ESSENTIALS OF COST ACCOUNTING FOR HEALTH CARE ORGANIZATIONS doc

Essentials ofCost Accounting for HEALTH CARE ORGANIZATIONS Third Edition STEVEN A.. Essentials of cost accounting for health care organizations / Steven A.. .63 Traditional Cost Allocati

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Essentials of

Cost Accounting

for

HEALTH CARE ORGANIZATIONS

Third Edition

STEVEN A FINKLER, PhD, CPA

Program in Health Policy and Management Robert F Wagner Graduate School of Public Service

New York University New York, New York

DAVID M WARD, PhD

College of Health Professions University of New England Biddeford, Maine

JUDITH J BAKER, PhD, CPA

The Resource Group Dallas, Texas

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Library of Congress Cataloging-in-Publication Data

Finkler, Steven A.

Essentials of cost accounting for health care organizations / Steven A Finkler, David M Ward, Judith J Baker.

— 3rd ed.

p ; cm.

Includes bibliographical references and index.

ISBN-13: 978-0-7637-3813-6

ISBN-10: 0-7637-3813-1

1 Health facilities—Costs—Accounting 2 Hospitals—Cost of operation—Accounting 3 Cost accounting

I Ward, David M (David Marc), 1964- II Baker, Judith J III Title

[DNLM: 1 Costs and Cost Analysis 2 Health Facilities—economics 3 Accounting—methods 4 Econom-ics, Hospital WX 157 F499e 2007]

HF5686.H7F563 2007

657’.8322042—dc22

2006028724 6048

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To Lilli, Joanne, and R.W (the Bear)

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Preface xiii

About the Authors xvii

PART I COST ACCOUNTING FOUNDATIONS 1

CHAPTER1 Introduction to Cost Accounting .3

The Purpose of Cost Accounting .4

Costs for Reporting vs Costs for Management Planning and Control .7

Good Cost Accounting Systems .8

The Human Element in Cost Accounting .9

Suggested Reading .10

Exercises .10

CHAPTER2 Cost Definitions .13

Definition and Characteristics of Costs .15

Cross-Subsidization of Costs .19

True Cost, Economic Cost, and Accounting Cost .21

The Long Term vs the Short Term .24

Departmental vs Product-Line Costing .26

External Costs .30

Notes .31

Exercises 31

Problems 31

CHAPTER3 Product Costing .33

The Need for Product Costing .34

Job-Order and Process Costing 34

Process Costing .36

Job-Order Costing .37

v

Contents

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Hybrid Approaches to Product Costing .40

Standard Costing Systems 41

Microcosting .46

Product Costing and Computers .46

Notes .47

Exercises 47

Problems 48

CHAPTER4 Cost Allocation 49

What Is Cost Allocation? .51

Determining Overhead Application Rates .52

Cost Allocation and Motivation .59

Allocating Joint Costs .63

Traditional Cost Allocation for Health Care Organizations .66

Is Good-Enough Cost Finding Good Enough? 76

Notes .79

Exercises 79

Problems 80

CHAPTER5 Costing for Nonroutine Decisions .83

Cost Information for Nonroutine Decisions .84

Sunk Costs Are Irrelevant .85

The Role of Volume .86

Terminology for Relevant Costing .88

Examples of Nonroutine Decisions .88

Cost-Benefit and Cost-Effectiveness Analysis .92

Notes .94

Exercises 94

Problems .95

CHAPTER6 Cost-Volume-Profit Analysis .97

The Cost-Volume-Profit Relationship .98

Breakeven Analysis 100

Caveats .107

Mixed Costs and Step-Fixed Costs .111

Using Breakeven Analysis for Decision Making .112

Exercises .113

Problems .114

vi CONTENTS

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PART II COST ACCOUNTING INFORMATION FOR

PLANNING AND CONTROL 117

CHAPTER7 Predicting Future Costs .119

Using Groups for Estimating Costs .121

Indexing for Inflation .122

Cost Estimation Using Linear Regression .125

Forecasting .136

Learning Curves .150

Exercises .155

Problems .156

Case Study—Part 1 .157

CHAPTER8 Budgeting .159

The Role of Budgeting .160

Budgeting Philosophy .162

The Master Budget .163

The Long-Range Budget 164

The Operating Budget 165

The Cash Budget .167

Program Budgets 175

The Capital Budget .175

Special-Purpose Budgets .187

The Negotiation and Approval Process .187

Flexible Budgets .188

Note .188

Exercises 189

Problems 189

Appendix 8–A: Present Value and Compound Interest Tables 193

CHAPTER9 Flexible Budgeting and Variance Analysis .199

Traditional Variance Analysis .201

Flexible Budget Variance Analysis .203

Calculation of Variances .210

Variance Analysis and Management Control .214

Revenue Variances .218

Notes .225

CONTENTS vii

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Exercises .225

Problems .226

CHAPTER10 Management Control .229

Is Management Control a Science? .230

Responsibility Centers for Management Control .231

The Management Control Process .233

Key Variables .235

Internal Control Systems 237

Transfer Pricing 242

Management Control of Projects .242

Notes .250

Exercises .251

Problem .251

PART III ADDITIONAL COST ACCOUNTING TOOLS TO AID IN DECISION MAKING 253

CHAPTER11 Cost Accounting Ratios 255

Financial Ratios 256

Development of a New Set of Ratios .257

Some Cost Accounting Ratios .258

Comparisons .260

Notes .262

Exercises .262

Problems .263

CHAPTER12 Measuring Productivity .265

Productivity Defined .266

The Traditional Approach to Measuring Productivity .266

The Total Productivity Ratio 267

The Partial Productivity Ratio .268

Productivity and Indirect Costs 270

Managing Discretionary Costs .273

Notes .280

Exercises .281

Problems .281 viii CONTENTS

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CHAPTER13 Inventory .283

Inventory Costing .284

Minimization of Inventory Costs .291

Inventory Issues Related to Health Care Manufacturing .303

Notes .303

Exercises .303

Problems .304

CHAPTER14 Dealing with Uncertainty .305

Uncertainty .306

The Expected Value Technique 306

Simulation Analysis .313

Network Cost Budgeting 319

Linear Programming .326

Notes .331

Exercises .332

Problems 332

CHAPTER15 Information Systems for Costing 335

Considerations in Designing Costing Systems 336

The Risks of Do-It-Yourself Computing .338

Exercises .343

CHAPTER16 Performance Evaluation and Incentive Compensation .345

Responsibility Centers .346

Evaluating Investment Centers and Their Managers .349

Creating Compensation Incentives .353

Notes .358

Exercises .358

Problem .359

PART IV COST ACCOUNTING FOR THE FUTURE .361

CHAPTER17 New Approaches to Cost Accounting .363

Is There a Problem with Traditional Cost Accounting? .364

Kaplan’s Four-Stage Cost Model .365

An Alternative: New Generally Accepted Accounting Principles for One Unified System .367

CONTENTS ix

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The Japanese Alternative .369

Dashboards .370

Balanced Scorecards .371

Notes .372

Exercises .373

CHAPTER18 Activity-Based Costing .375

What is ABC? .376

Why Use ABC? .378

Two Approaches to ABC .378

Tracing vs Allocating in ABC .378

ABC Allocation Principles .379

What Should Be Allocated in ABC? 380

An ABC Example in the Pharmacy .381

Designing and Documenting an ABC Project .386

Commencing an ABC Project in the Day Surgery .387

Another Approach to ABC .389

The Activity-Based Management Concept 390

Does ABC Make Sense for Health Care Organizations? .391

Notes .392

Exercises 392

Problems 393

Chapter 19 Total Cost Management: Measuring the Costs of Quality .395

Cost Accounting and Quality Management .396

An Introduction to TQM .397

A Focus on Time .399

A Focus on Cost .400

Total Cost Management .401

The Quality of Cost Data .416

A Focus on Customers .419

Notes .419

Exercises 420

Problems 421

Chapter 20 Summary and Issues for the Future .423

Cost Accounting Foundations 424

Cost Accounting Information for Planning and Control .427

Additional Cost Accounting Tools to Aid in Decision Making .429

Cost Accounting for the Year 2010 and Beyond .431

Additional Future Issues .433

x CONTENTS

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Notes .438

Exercises 439

Glossary 441

Index 461

CONTENTS xi

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Cost accounting is an essential part of health care management As managed care has taken hold, all health care organizations have increased their focus on the measurement and control of costs All health care managers, not just accountants, are becoming more and more aware of the importance of understanding as much about costs as they possibly can

A number of textbooks are available in the cost accounting field However, these generic cost ac-counting texts focus primarily on manufacturing industries and only secondarily on service industries such as health care Their emphasis is therefore largely on the process of converting raw materials into finished goods Such books give a great deal of attention to determining the cost of work-in-process and by-products However, cost accounting texts written expressly for health care are scarce

This book thoroughly covers the essentials of cost accounting from a health care perspective, in-cluding all of the basic tools of cost accounting common to all industries, using health care examples

Essentials of Cost Accounting for Health Care Organizations, Third Edition, focuses on costing issues and concepts unique to the health care field The tools covered are all practical, although not all are commonly used Some approaches, such as learning curves, are commonly used in other industries but not in health care It is our hope that readers will see the value of some of these less frequently used techniques and adopt them for use in their organizations

The main theme of the book is the generation of useful cost information to aid managers in making decisions The contents are therefore oriented toward both current and future accountants who will generate the information, as well as all current and future health care managers who want to know the types of information potentially available

Essentials of Cost Accounting for Health Care Organizationsdoes not rely heavily on debits, cred-its, journal entries, and other technical accounting terminology This omission was intentional to make the book accessible to a wide range of readers—students and faculty in university programs for health administration (both undergraduate and graduate), as well as individuals already working in the field of health administration The need to obtain improved information to facilitate decisions is critical at all levels of management

In keeping with the first and second editions, this book provides a thorough conceptual foundation

In this third edition, we have continued to follow the trend of the health care industry, moving away from a dominant focus on hospitals The concepts and examples used in the text address not only hos-pitals but also nursing homes, physician practices, managed care organizations, clinics, surgicenters, and a wide range of other types of health care organizations

xiii

Preface

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In the third edition, we also continue to integrate personal computers (PCs) and the internet Many chapters provide examples designated as “Excel®Problems.” These problems are specifically designed

to be solved with a computer-based spreadsheet application like Microsoft Excel® In addition, we have created ancillaries at www.jbpub.com/catalog/0763738131 that include data sets and Excel® tem-plates that readers can download to solve the Excel®problems On this site, we also include instruc-tions on specific Excel®tasks related to the chapters and the problems

The text is broken into four parts Part I provides the foundations of cost accounting Part II ad-dresses the use of cost accounting for planning and control Part III provides additional cost accounting tools to aid in decision making, and Part IV discusses the latest trends and techniques in cost account-ing

Part I provides the reader with a solid base in the essentials of cost accounting The chapters in this section introduce costing and cost definitions Various approaches to product costing and cost alloca-tion are discussed Breakeven analysis is also covered in the secalloca-tion, as are techniques for making non-routine decisions

A primary focus of cost accounting is on developing information that managers can use for planning and control Once the reader is familiar with the foundations of cost accounting provided in Part I, Part

II presents a number of specific tools for improved planning and control The chapters in this section focus on forecasting and predicting future costs, budgeting, flexible budgeting and variance analysis, and management control

Part III addresses a number of additional cost accounting tools that can be helpful in generating management information for decision making Specifically, there are chapters on cost accounting ra-tios, productivity measurement, inventory, uncertainty, information systems, and performance evalua-tion

For the past several decades, literature critical of current cost accounting practices throughout all U.S industries has been growing The concern is that costing has evolved primarily into a tool for ex-ternal reporting of financial results rather than for managing the organization This concern has led to a movement to revise cost accounting practices drastically to make them more relevant The criticisms of cost accounting and a number of suggested approaches for improvement are discussed in Part IV A new chapter about activity-based costing has been added to this third edition The chapters in this part also examine total quality management and the future of costing

The last chapter summarizes the book Some instructors may choose to assign this last chapter at the beginning of the course to provide an in-depth overview of the material It can then be assigned again

at the end, for review, and to integrate the great breadth of material covered in the book

Each chapter begins with a set of specific learning objectives listed for the reader In addition, we present key application questions, which serve as examples of typical questions readers will be able to answer after completing the chapter The key application questions are followed by a set of key terms used in the chapter Each of the key terms is shown in boldface italics the first time it appears in the chapter, and all are defined in the glossary at the end of the book Each chapter has exercises and ques-tions for discussion

An instructor’s manual is available online for instructors who adopt the book for classroom use The manual includes solutions to all questions and problems at the end of the chapters and an exami-nation test bank with solutions, along with PowerPoint slides arranged by chapter

While the task of updating and revising is certainly easier than creating, putting together the third edition of this book proved to be quite a challenge We have attempted to create a book that provides

xiv PREFACE

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