Costing

Asked: 13 Dec 2019 | 1118

For instance, the equipment was bought in 2017 and its lifespan is 10 years, I want to calculate the cost of this equipment for 2019. How do I annulize the cost of medical equipment? Do I need to convert the cost of equipment to current year using CPI before annulizing the cost or annulize directly using the EAC formula? If I use CPI and converted to 2019 value, then to calculate the EAC for 2019, can I take useful life of equipment as 8 years (i.e, subtracting the no.of years used from the total lifespan)? Thank you for your time.

Costing

Expert Replies:

Hugo Turner

Lecturer | United Kingdom | Replied: 17 Dec 2019 at 00:53

A paper from Damian Walker and Lilani Kumaranayake (Allowing for Differential Timing in Cost Analyses: Discounting and Annualization) goes through annualization in more detail.

What is the purpose of the study? (i.e. for a future economic evaluation or budget/financial planning) Depending on the purpose of the costing study the current replacement cost of the capital resource is often used when performing annualization. If this is not available and /or you need to adjust for inflation, the following paper may be helpful (Adjusting for Inflation and Currency Changes Within Health Economic Studies).

When estimating the annualized financial cost of a capital resource, the total cost can simply be divided by its useful life expectancy. This accounts for the depreciation (the reduction in its value with the passage of time) of the resource.
I would use 10 years as the lifespan and not 8 years even if you adjust for inflation.

Estimating the annualized economic cost of a capital resource also needs to account for the opportunity cost of spending that money i.e. the resources invested in its purchase that cannot be used elsewhere (such as investing that money and having it earn interest over that time period). This is accounted for by using an annualization factor (also referred to as amortization factor). This factor accounts for both the resource’s depreciation (the reduction in its value with the passage of time) and the opportunity cost for spending the money on it. These factors are obtained based on the useful life of the resource and an assumed discount/interest rate – and can be found online. The annualization factor is lower than the corresponding useful lifespan, thus when the total cost of the capital resource is divided by this factor, it results in a higher annualized economic cost compared to only dividing by the useful life expectancy i.e. the economic cost is larger than the financial cost. For example, a useful life span of 5 years and a 3% discount rate would result in an annualization factor of 4.58.

Pempa Pempa

Program Officer | Bhutan | Replied: 18 Dec 2019 at 15:23

Thank you for your answer.
The purpose is to determine the cost of healthcare in our country. Currently, there is no unit cost study done on healthcare. I plan to determine the unit cost of healthcare based on healthcare resources consumed and healthcare out-put generated in 2018-2019 financial year. This unit cost will be used as a healthcare cost input in future economic evaluation studies. This unit cost also be used for charging the patient for healthcare service. So I would say it is for both purposes i.e economic evaluation and financial planing. Any comments?