The Behavior of Overhead Costs: Evidence from Hospital Service Departments

Costing systems including activity-based costing generate average cost data. When these average costs are used for decision-making it is implicitly assumed that they approximate marginal costs. (In other words it is assumed every cost is strictly proportional to activity they are entirely variable.) Using data from hospitals in the State of Washington we examine the time-series behavior of overhead costs. In most instances a fixed cost model depicts cost behavior more accurately than a variable cost model. And nearly all of the effect of a change in activity on costs appears to occur in the same year as the change in activity. Finally when a mixed cost model allowing for both fixed and variable elements is estimated the estimated proportion of variable costs in the overhead accounts is very modest.