Standard Costing

Standard Costing in Health Care Services

In a hospital or clinic, standard costing writes down before the year starts what one unit of a service ought to consume, such as nurse hours, consumables and a share of equipment, and prices each input at an expected rate. During the year, spending is compared with that standard, and the gap is split into a part caused by paying a different price and a part caused by using a different quantity. Health economists meet the idea in two forms, as a management accounting tool inside provider budgets and as the published standard unit costs that many national guidelines use to value resource use in economic evaluation. Both rest on a predetermined unit cost, yet a standard built for cost control is not automatically the right price for a cost-effectiveness model. Mogyorosy and Smith place standard costing among the techniques of cost accounting, beside absorption and marginal costing.

Standard quantities, standard prices and the standard cost card

Franklin and colleagues, in the OpenStax managerial accounting text, describe a standard cost as an expected cost usually set at the beginning of a financial year for prices paid and amounts used, with the standard quantity being the expected usage of materials or labour. The quantities and prices for one unit of output are recorded on a standard cost card. The standard cost of one unit of service is then found as follows.

$$c^{s} = \sum_{i=1}^{n} q_{i}^{s} \, p_{i}^{s}$$

where $c^{s}$ is the standard cost of one unit of service (for example one attendance or patient day), $n$ is the number of inputs on the standard cost card, $q_{i}^{s}$ is the standard quantity of input $i$ per unit of service and $p_{i}^{s}$ is the standard price of one unit of input $i$.

Franklin and colleagues note that total fixed costs stay the same across levels of production, so the standard fixed cost per unit changes with each level. A fixed element on a standard cost card, such as equipment or estate, is therefore the budgeted fixed cost divided by planned activity.

$$f^{s} = \frac{F^{b}}{Q^{b}}$$

where $f^{s}$ is the standard fixed cost per unit of service, $F^{b}$ is the budgeted fixed cost for the period and $Q^{b}$ is the planned number of units of service in the same period.

Mogyorosy and Smith, reviewing costing methods for health care services, note that a bottom-up approach can be used to calculate standard costs per service. The quantities for a hospital service can be taken from past activity records or from the inputs that a clinical pathway or treatment protocol specifies for each case.

How demanding the standard should be

The level at which a standard is set decides what a variance means. Franklin and colleagues distinguish an ideal standard, which assumes that nothing goes wrong, from an attainable standard that staff can reach with reasonable effort, and say standards are typically set at attainable levels. Mogyorosy and Smith describe standard costs as target unit costs calculated or agreed as fair, usually attainable but challenging.

A standard based on past spending is easy to set but carries forward whatever inefficiency the past contained, while a standard built from a protocol may describe care that has rarely been delivered. Franklin and colleagues add that standards often become less reliable towards the end of the year as prices and conditions change. A persistent variance in the same direction is often a sign that the standard needs revising rather than a sign of poor performance.

Splitting a variance into price and usage

A variance is the difference between a standard and actual performance, favourable when less is spent or used than the standard and unfavourable when more is spent or used. For any input the total variance divides exactly into a price part and a usage part. Franklin and colleagues call these the price and quantity variances for materials and the rate and time variances for labour.

$$AQ \cdot AP - SQ \cdot SP = (AP - SP)\,AQ + (AQ - SQ)\,SP$$

where $AQ$ is the actual quantity of the input used, $AP$ is the actual price paid per unit of the input, $SP$ is the standard price, and $SQ$ is the standard quantity allowed for the output actually delivered (the standard quantity per unit of service multiplied by actual activity). The first term on the right is the price (or rate) variance and the second the quantity (or time) variance. A positive value is unfavourable.

The two parts are often linked. Franklin and colleagues give the example of substandard materials, where a favourable price variance can cause an unfavourable labour efficiency variance and an unfavourable material quantity variance. A cheaper clinic consumable that fails more often shows the same pattern, so the variances are best read together.

Flexing the standard for activity and case mix

Because $SQ$ is set at actual activity, the standard moves with the volume of work, and a ward that treats more patients than planned is judged against what those patients should have cost. The fuller split of a budget variance into volume, rate and time parts, and which parts a budget holder can influence, is on the controllable cost page, and in-year monitoring is on the budget control page.

In health care the unit of output itself varies, since two admissions can need very different inputs. A standard for a single average attendance will show a change in case mix as an unfavourable usage variance even when every patient was treated efficiently. One answer is to set standards per case group. Meeting and colleagues, writing in 1988 after the introduction of the prospective payment system, describe methods for budgeting and controlling inpatient nursing costs that combine diagnosis related groups with standard costs.

Standard unit costs in economic evaluation

Economic evaluations need a unit cost for each item of resource use. Mogyorosy and Smith list standard unit costs as one of five general ways in which costing studies and economic evaluations value resources. In their review of European guidelines, those of Belgium, Portugal, Poland, the Netherlands and England and Wales, among others, recommended standard costs.

Oostenbrink and colleagues describe the Dutch Manual for Costing, in which standard costs are average prices of health care services. Its basic principles, standard values and minimum reporting requirements were obligatory for studies supporting reimbursement submissions for new medicines, while the use of standard costs themselves was left mainly to the investigator. Krauth and colleagues proposed standard costs for German evaluations based on administrative charges and rates or official statistics, aiming at an average valuation of resource use that makes studies comparable. They warned that institutional changes, such as the introduction of DRGs, can alter those rates.

In England, the NICE technology appraisal manual (PMG36, section 4.4.9) describes healthcare resource groups as a valuable source for estimating resource use, with the national average unit cost of each HRG reported through the annual mandatory collection of reference costs, and says using these costs can reduce the need for local micro-costing. Section 4.4.10 adds that HRG data may not be appropriate when the new technology and its comparator fall under the same HRG, or when the mean cost does not reflect resource use with the new technology.

The case for standard unit costs is comparability. Mogyorosy and Smith report that standard costs reduce the impact of cost differences caused by accounting practice, measurement methods and practice variation. The same authors warn that standard costs reflect national averages, may be a poor proxy for resource use in a particular organisation, and reflect average rather than marginal costs, so they may not suit decisions that need marginal analysis.

Worked example of an infusion day unit (illustrative)

All figures are illustrative. An infusion day unit sets a monthly standard for one attendance with three inputs. Nurse time is 1.5 hours at GBP 40 per hour, or GBP 60. Infusion consumables are 2 packs at GBP 17.50, or GBP 35. Chairs and pumps cost GBP 22,000 a month, or GBP 55 over 400 planned attendances. The standard cost per attendance is 60 + 35 + 55 = GBP 150.

The unit delivers 420 attendances. It switches to a cheaper pack at GBP 16.00 but more cannulations fail, so the unit uses 924 packs and 651 nurse hours at the standard GBP 40. Fixed cost is GBP 22,000 as budgeted.

1. Standard quantities for actual activity. Packs allowed are 420 x 2 = 840, and nurse hours allowed are 420 x 1.5 = 630.
2. Consumables price variance. (16.00 − 17.50) x 924 = minus GBP 1,386, a favourable variance of GBP 1,386.
3. Consumables quantity variance. (924 − 840) x 17.50 = 84 x 17.50 = GBP 1,470 unfavourable.
4. Consumables total. Actual spending is 924 x 16.00 = GBP 14,784 against a standard of 840 x 17.50 = GBP 14,700, a GBP 84 unfavourable variance, which equals 1,470 − 1,386.
5. Nurse time variance. (651 − 630) x 40 = 21 x 40 = GBP 840 unfavourable. With no change in pay rate the rate variance is zero.
6. Fixed cost. The 420 attendances absorb 420 x 55 = GBP 23,100 of fixed cost against GBP 22,000 actually spent, an over-absorption of GBP 1,100 caused only by spreading the same fixed cost over more attendances.
7. Totals. Nurse cost is 651 x 40 = GBP 26,040, so actual cost is 26,040 + 14,784 + 22,000 = GBP 62,824. At the full standard the month's work is worth 420 x 150 = GBP 63,000, so the headline variance is GBP 176 favourable.

The headline figure hides the result of the pack switch. The variable standard is 60 + 35 = GBP 95, so the flexible budget is 420 x 95 = GBP 39,900 plus the GBP 22,000 fixed cost, or GBP 61,900. Against that budget the unit overspent by 62,824 − 61,900 = GBP 924. That overspend is the extra packs of GBP 1,470 plus the extra nurse time of GBP 840, less the price saving of GBP 1,386. The favourable GBP 176 is the GBP 1,100 over-absorption less this GBP 924, so the cheaper pack cost the unit money once its effect on usage and staff time is counted.

The same card gives a misleading price for an evaluation. If a new medicine added 40 attendances a month within spare chair capacity, its short-run incremental cost at standard would be 40 x 95 = GBP 3,800 a month, while valuing the attendances at the full standard would give 40 x 150 = GBP 6,000, an overstatement of GBP 2,200.

Standard costing beside actual costing and micro-costing

Mogyorosy and Smith define standard costing as a technique that estimates the cost of a service in advance and then compares actual costs with that predetermined cost. Actual costing records spending after the event, as in top-down costing, which the same authors note is retrospective and cannot produce a standard cost.

Activity-based costing and micro-costing describe how resource use is traced, so either can supply the quantities on a standard cost card, and budget planning multiplies the resulting standards by expected activity. A national standard unit cost in an evaluation is a different object again, an average across providers chosen for comparability rather than a local target for control.

Where standard costs mislead

Standard costing assumes a repeatable service with stable inputs, and several weaknesses follow from that assumption. Others arise when a standard built for control is used for evaluation.

1. Maintenance is costly. Mogyorosy and Smith note that a standard cost system can be very costly to maintain because it requires regular updates, and an unrevised standard turns price changes into apparent overspending.
2. Case mix appears as inefficiency. A single standard per attendance or episode treats sicker patients as excess usage unless standards are set per case group.
3. Over-absorption looks like saving. Extra activity is credited with fixed cost that was never saved, as step 6 of the example shows.
4. Average is not marginal. A full standard is an average cost, whereas an evaluation needs the change in cost caused by the decision, which is lower than the average when capacity is spare.
5. Internal standards may not suit evaluation. Špacírová and colleagues note that the researcher cannot easily use standard unit cost estimates that an organisation produces for its own purposes when costing composite resources such as a hospital day, because direct costs already recorded at patient level must be excluded and shared overheads included.

In an evaluation the relevant value is the opportunity cost of the resources, and a standard cost is a usable estimate of that only when its basis, year and contents are reported.

Sources

• Franklin M, Graybeal P, Cooper D. Principles of Accounting, Volume 2: Managerial Accounting. Houston, TX: OpenStax; 2019. Sections 8.1 to 8.4. https://openstax.org/books/principles-managerial-accounting/pages/8-1-explain-how-and-why-a-standard-cost-is-developed
• Krauth C, Hessel F, Hansmeier T, Wasem J, Seitz R, Schweikert B. Empirical standard costs for health economic evaluation in Germany, a proposal by the working group methods in health economic evaluation (article in German). Gesundheitswesen. 2005;67(10):736-746. https://doi.org/10.1055/s-2005-858698
• Meeting DT, Saunders G, Curcio RF. Using DRGs and standard costs to control nursing labor costs. Healthcare Financial Management. 1988;42(9):62-64, 66, 68. PMID 10312677
• 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. https://www.nice.org.uk/process/pmg36/chapter/economic-evaluation-2
• Oostenbrink JB, Koopmanschap MA, Rutten FF. Standardisation of costs: the Dutch Manual for Costing in economic evaluations. PharmacoEconomics. 2002;20(7):443-454. https://doi.org/10.2165/00019053-200220070-00002
• Špacírová Z, Epstein D, García-Mochón L, Rovira J, Olry de Labry Lima A, Espín J. A general framework for classifying costing methods for economic evaluation of health care. European Journal of Health Economics. 2020;21(4):529-542. https://doi.org/10.1007/s10198-019-01157-9