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16/12/2025
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In the ever-evolving landscape of healthcare, where costs are skyrocketing and efficiency is paramount, understanding the true drivers of expenses can make all the difference. The cost crisis in health care has become a pressing issue, with health systems facing mounting pressures from rising expenses, regulatory demands, and the need for sustainable operations. At Young and Right, your trusted accounting and tax consultancy firm, we specialize in helping healthcare providers navigate complex financial strategies to solve the cost crisis. One such powerful tool is activity-based costing in healthcare, a method that offers unparalleled insights into resource allocation. This approach, often referred to as ABC costing, has been applied for more than 30 years to allocate costs more accurately across various industries, including the healthcare sector. In this comprehensive blog, we'll dive deep into what activity-based costing (ABC) entails, its benefits, challenges, and real-world applications, while also exploring related concepts like time-driven activity-based costing (TDABC). By empowering you with knowledge on these costing methods, we aim to help you optimize your operations, enhance cost containment, and align with value-based healthcare principles.
Activity-based costing (ABC) is a managerial accounting method that assigns costs to products, services, or activities based on the resources they consume. Unlike traditional costing systems, which often allocate overhead costs using broad averages (e.g., based on direct labor hours or machine hours), ABC identifies specific activities within an organization and traces costs more accurately to those activities. This methodology was popularized in the 1980s by researchers like Robert Kaplan and Robin Cooper, aiming to provide a more precise understanding of cost drivers in complex environments. Over the past three decades, ABC has evolved, with variations like time-driven activity-based costing emerging to address specific challenges in dynamic sectors.
In healthcare, ABC is particularly relevant due to the sector's intricate operations, involving diverse services like diagnostics, treatments, surgeries, and administrative tasks. Healthcare providers often grapple with the cost crisis in health care, including regulatory pressures from bodies like the Department of Health and Human Services, and the need for efficiency in care delivery. ABC helps reveal the true cost of care by breaking down processes into activities, such as patient intake, lab testing, or post-operative care, and assigning costs based on actual resource usage rather than simplistic averages. This costing approach focuses on every activity, ensuring that indirect costs—such as utilities, administrative overhead, or support staff—are allocated precisely. By applying ABC, organizations can identify the cost associated with each step in the patient journey, leading to more reliable cost information at the patient level.
Traditional cost accounting in healthcare typically uses volume-based allocation, such as per-patient-day or per-procedure rates. For example, overhead costs like utilities or administrative salaries might be spread evenly across all patients, leading to distortions—high-complexity cases might be undercosted, while simpler ones are overcosted. This traditional approach often relies on relative value units (RVUs) or broad metrics, which can obscure the true financial aspects of health services.
In contrast, ABC focuses on activities as the fundamental cost units, based on the activities that consume resources. It follows a two-stage process: first, identify and pool costs into activity cost pools (e.g., nursing care, radiology); second, allocate costs using cost drivers (e.g., time spent, number of tests, or patient interactions). This results in more granular insights, allowing for better cost determination and avoiding cross-subsidization. Activity-based costing and time-driven activity-based costing both enhance this by incorporating time metrics, making them ideal for comparative studies between service lines.
By adopting activity-based costing in healthcare, providers can avoid the pitfalls of traditional methods and gain a clearer picture of their financial health. Applying these cost systems, such as ABC or TDABC, enables a shift from volume-based to value-based models, where the focus is on the value of health care rather than just quantity.
Healthcare organizations adopt ABC to address challenges like cost control, value-based health care, and reimbursement pressures from insurers or governments (e.g., Medicare in the U.S., overseen by the Department of Health). Key motivations include improved pricing and reimbursement, where understanding true costs allows hospitals to negotiate better with payers and set accurate prices for services. Resource optimization is another driver; ABC identifies high-cost activities, enabling process improvements, such as reducing wait times in emergency departments, which can lead to using fewer resources overall. This approach is particularly effective for clinical costing, as it provides detailed insights into the expenses associated with direct patient care and clinical procedures.
Performance measurement is enhanced through ABC, supporting benchmarking and quality initiatives under frameworks like the Affordable Care Act. It links costs to outcomes, fostering value in health by aligning financial and clinical aspects. Strategic decision-making benefits as well, helping decide on service expansions, outsourcing, or technology investments (e.g., adopting electronic health records to streamline activities). In the broader healthcare sector, health systems face ongoing pressures, and ABC allows for robust costing that reveals costs associated with each episode of care—from initial diagnosis to discharge—making it an essential tool for precise clinical costing at the patient level.
Moreover, the application of time-driven activity-based costing (TDABC) is gaining traction as a refined costing methodology. Using time-driven activity-based costing simplifies the process by focusing on time as a universal driver, making it easier to apply in real-time scenarios. For example, in a health system dealing with chronic conditions, TDABC can quantify the time spent on patient education or monitoring, leading to more accurate cost analysis and better cost containment strategies, further enhancing clinical costing accuracy.
To provide a well-rounded perspective, this paper seeks to review previous literature on ABC and its variants. A review of the literature, including studies indexed in databases like Scopus, reveals that ABC has been a topic of interest for decades. The review includes descriptive analyses, case studies, and comparative studies that highlight how ABC can help solve the cost crisis in health care. For instance, early works from the 1990s applied ABC in manufacturing but soon extended to healthcare, showing its potential in allocating indirect costs more effectively and supporting clinical costing efforts.
More recent literature emphasizes the application of TD-ABC (time-driven activity-based costing) in value-based healthcare. Studies in journals like Health Policy and Planning discuss how ABC methods improve healthcare delivery by providing reliable cost data at the patient level, often framing it as a cornerstone of clinical costing. One comparative study found that applying ABC in outpatient settings reduced perceived costs by identifying inefficiencies in service-based activities. Another seeks to review previous literature on cost accounting in healthcare, noting that traditional systems often fail to capture the full spectrum of costs as well as ABC does, particularly in the realm of clinical costing where precise resource tracking is crucial.
Implementing ABC involves several steps, often requiring software tools like ERP systems or specialized costing software (e.g., from vendors like Health Catalyst or Strata Decision Technology). Here's a detailed breakdown:
Map out all processes in the health care system. Categories might include direct patient care (e.g., consultations, surgeries), support activities (e.g., scheduling, billing), and overhead (e.g., facility maintenance). This step ensures every activity is accounted for.
Collect data on resources like labor, materials, and equipment. This includes time studies or electronic tracking to measure activity durations, crucial for indirect costs.
Select appropriate drivers for each activity. Examples include number of patient visits for outpatient services, procedure time for surgical activities, or bed occupancy for inpatient care. For TDABC, time becomes the primary driver.
Divide total costs in each activity pool by the total driver units (e.g., cost per minute of nursing time). This creates a robust costing framework.
Apply rates to specific patients or services. For a knee replacement surgery, costs might include pre-op assessment (driven by consultation time), surgery (driven by operating room hours), and recovery (driven by nursing shifts). This patient-level assignment reveals the cost of care accurately.
Use the data for ongoing monitoring, with periodic updates to reflect changes like new regulations or technologies. Costing and time-driven activity-based costing can be integrated here for enhanced precision.
Challenges during implementation include data collection burdens, resistance from staff, and initial high setup costs. However, pilot programs in specific departments (e.g., radiology) can ease adoption. Our team at Young and Right can assist with tailored implementation strategies to minimize these hurdles, ensuring the ABC method is applied effectively.
Activity-based costing (ABC) gives a clearer picture of the true cost of care by tracing resources to specific clinical and operational activities. In healthcare, it can sharpen budgets, expose waste, and support value-based models—but it also brings data, complexity, and integration challenges. Below is a quick look at the major benefits and common drawbacks.
The benefits of activity-based costing in healthcare are substantial and multifaceted:
→ Enhanced Cost Transparency:
Reveals hidden costs, such as indirect expenses in supply chain management, leading to better budgeting and cost information.
→ Better Decision-Making:
Supports lean management by pinpointing inefficiencies, potentially reducing waste by 10-20% in some studies. ABC allows organizations to identify the cost at the lowest level, optimizing resources.
→ Improved Patient Outcomes:
By aligning costs with value, it encourages high-quality, efficient care models like bundled payments, focusing on cost and quality.
→ Competitive Edge:
In markets with narrow margins, accurate costing helps in profitability analysis per payer or service line, addressing the challenges health systems face.
Despite its benefits, ABC isn't without drawbacks:
→ Complexity and Cost:
Requires detailed data, which can be time-consuming and expensive to gather, especially in large hospitals. Gathering data on every activity demands significant resources.
→ Subjectivity in Driver Selection:
Choosing the wrong drivers can lead to inaccuracies, affecting the overall costing methodology.
→ Limited Adoption:
Many healthcare providers still rely on traditional cost accounting due to regulatory requirements or lack of expertise in applying ABC.
→ Scalability Issues:
In dynamic environments like emergency care, activities can vary unpredictably, making consistent application hard. This is particularly true in the healthcare sector, where patient-level variations abound.
→ Integration with Existing Systems:
Merging ABC with electronic health records or billing software can be technically challenging, especially when incorporating TDABC elements.
These challenges highlight why activity-based costing may not be universally adopted, but with expert guidance, they can be mitigated.
Getting ABC right starts with clarity and ends with action. At Young & Right, we turn activity-level data into decisions you can trust—so you price accurately, improve care pathways, and grow sustainably with activity-based costing in healthcare.
We assess your current costing, data quality, and reporting gaps, then outline a practical roadmap for activity-based costing in healthcare. You’ll see where value leaks occur and which service lines benefit most from ABC first, including potential for TDABC integration.
Working with clinicians and admins, we map patient journeys (intake → diagnosis → treatment → discharge) and translate them into activity cost pools. This creates a shared, audit-ready view of how resources are truly consumed, identifying costs associated with each episode of care.
We select drivers that reflect reality—time, touches, consumables—and build time-driven ABC rates where useful. The result: reliable cost per visit, procedure, specialty, payer, and location, enhancing value-based healthcare.
Whether you use an EHR, LIS, RIS, or ERP, we connect the dots—billing, supply chain, rostering, and fixed assets—so ABC runs on clean, automated feeds. No vendor lock-in; we work with your existing tools to ensure robust costing.
We link costs to quality and outcomes metrics to spotlight high-value care. Leaders get dashboards that track pathway efficiency, variance by provider, and opportunities for continuous improvement, solving the cost crisis effectively.
Our expertise in cost accounting ensures that we address the financial and clinical intersections, providing value to the organization while improving service to the patient.
In summary, activity-based costing in healthcare transforms costing from a blunt instrument to a precise tool, fostering efficiency and sustainability. While implementation requires commitment, its potential for cost savings and improved care quality makes it a valuable approach in modern healthcare management. By incorporating methodologies like time-driven activity-based costing, providers can achieve even greater precision in addressing the cost crisis in health care.
At Young and Right, we understand the nuances of activity-based costing in healthcare and can provide expert consulting to help your organization implement it effectively. Whether you're a hospital, clinic, or healthcare network, contact us today to unlock the full potential of your financial strategies and drive better outcomes.
Partner with Young & Right to implement activity-based costing in healthcare and turn financial complexity into actionable insights. From data mapping to TDABC models and EHR integration—we guide you every step of the way toward smarter decision-making and better outcomes.
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