DB 4

Chapter 15

Product Costing

Learning Objectives

• Describe the existing needs for cost information in healthcare firms.
• Describe how cost information relates to the three key activities of management: planning, budgeting, and control.
• Describe the three main phases of the costing process.
• Explain the two systems necessary to accurately cost healthcare encounters of care.
• Describe the concept of relative value units.

Three Questions for Healthcare Cost Accounting

• What are we trying to cost?
• For what time period is the cost information of value?
• How do our needs for cost information relate to existing cost systems?

What Are the Cost Objects of Health Care?

• Healthcare firms produce a large number of products.
• Many of these products are bundled into an encounter of care.
• An encounter of care includes all products and services during a specific treatment or episode of care.
• Examples of encounters:

• –Inpatient: MS-DRGs (e.g., MS-DRG #193 –Simple Pneumonia and Pleurisy w/MCC)
• –Outpatient: APCs (e.g., #0143 –Lower GI Procedures)

What Time Period Is Relevant?

• Time periods will either be historical or future.
• Historical costing is by itself of little value.
• Future costs are most relevant, but often rely on historical cost data.

How Can Present Reporting Systems Be Best Utilized in Costing Encounters of Care?

• Present financial accounting systems will continue to exist because they fulfill reporting needs.
• Basics of most current financial accounting systems:

• –A measure of facility cost (e.g., $100 million)
• –Allocation of facility cost to responsibility centers or departments

• Dilemma of costing

• –How to take departmental cost measures and assign those values to encounters of care

FIGURE 15-1 The Planning-Budgeting-Control Process

Planning and Product Issues

• Products versus product lines
• A treated patient represents a product; also called “encounter of care”
• Strategic business units (SBUs)

• –DRGs or APCs are not SBUs or product lines
• –Clinical specialty areas may represent SBUs

Budgeting and Resource Expectations

• Budgeting translates product decisions into resource expectations.
• Two major objectives are

• –Assure financial viability of plan
• –Establish a basis for management control

• Primary output of a budget is a set of departmental budgets outlining expected costs.

Control and Corrective Action

• Deviations or variances from the budget are identified.
• Corrective action may be taken to correct the variance in future time periods if unfavorable.
• Sometimes variances may reflect changes in budget assumptions.

FIGURE 15-2 The Cost Measurement Process

Valuation Areas

• What basis should be used?

• –In most cases, it is historical cost.

• Assigning cost to a time period can be an issue in two types of cases:

• –Long-lived assets, such as buildings and equipment
• –Normal accruals where costs are recognized prior to expenditure (e.g., payroll)

Allocation Areas

• Primary task is assignment of costs charged to indirect departments to direct departments.
• Allocation of indirect costs requires two decisions:

• –Allocation basis (e.g., hours worked or square feet)
• –Apportionment method

• Step-down
• Double distribution
• Simultaneous equations

Production Phases

• Actual process of creating products/services in a health setting is split into two stages:

• –Stage 1

• Departments/activity centers acquire resources and produce product “service units” (SUs).
• Some SUs are traceable to the patient, others are not.

• –Stage 2

• Consumption of SUs in treatment process (e.g., surgeries, lab tests, etc.)
• Physicians often direct this stageof production.

FIGURE 15-3 The Production Process for Healthcare Firms

Two Required Systems for Costing Encounters of Care

• Standard cost profiles

• –Tells how much it did or will cost to produce specific SUs, such as lab tests or surgical procedures

• Standard Treatment Protocols (STP)

• –Tells us how many units of a SU either were required or will be required to produce a specific encounter of care

Relative Value Unit Costing

• Some departments, such as the lab, have many products or SUs.
• Relative values are often used to collapse many units to just one. In relative value unit (RVU) costing, some relative weights are assigned for each of the commonly produced outputs. For medical groups, the most commonly accepted classification of outputs is current procedural terminology (CPT) codes.