DB 4

Chapter 17

Cost Variance Analysis

Learning Objectives

• Describewhatismeantbycostcontrol.
• Describethetwomajortheoriesusedforthedetectionofout-of-controlcosts.
• Definevarianceanalysisandhowitisusedbymanagement.
• Calculatethevarioustypesofcostvariances.
• Explainandcalculateprice,efficiency,andvolumevariances.

FIGURE 17-1 Out-of-Control Timing

Efficiency Cost

• Total cost incurred by an organization that results from an out-of-control situation
• Efficiency cost = T x R x P

• –T = Total time units from problem occurrence to correction
• –R = Loss or cost per time unit
• –P = Probability that problem can be corrected

Alternatives for Minimizing Efficiency Cost

• Preventive Approach

• –Attempts to minimize P (probability of a problem occurring)
• –Emphasis on staffing the right people, giving the right motivation, providing relevant training

• Detection-Correction (DC) Approach

• –Attempts to minimize T (total time problem is present)
• –Emphasis on reporting and variance analysis

Cost Variance Analysis

Requirements for variance analysis

• Standards (budgets)
• Related cost accounting system
• Fixed/variable split of costs

Phases in cost control

• Recognition of problem
• Determination of problem/cause
• Correction of problem
• –Budgetary
• –Operational

Alternative Methods to Determine when to Investigate a Variance

Control Chart

Biggest problem is failure to recognize costs of investigation or benefits of problem correction

x= 0

x+ 2 σ

x-2 σ

Alternative Methods, cont.

• Decision Theory (Payoff Table)
• –I = Cost of Investigation
• –L = Loss if system out of control

Variance Analysis Areas

• Facility Level
• –High-level explanation of why costs have changed
• Departments/Responsibility Centers
• –Prior period cost analysis
• –Budgetary cost comparisons
• Health Plan/Managed Care

Variance Analysis: Facility Level

• Cost per discharge changes result from
• –Resource price changes
• –Productivity changes
• –Intensity changes

Cost Equation

• CPDt= Ct×Qt
• Ct
• Units of output in each department required per adjusted discharge

= Cost (direct and indirect) per unit of out put in each department

Variance Analysis: Facility Level, cont.

• Two indices split the variance into causes:
• –Hospital Cost Index (HCI): change in cost due to price and productivity
• –Hospital Intensity Index (HII): change in cost due to changes in service intensity

Variance Analysis: Facility Level, cont.

• Change in cost per discharge
• –CPDt/ CPD0
• –HCI x HII
• HCI is defined as the following:
• HII is defined as the following:

HCI

=

C Q

C Q

t

0

0

0

HII

=

C Q

CQ

t

0

0

0

Variance Analysis: Facility Level, cont.

• Compute HCI (CtQ0/ C0Q0)

Variance Analysis: Facility Level, cont.

• Compute HII (C0Qt/ C0Q0)

Variance Analysis: Summary

Total Cost/Discharge Example

2015 Cost / Discharge =$3,275.00

2017 Cost / Discharge =

$4,310.34

% Increase

31.6%

HCI %

24.2%

HII %

5.5%

Joint %

1.9%

Total

31.6%

One Department (Lab)

HCI = = 1.143

HII= = 1.207

Variance Analysis (2015 to 2017)

Cost Increase % =

14.3

Intensity Increase % =

20.7

Joint Effect Increase % =

2.9

Total

37.9%

$85.71 x 5.0

$75.00 x 5.0

$75.00 x 6.0345

$75.00 x 5.0

Variance Analysis: Facility Level, cont.

Variance Analysis: Departmental

• Causes of variance
• –Price (wages or prices of supplies differed from budget)
• –Efficiency (resource quantities used differed from budget)
• –Volume (actual volume of services differed from budget)
• –Utilization (output provided differed from what was required)

Categories of Variances

Price

Efficiency

Volume

Variance = [Actual Price –Standard Price] x Actual Quantity

Variance = [Actual Volume –Standard Volume] x Standard Fixed Cost/Unit

Variance = [Actual Quantity –Standard Quantity] x Standard Price

Variance Analysis: Departmental, cont.

Departmental Variance Example

• Efficiency Variances
• a.Head nurse = (180 –189) x $30.00 = $270.00 (Favorable)
• b.RN = (1,800 –1,830) x $24.00 = $720.00 (Favorable)
• c.LPN = (1,200 –1,200) x $16.00 = 0
• d.Aides = (2,400 –2,430) x $10.00 = $300.00 (Favorable)
• e.Supplies = (1,300 –1,200) x $4.40 = $440.00 (Unfavorable)

Departmental Variance Example, cont.

• Price Variances
• a.Head nurse = ($31.00 –$30.00) x 180 = $180.00 (Unfavorable)
• b.RN = ($25.00 –$24.00) x 1,800 = $1,800.00 (Unfavorable)
• c.LPN = ($16.20 –$16.00) x 1,200 = $240.00 (Unfavorable)
• d.Aides = ($9.60 –$10.00) x 2,400 = $960.00 (Favorable)
• e.Supplies = ($4.80 –$4.40) x 1,300 = $520.00 (Unfavorable)
• Volume Variance
• a.Volume variance = (630 –600) x $43.00 = $1,290.00 (Unfavorable)

Variance Analysis: Departmental, cont.

• Summary
• –Price Variance$1,780 (U)
• –Efficiency Variance$850 (F)
• –Volume Variance$1,290 (U)
• –Total$3,920

Variance Analysis: Managed-Care Contracts

• Cost = Inpatient (IPC) + Outpatient (OPC)
• IPC = Admissions x Cost per Admission

= [Enrollees (E)] x [Admission per Member (APM)] x

[Cost per Admission (CPA) x Admission Case-Mix Index (ACMI)]

• OPC = Visits x Cost per Visit

= [Enrollees (E)] x [Visits per Member (VPM)] x

[Cost per Visit (CPV) x Visit Case-Mix Index (VCMI)]

• Cost Drivers
• 1.Enrollment (E)
• 2.Utilization (APM or VPM)
• 3.Efficiency (CPA or CPV)
• 4.Patient Mix (ACMI or VCMI)
• Sample Data

Variance Analysis: Managed-Care Contracts, cont.

Budget	Actual
IP Costs	$12,568,500	$16,531,200
OP Costs	5,433,120	5,372,640
Total	18,001,620	21,903,840
Members (E)	42,000	41,000
Admission Rate (APM)	0.070	0.080
Admissions	2,940	3,280
Visit Rate (VPM)	0.400	0.390
Visits	16,800	15,990
IP Case Mix (ACMI)	0.90	1.05
OP Case Mix (VCMI)	1.10	1.20
Cost per Admission (CPA)	$4,750	$4,800
Cost per Visit (CPV) (VCMI = 1.0)	$294	$280

• Enrollment Variance = Change in Members x Budgeted Use Rates x Budgeted Cost per Unit

1. Inpatient

= (Ea–Eb) x APMbx CPAbx ACMIb

= –1000 x 0.07 x $4,750 x 0.90

= –$299,250 (Favorable)

2. Outpatient

= (Ea–Eb) x VPMbx CPVbx VCMIb

= –1000 x 0.400 x $294 x 1.10

= –$129,360 (Favorable)

Variance Analysis: Managed-Care Contracts, cont.

• Utilization Variances = Change in Use Rates x Actual Members x Budgeted Cost per Unit

1. Inpatient

= (APMa–APMb) x Eax CPAbx ACMIb

= (0.080 –0.070) x 41,000 x $4,750 x 0.90

= $1,752,750 (Unfavorable)

2. Outpatient

= (VPMa–VPMb) x Eax CPVb x VCMIb

= (0.390 –0.400) x 41,000 x $294 x 1.10

= –$132,594 (Favorable)

Variance Analysis: Managed-Care Contracts, cont.

• Efficiency = Change in Cost per Unit x Actual Units

1. Inpatient

= (CPAa–CPAb) x ACMIax Eax APMa

= ($4,800 –$4,750) x 1.05 x 41,000 x 0.08

= $172,200 (Unfavorable)

2. Outpatient

= (CPVa–CPVb) x VCMIax Eax VPMa

= ($280 –$294) x 1.20 x 41,000 x 0.390

= –$268,632 (Favorable)

Variance Analysis: Managed-Care Contracts, cont.

• Patient Mix = Change in Case Mix x Budget Cost per Unit x Actual Volume

1. Inpatient

= (ACMIa–ACMIb) x CPAbx Eax APMa

= (1.05 –0.90) x $4,750 x 41,000 x 0.08

= $2,337,000 (Unfavorable)

2. Outpatient

= (VCMIa–VCMIb) x CPVbx Eax VPMa

= (1.20 –1.10) x $294 x 41,000 x 0.390

= $470,106 (Unfavorable)

Variance Analysis: Managed-Care Contracts, cont.

• Summary Variance Analysis (negative values are favorable)

Enrollment

Utilization

Efficiency

Patient Mix

Total

($299,250)

1,752,750

172,200

2,337,000

$3,962,700

($129,360)

(132,594)

(268,632)

470,106

($60,480)

($428,610)

1,620,156

(96,432)

2,807,106

$3,902,220

InpatientOutpatientTotal

Variance Analysis: Managed-Care Contracts, cont.

Variance Analysis: Managed-Care Contracts, cont.

• Conclusions
• –A large increase in both IP and OP case mix increased costs
• –IP usage was also up, increasing costs