5 Strategies to Implement a Cost Accounting System and How it Can Improve Profitability

5 Strategies to Implement a Cost Accounting System and How it Can Improve Profitability

Aside from perhaps being one of the more boring topics that exists in the world, cost accounting can also be one of the most useful when running a business. What exactly is this spellbinding practice?


According to Investopedia, the high level definition is, “a form of managerial accounting that aims to capture a company’s total cost of production by assessing the variable costs of each step of production as well as fixed costs, such as a lease expense.”


Great, so not helpful unless we define “Managerial accounting.” According to the same site, “Managerial accounting is the practice of identifying, measuring, analyzing, interpreting, and communicating financial information to managers for the pursuit of an organization’s goals. It varies from financial accounting because the intended purpose of managerial accounting is to assist users internal to the company in making well-informed business decisions.”


Okay, now we are getting somewhere. Basically, cost accounting is looking deeply into the activities your organization is performing to function well, improve profitability, generate more revenue, etc. It goes deeper than standard financial metrics like cost of goods sold, or overhead expenses. One type of cost accounting that can be wildly valuable to hospitals is Activity Based Costing.


Activity Based Costing takes every cost, direct and indirect associated with a function and allocates that cost. So, while a hospital may typically think of allocating all supply costs and personnel hours to a surgery type to understand the cost of it, activity-based costing goes another layer down. It would also calculate and allocate electricity, rent or leases, support personnel, etc. to the procedure. Any cost driver you can think or would be allocated.


While this is not a minor undertaking and can be considerably complicated, it is also plain to see the benefit. If your hospital is looking at its income, costs, and profits at a higher financial level, it is easy to miss the major cost drivers and the major profit drivers. It is also nearly impossible to accurately price services, an important trend in healthcare.


In fact, the undertaking is so cumbersome to most, only a fraction of hospitals are currently utilizing an advanced costing system, with most opting for a ratio of cost to charge method. However, in addition to the rudimentary nature of this method, how can you truly identify your ratio if you do not truly know your cost? One survey, found that 9 out of 10 hospital executives do not know their true costs. So, if you were to ask the true cost of a c-section for example, no one would be able to tell you.


Not only does this sound like poor business management, it will be a major impediment to shift to value-based care, should that day finally arrive.


Before we point too many fingers at hospitals and their executives, it is worth noting that we have arrived in this position through no one person’s fault. Because the evolution of care, changing reimbursement landscape, complexity of care delivery has all accelerated so quickly in recent years it has been near impossible to keep up. Additionally, it is a huge time and cost undertaking to implement a cost accounting system.


IUf it is such a time consuming undertaking, why even try?


Two reasons:


  1. Gone or close to gone are the days of improving profitability by increasing volume of high margin procedures or simply charging more
  2. The only remaining lever to improve profitability is lowering costs. You cannot lower costs if you do not know what those costs are


The main adopters of advanced cost accounting are hospitals and healthcare systems that either offer their own health insurance plans or compete with those offering their own healthcare plans. When a healthcare system is insuring the patients it treats, it is monumentally important to know the cost of everything rather than simply charge more for more procedures. The latter strategy is only tenable when someone else is paying.


By knowing your costs, not only can you reduce them in every area of the hospital by identifying waste or areas for improvement, you can also focus on areas already proving to be extremely profitable.


Here are 5 strategies to get you and your organization on the path to implementing a cost accounting system:


Strategy 1: Look for best practices


As previously mentioned, there are a number of health systems already practicing advanced cost accounting. Among them, University of Pittsburg Medical Center, Geisinger, Intermountain Healthcare, and University of Utah Health System. Reach out to them. Ask if they used consultants, what the approach was, learnings, etc. You may be surprised how much information you can get by a simple phone call. Certainly, barring geographical competitive forces, one phone call from your CEO to another hospital CEO to discuss how they improved through activity based costing, may just get the ball rolling.


Strategy 2: Find experts


I am not usually one for consultants. They sometimes (most of the time) are just trying to sell something else. Keep you on the hook for future services. But installing a cost accounting system is no small task. Finding an expert can be extremely beneficial. Look for help from individuals or groups who do not look to imbed themselves in your organization. Rather find individuals who contract and train your teams to be able to install manage and maintain a newly implemented cost accounting system once they leave. While the cost may be high, the savings as a result of having a robust cost accounting system will likely be higher.


Strategy 3: Leverage internal assets


Implementing a cost accounting system takes a large cross functional team. Clinical, finance, business administration, billing departments, charge master departments, supply chain, etc. Basically everyone in the hospital will play a role in developing a system and process. When you are accounting for so many cost items, it does require commitment and input from across the organization. From a practical standpoint, start with finance, it will at least begin to paint a high level picture of costs in addition to providing you with the talent that will be able to understand the complexity of cost systems and allocation. Expand from there.


Strategy 4: Involve executive leadership


If you are an executive, involve more executives. If not, start with one and go from there. The executive team must be onboard with this idea. If the leadership team does not support implementing an extensive and robust system, it will not survive. Not to mention executive leadership will likely be approving this expense. However, sold properly to the executive team is only half the battle. The executive team must deliver the message in the right way to the rest of the organization in order to ensure compliance and leverage the new cost information available to yield improved business results.


Strategy 5: Think of this a process improvement project


Sometimes when faced with a tremendous undertaking it is easy to become overwhelmed. To want to throw in the towel before starting. Approaching the project as if it were a process or quality improvement project may help make it more manageable. Utilize Lean Six Sigma resources you have inside or close to your organization. Focus the scope of the project. Scope creep kills projects out of the gate. Starting with the Emergency Department may be the right approach to make an impact and learn how best to roll out a cost accounting system to the entire hospital or healthcare system. Thinking smaller can help make larger impacts.




Hospitals and healthcare systems need accurate cost data not only to improve their own financial performance, but to also meet the demands of a changing healthcare environment. As more people and policy demands price transparency, as we shift to value-based care, as more pressure is put on cost, it is critical to understand cost drivers. While complex in the healthcare setting, investing now can help operations in the long term.

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