What is activity-based costing (ABC), and how can it be applied in a hospital to improve costing accuracy?

• A. ABC assigns overhead costs to activities based on drivers, improving accuracy of departmental costs and pricing decisions.
• B. ABC allocates overhead using a single plant-wide rate.
• C. ABC allocates overhead costs uniformly across all departments.
• D. ABC assigns overhead costs to activities based on drivers, improving accuracy of departmental costs and pricing decisions.

Answer: (D)

Activity-based costing traces costs to the activities that actually consume resources, using drivers that reflect how much of each activity is used. In a hospital, you would identify activities like patient admissions, registration, imaging, lab testing, surgeries, and nurse or physician time spent with patients. Each activity has its own cost pool, and you determine a driver for that activity—for example, the number of patient encounters, minutes of nursing time, or number of tests performed. You then calculate an activity rate by dividing the total cost in the pool by the total units of the driver, and assign overhead to patient services based on how much of each activity they use. This gives a more accurate view of what different services actually cost and supports better pricing decisions and budgeting.

Using a single plant-wide rate or spreading overhead uniformly across departments tends to distort costs in a hospital, because different areas use resources in different ways. An ICU may consume much more nursing time and specialized equipment, while outpatient labs might drive costs mainly through the volume of tests. ABC captures these differences by tying costs to the specific activities and their drivers, leading to more precise departmental costings and more informed pricing and resource allocation decisions.