ARE OVERHEAD COSTS STRICTLY PROPORTIONAL TO ACTIVITY - EVIDENCE FROM HOSPITAL-SERVICE DEPARTMENTS

Using cross-sectional data from hospitals in Washington State, we test whether overhead costs are proportional to overhead activities. This assumption is at the heart of nearly all cost accounting systems, whic h implicitly assume that marginal cost is equal to average cost. Empir ically, the proportionality hypothesis can be rejected for most of the overhead accounts. On average across the accounts, the average cost p er unit of activity overstates marginal costs by about 40% and in some departments by over 100%. Thus, the average cost per activity should be used with a great deal of caution in decisions.