ote on Full and Differential Cost Accounting in Health Care

The question “What did it cost?” is important in many organizations. Arriving at an answer can be much more difficult than it might first appear. Obviously, it is rather easily answered if we are discussing the purchase of inputs (supplies, labor, and so on) for the service-delivery process. Even calculating the full cost of a “unit” produced—whether it is a dialysis procedure or 50 minutes of psychotherapy—is relatively easy as long as the organization provides completely homogeneous goods or services. Complications arise, however, when we introduce multiple goods and services into an organization, particularly when we use different kinds and amounts of resources to provide them. This note discusses these matters.

Additional complications arise when we move from the computation of full cost to the question of how costs will change under different decision-making scenarios. Full cost accounting does not address how costs will vary with changes in volume (or other factors, such as time), yet information on cost behavior is important for several types of decisions that managers make on a fairly regular basis. Using full cost information as a basis for deciding which costs will change, or how costs will change under different scenarios, can lead managers to make decisions that are financially detrimental to the organization.

The first section of the note discusses full cost accounting, its uses, and the managerial choices that are involved in setting up a full-cost accounting system. The second section of the note, on differential cost accounting, addresses the nature of costs, defines several terms and concepts, and takes up the subject of cost-volume-profit (CVP) analysis. It then looks at CVP analysis (sometimes called breakeven analysis) in its most basic form. It also examines a variety of special considerations that can serve to complicate CVP analysis. Finally, the note discusses when differential costs should be used rather than full costs, and some of the complications in using them.