Activity-Based Costing

Activity-Based Costing for Patient-Level Costs and Unit Costs in Economic Evaluation

Activity-based costing (ABC) costs a health service by asking which activities it needed, such as booking, a ward round or a case review, and what each of those activities cost, instead of spreading overheads in proportion to the number of patients seen. It matters in health economics because the patient-level costing that NHS trusts in England submit to the National Cost Collection follows the same resources, activities and patients logic, and ABC and time-driven ABC studies supply unit costs for economic evaluations.

Why volume-based overhead allocation distorts unit costs

Costing has to assign overheads that cannot be traced to one patient, such as administration, estates and shared equipment. Traditional methods use one or a few allocation bases, such as attendances, bed-days or budget size, and so assume that overheads rise in proportion to volume. Mogyorosy and Smith, reviewing health care costing methods, note that overheads frequently vary with the complexity and diversity of services rather than with volume.

The method came into health care from management accounting. As Schmidt and colleagues recount, Cooper and Kaplan argued in 1988 that overhead costs are in most cases not proportional to production quantities and proposed ABC in response. The pattern in which a volume-based system overcosts high-volume products and undercosts low-volume ones is called product cost cross-subsidisation. In a hospital the same logic lets routine, high-volume clinics absorb overhead that complex, low-volume services use, as the worked example below shows.

The two-stage calculation from resources to activities to cost objects

ABC rests on the idea that activities consume resources and that services are the result of activities. The first stage moves resource costs (staff, equipment, consumables) into activity cost pools; the second stage assigns each pool to cost objects, such as patients, procedures or pathways, in proportion to their use of a cost driver. Mogyorosy and Smith describe the difference from traditional costing as smaller, more homogeneous cost pools, some indirect costs reclassified as direct, and allocation bases with a cause-and-effect link to each pool's costs.

The rate for each activity pool and the cost of a cost object are given below.

$$r_a = \frac{C_a}{D_a}, \qquad C_j = C_j^{dir} + \sum_{a=1}^{A} r_a\, d_{aj}$$

where $r_a$ is the cost per unit of driver for activity $a$, $C_a$ is the total cost in the activity pool, $D_a$ is the total volume of its cost driver in the same period, $C_j$ is the cost of cost object $j$, $C_j^{dir}$ is the cost traced directly to $j$, $d_{aj}$ is the number of driver units that $j$ uses, and $A$ is the number of activity pools.

Choosing cost drivers

A cost driver should explain why the pool's costs arise and be measurable for each cost object. Health care examples include length of stay or ward minutes for ward costs and staff minutes for clinical review. Mogyorosy and Smith note that an organisation may use from a dozen to hundreds of drivers, and describe a trade-off between the accuracy of overhead allocation and the cost of running the system.

A driver can be a poor proxy for the overhead it allocates, the relationship between driver use and cost may not be linear, and common or joint costs, such as a building shared by several services, remain hard to apportion however many pools are created.

Time-driven ABC with capacity cost rates and time

Traditional ABC needs data on how each resource is split across activities, which is costly to collect and keep up to date. Crocker-Buque and colleagues describe how ABC was later updated to reduce the administrative burden of data collection and is now termed time-driven activity-based costing (TDABC). TDABC estimates a capacity cost rate for each resource (its cost divided by its practical capacity, usually in minutes) and multiplies it by the time each activity takes.

A systematic review by Shakya and colleagues, which excluded surgical costing studies, included 32 studies using TDABC in health economic analyses, comprising 25 costing studies and seven full economic evaluations. The authors note that other costing methods have difficulty identifying practical and unused capacity because they do not track resource time, which TDABC does. Eight of the reviewed studies calculated practical capacity without allowing for breaks, holidays and training days, which overstates capacity and so understates the cost rate.

Patient-level costing in the NHS

In England, NHS England's Approved Costing Guidance explains how NHS trusts should cost at patient level using the costing standards and then submit the results to the National Cost Collection. Its quick guide summarises the aim as a record of "Who did What to Whom for What amount", in which resources cover the who, activities the what, and patients or services the whom.

The integrated costing standards require patient-facing costs to be allocated using an activity-based method. Standard CP3 allocates resources to activities and standard CP4 matches the costed activities to the right patient event. Resources are split across activities using actual time or costs from patient-level information feeds, relative weight values agreed with departments, or local traceable costs, and the standards give the example of a consultant whose GBP 100,000 cost is divided between ward rounds, outpatient care, supporting contacts and telemedicine. Corporate overheads such as finance are allocated reciprocally, so support services can charge each other. Weighting costs by income or national averages is not accepted as a superior method.

The National Cost Collection publishes both aggregated costs (the average unit cost of providing defined services) and patient-level costs. NHS England states that the data inform the patient-level information and costing systems (PLICS) dashboards, the Model Health System, Getting It Right First Time and NHS Payment Scheme prices. The patient-level collection covers acute, mental health, Talking Therapies and community services, with a separate ambulance dataset.

ABC unit costs in economic evaluation

The NICE technology appraisal manual (PMG36, section 4.4.9) describes healthcare resource groups as a valuable source for estimating resource use, with national average unit costs reported through the annual mandatory collection of reference costs; using them can reduce the need for local micro-costing. Section 4.4.10 adds that HRG data may not fit when the technology and its comparator fall in the same HRG, or when the mean cost does not reflect the resource use of the technology being evaluated, and that micro-costing studies may then be more appropriate. A bespoke ABC or TDABC study is one way of producing such estimates.

Published TDABC studies also supply unit costs for England. The Unit Costs of Health and Social Care 2025 manual lists unit costs for routine vaccination at GP practices taken from a TDABC study. These are GBP 14.05 per adult appointment and GBP 18.20 per child appointment in 2017/18 prices, uprated to GBP 17.53 and GBP 22.71 in 2024/25 prices. The underlying study by Crocker-Buque and colleagues covered nine practices and attributed 75% of appointment cost to staff, 24% to facilities and 1% to consumables.

Two cautions apply in a model. ABC produces organisation-specific averages. Mogyorosy and Smith note that an ABC unit cost may have better internal validity than a DRG-based cost but less external validity, because DRG costs are national or regional averages. And absorption costing, ABC included, allocates historical costs, so the resulting unit cost may or may not be a good estimate of opportunity cost. The relevant figure for an incremental cost is the change in resource use between alternatives, which is not always the fully allocated average.

Worked example with one overhead pool and two clinics (illustrative)

The figures are illustrative. An outpatient department has GBP 300,000 of shared overhead a year, serving a routine follow-up clinic (A, 9,000 attendances) and a complex new-patient clinic (B, 3,000 attendances). The overhead consists of two activities, booking and registration (GBP 120,000) and multidisciplinary case review (GBP 180,000).

1. Volume-based allocation. 300,000 / 12,000 attendances = GBP 25 per attendance in both clinics.
2. Activity rates. For booking, 120,000 / 12,000 bookings = GBP 10 per booking. For case review, 180,000 / 9,000 review minutes = GBP 20 per minute.
3. Clinic A by activity. Booking for 9,000 attendances is 9,000 × 10 = 90,000 and its 1,800 review minutes cost 1,800 × 20 = 36,000, giving GBP 126,000, or 126,000 / 9,000 = GBP 14 per attendance.
4. Clinic B by activity. Booking for 3,000 attendances is 3,000 × 10 = 30,000 and its 7,200 review minutes cost 7,200 × 20 = 144,000, giving GBP 174,000, or 174,000 / 3,000 = GBP 58 per attendance.
5. Reconciliation. 126,000 + 174,000 = 300,000, so the whole pool is assigned once.

Volume-based allocation overcosts each routine attendance by GBP 11 and undercosts each complex attendance by GBP 33. These remain average costs. If a new pathway moved patients from clinic B to clinic A, a model counting GBP 44 of overhead saved per moved attendance would be right only if the case-review team's cost actually fell; with unchanged staffing the short-run saving is much smaller.

ABC beside micro-costing, top-down costing, budgeting and funding

ABC is usually placed against two other ways of costing. Top-down costing starts from aggregate expenditure and divides it among outputs; bottom-up costing and micro-costing count the resources each patient uses and value each one. Mogyorosy and Smith treat ABC as following bottom-up principles, while noting it can use a bottom-up or mixed approach, and Shakya and colleagues call TDABC a bottom-up micro-costing approach. An ABC system reaches a patient-level cost through activity rates, whereas a micro-costing study may enumerate every input directly. Xu and colleagues note that hospitals are increasingly adopting micro-costing or activity-based cost allocation systems, which researchers may draw on if they report enough detail. Cost allocation is the general task; ABC is one rule for doing it.

Two terms with the same prefix concern money rather than measurement. Activity-Based Budgeting sets a budget from forecast activity and its resource needs, and Activity-Based Funding pays providers according to the volume and type of cases treated. Costing data can inform both, as the National Cost Collection informs NHS Payment Scheme prices, but a nationally set price need not equal any one provider's activity-based cost.

Where activity-based costs mislead

Mogyorosy and Smith report that ABC can be costly and difficult to implement, partly because suitable drivers cannot always be found, and that it may suffer from similar data problems to traditional accounting systems, namely missing data, misclassified costs and resource-intensive maintenance. Where most costs can already be traced directly, an ABC system may not be worth its cost.

1. More detail is not more accuracy. A unit cost reported to the penny can rest on an estimated time, a negotiated relative weight or a weak driver.
2. Fully allocated cost is not incremental cost. ABC assigns all of a period's cost, including fixed and spare capacity; an evaluation needs the costs that change between options.
3. Better costing need not change decisions. Mogyorosy and Smith cite evidence that cross-subsidisation between services is driven mainly by payment policy and market forces, so a more precise unit cost may not alter what a provider does.

Sources

• Crocker-Buque T, Mohan K, Ramsay M, Edelstein M, Mounier-Jack S. What is the cost of delivering routine vaccinations at GP practices in England? A comparative time-driven activity-based costing analysis. Human Vaccines & Immunotherapeutics. 2019;15(12):3016-3023. https://doi.org/10.1080/21645515.2019.1619403
• Jones K, Weatherly H, Barker A, Birch S, Castelli A, Chalkley M, Dargan A, Findlay D, Hinde S, Markham S, Smith D, Teo H. Unit Costs of Health and Social Care 2025 Manual. Canterbury and York: Care and Outcomes Research Centre (University of Kent) and Centre for Health Economics (University of York); 2026. Tables 1 and 2. doi:10.22024/UniKent/01.02.115569.
• Mogyorosy Z, Smith P. The main methodological issues in costing health care services: a literature review. CHE Research Paper 7. York: Centre for Health Economics, University of York; 2005. https://www.york.ac.uk/media/che/documents/papers/researchpapers/rp7_Methodological_issues_in_costing_health_care_services.pdf
• National Institute for Health and Care Excellence. NICE technology appraisal and highly specialised technologies guidance: the manual (PMG36). London: NICE; 2022, last updated 13 October 2026. Sections 4.4.9 and 4.4.10.
• NHS England. Introduction to the 2026 Approved Costing Guidance; Approved Costing Guidance: quick guide; Integrated information requirements, costing processes and costing methods 2026 (integrated costing standards; IR1 and CP2 to CP4). London: NHS England; 2025 and 2026. Internet Archive captures, April to June 2026. https://www.england.nhs.uk/costing-in-the-nhs/approved-costing-guidance/
• NHS England. National Cost Collection for the NHS and Patient-level costing information (web pages). Accessed via the Internet Archive, captured 27 September 2026. https://www.england.nhs.uk/costing-in-the-nhs/national-cost-collection/
• Schmidt M, Mertens KG, Meyer M. Cost hierarchies and the pattern of product cost cross-subsidization: Extending a computational model of costing system design. PLoS One. 2023;18(9):e0290370. https://doi.org/10.1371/journal.pone.0290370
• Shakya S, Bohingamu Mudiyanselage S, Robinson S, Randall S, Gao L. Time-driven activity-based costing and its use in health economic analysis: a systematic literature review. Applied Health Economics and Health Policy. 2025;23(6):989-1004. https://doi.org/10.1007/s40258-025-00988-3
• Xu X, Lazar CM, Ruger JP. Micro-costing in health and medicine: a critical appraisal. Health Economics Review. 2021;11:1. https://doi.org/10.1186/s13561-020-00298-5