For questions 1-4 below, keep it high-level. Don't go off into the weeds. I just need a summary really of what the overall concept is and why the analysis is performed, what information we get out o
THE TEXTBOOK
Introduction to the Financial Management of Healthcare Organizations
Author: Michael Nowicki
Publisher: Health Administration Press, Chicago, Illinois.
Edition: 6th or 7th
Cost Accounting
While this is a very short chapter in the text, any successful healthcare organization will have some method for tracking the costs associated with the services they provide.
Methods of Classifying Costs
The first step in cost accounting is classifying costs. Several methods are used.
The first method is by accounting function, which has two categories. The first of these is financial accounting costs. These are a measurement in monetary terms of the amount of resources used for a certain purpose.
The second is managerial accounting costs, which are present and future costs that help management make better decisions.
The second method is by management function. Operating costs are the costs associated with producing the product or service. Non-operating costs are associated with supporting the production of a product or service. An example in a hospital setting would be housekeeping expenses.
The third method of classifying costs is by traceability. Direct costs are costs that can be traced directly to a department, product, or service. Indirect costs are overhead costs that cannot be traced directly to a department, product, or service. An example would be utilities.
The fourth method is behavior, which allocates costs by behavior in relation to the volume of the product or service. Variable costs vary directly and proportionally to changes in volume. Semi-variable costs vary incrementally to changes in volume. The costs would be the same for items 1-6, increase for items 7-12, etc. Fixed costs remain constant in relation to changes in volume. An example here would be rent, which is the same amount every month no matter how many units are produced.
Also important is the relevance to decision making. Controllable costs are under the manager's influence. Uncontrollable costs are outside the manager's influence. An example would be utilities. As these rates increase and are shared by all departments, the manager has no control of the utility expense. Sunk costs are costs that have already been incurred and should have no relevance to future decisions.
Methods for Allocating Costs
Healthcare organizations do not generate a separate charge for every product or service they sell. For example, there is not a charge generated for utilities. Instead these charges are allocated to each department that generates charges, such as lab or radiology. This process is called cost allocation. The primary purpose of cost allocation is to allocate indirect costs and some direct costs in a way that ensures patients are paying for only the costs of the products or services received.
First, each department is designated a cost center, but not all departments are revenue centers. In the organizational chart, each department has a person designated as the department head, and as such, this is the person responsible for the costs and/or revenue for that department.
Second, for those departments that do not generate revenue, their costs must be allocated to departments that do generate revenue. Housekeeping expenses are usually allocated by square footage, as are utilities.
Third, the organization must have an accounting system that properly and accurately applies costs and charges to the appropriate revenue and cost centers. This system will have general ledger account numbers assigned to each department for revenues and account numbers assigned for costs. By using these, the organization can produce reports showing the expenses of each department and the profit or loss for each revenue center.
Fourth is the workload statistic. The organization's information system should generate accurate non-financial statistics for every department. This should reflect the work generated by that department. The workload for the laundry department is usually pounds of laundry. The workload for the health information department (medical records) is usually discharges.
Fifth, the organization must determine the cost allocation method. There are several methods from which to choose. The text lists several methods, but the most common methods are the direct apportionment method and the step-down apportionment method. In the direct apportionment method, a one-time allocation of all costs from non-revenue-generating departments is allocated to the departments that do generate revenue.
In the step-down method, a two-step process is involved. First, a one-time allocation of costs to departments that do not generate revenue is allocated to other cost center departments that do generate revenue. The costs of utilities and housekeeping would be allocated to the business office before the business office expenses would be allocated to revenue generating departments. This allows for the cost allocations of non-revenue departments that provide services to other non-revenue departments. The step-down method is the most commonly used method within hospitals. However, most large facilities will use the double apportionment method of allocating costs but it requires a significant computer system which may make it cost-prohibitive for smaller hospitals.
The relationship of costs to volume and revenue is as simple as this:
Profit = Revenue - Expenses
As mentioned earlier, a proper accounting system will generate an income statement for the manager of a revenue producing department. The manager will be evaluated by the amount of profit. This will also be analyzed against budget expectations, the previous month's profit, and the same period from the previous year. For managers of non-revenue generating departments, their reports will show the actual expenses versus the budget, the previous month, and the same period for the previous year.
In all things, such as cost containment and revenue generation, we are held accountable for maintaining the standards established in the development of the operational plan and budget
