Activity-Based Costing & Service Industries

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  • 0:03 Service Industries
  • 0:44 Activity-Based Costing
  • 2:43 Benefits & Drawbacks
  • 4:00 Lesson Summary
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Lesson Transcript
Instructor: Natalie Boyd

Natalie is a teacher and holds an MA in English Education and is in progress on her PhD in psychology.

Activity-based costing is common in manufacturing, but can it be applied to service industries too? In this lesson you'll find out what activity-based costing is, how it works in service industries, and some of the benefits and challenges of using it.

Service Industries

Juanita is a hospital administrator, which means she's in charge of the business side of the organization. She is tasked with making sure that the hospital remains open. Something that won't happen if it isn't making money. Hospitals, banks, and insurance companies are just a few examples of service businesses. A service industry is a business industry that provides a service instead of a product.

Juanita wants to know how the accounting system her employer uses can assist her in making sure the hospital is profitable. To help her out, let's look at activity-based costing and how it can be applied to service industries.

Activity-Based Costing

One way for Juanita to ensure that her hospital is profitable is to compare the services it offers with how much each service costs to deliver. If she knows, for example, how much it costs to treat someone who needs heart surgery, she can compare that amount to how much the hospital bills for that surgery to make sure it's making money on it.

Activity-based costing looks at the whole cost of a single product or service, as opposed to looking at the cost of an entire department or simply looking at one aspect of a product or service. Activity-based costing has traditionally been used in manufacturing products. For example, a company might look at all the costs (like design, testing, manufacturing, assembly, and so forth) that go into product A, product B, and so on. In this way, it can see which products cost the most to bring to market and how to best price those products.

But Juanita isn't worried about products: remember she's the administrator in a service industry, so she's worried about services, not products.

Activity-based costing can also be applied to service industries by investigating the costs of different services. For example, in the past, Juanita's hospital has looked at the overall costs of each department, but that doesn't give her much information. After all, she knows that the surgery department has certain costs, but she doesn't how brain surgery and heart surgery differ in cost.

To help her gather more information, Juanita can apply activity-based costing. This will involve looking at each type of surgery and tallying up the total costs. Juanita might even find that the differences found among different types of heart surgeries are surprisingly stark once she looks at the costs of equipment, training staff, and time spent in the operating and recovery rooms. But by knowing what each operation costs the hospital, Juanita can see if it is charging the correct amount for each surgery.

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