Ruhl, J. M. and B. P. Hartman. 1998. Activity-Based Costing in the Service Sector. Advances in Management Accounting (6): 147-161.
by Melissa Hagood
Master of Accountancy Program
University of South Florida, Fall 2001
ABC Main Page | Service Industry Accounting Main Page
its core, activity-based costing (ABC) is about cost management. This is
reducing and controlling costs while still creating a quality product. ABC
allows managers to identify how various cost objects are using resources
differently and to highlight areas for continuous improvement. The literature on
ABC focuses mainly on its use in manufacturing settings because it has been so
successful in that area. This article discusses the use of ABC in service
Cooper (1996) defined cost behavior as falling into four levels:
services may consume very different amounts of a resource in a service firm. The
levels of competition and regulation in a service environment influences the
costing system. More competitive markets require more sophisticated systems that
better match costs to different cost objects. ABC is such a sophisticated
firms are becoming more interested in costing accurately in order to make long-
term strategic decisions as well as day-to-day operating decisions. Accurate
costs are necessary to make product pricing, staffing, and resource allocation
decisions. Service customers all require different amounts of resources.
Accurate costs, along with the quantity and patterns of resource consumption,
let managers know the proper price to charge for services. But ABC is hard to
implement in service firms since employees often work on many projects in a day
and for different amounts of time. This makes it hard to trace the resources
used by cost objects.
ABC to Service Businesses
companies have had problems coming up with decent cost accounting systems
because they have been modeling them after systems found in manufacturing firms.
The problems with this are that manufacturing firms place emphasis on valuing
inventory, which service firms do not even have, and use standard costs
calculated for direct materials and labor. Direct materials and direct labor
costs are not major in service firms and it is hard to calculate standard costs
in that setting. Nonetheless, service firms do need to know accurate costs for
product profitability analysis. They need to find out:
means that costing in the service sector needs to be forward-looking, and ABC is
a tool for such analysis. There are several service industries where ABC has
started to emerge, and will continue to prove useful.
the regulation ended in the banking industry, costing became more important as
banks competed with one another. Banking costs are not driven by the volume of
customers, but rather the number of transactions processed. Traditional volume
based costing is obviously inappropriate in this case. Banks are moving to the
concept where the user pays for the cost of the services they use, so that all
users do not share the bill evenly. To do so they must have an accurate
reflection of the cost of services.
(1992) described step-by-step how banks should implement ABC:
banks have already had success applying such division principles. Refer to the
article for specific examples.
providers used to be able to increase their prices or service to increase
revenues and profitability. Today Medicare or managed care firms essentially set
revenues with their prospective payment system (PPS). All healthcare providers
can do to improve profitability is make good decisions with accurate cost
information. PPS improved the sophistication of cost accounting systems in
a survey of hospital administrators about what information they needed to manage
effectively, they said:
of this information is available from an ABC system. There are examples of
hospitals successfully implementing ABC systems in the article.
and Pearlman (1993) believed that hospitalís cost accounting systems evolve in
a four-step process:
viewpoint on hospital cost accounting systems is provided by Ramsey (1994). He
believes that it should serve three purposes:
industry is also making the move toward better management of costs due to
increased competition. Here workers may spend a long time working on one task
and the time on each task varies greatly depending on the case. The discussion
in this section is mainly about ABC concepts and hospital malpractice insurance.
A study found that a variety of factors drove malpractice costs and that the
risk of malpractice was also tied to geographical locations. With these facts a
malpractice insurance cost per medical procedure was calculated and divided by
the number of that type of procedure for accurate costing.
can be applied in service industries other than those described here. It has
become increasingly important for companies whose markets are becoming more
competitive. Since ABC is really about cost management, using it allows service
companies to reduce and control their costs in order to make correct pricing and
other decisions, and to increase their profitability. It is likely to continue
to become more prevalent in the service industry in the future.
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V. 1992. Determining product profitability. The Bankers Magazine.
D. W., and L. K. Pearlman. 1993. Managing the stages of hospital cost accounting.
Management (April): 58-80.