleming & McKinstry, 2001: 205), the model structure of an organisation is simplified and powerful information results. 8.1 These are the Health Business Issues - For a costing system which is not activity based: * Lack of good information * Requirement to understand costs * Requirement to satisfy ever-changing statutory information demands 8.2 The Business Benefits achieved by Activity Based Management include the following: * Identifies full costs of organisation * Identifies value-adding and non-value-adding processes and activities * Improved information to support decision making * Supports internal and external benchmarking. 8.3 It is recognised that absorption-costing systems suffer from a number of drawbacks, particularly when applied to modern service systems. The development of the activity-based costing approaches in the service sectors have gone some way to overcoming the drawbacks associated with absorption costing. 8.4 Activity Based costing is the most appropriate costing approach to use for efficient results and to reduce costs in hospitals. If adopted by all hospitals, the variables acknowledged in the views of Gordon Brown will be diminished. ...read more.

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