Health Care Finance
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ch4book.docx4.1 introduction
Healthcare managers have many responsibilities. The more important ones include planning for the future, establishing policies that control the operations of the organization, and overseeing the day-to-day activities of line employees.
For example, the practice manager of a primary care practice must estimate future demand (volume) and see to it that the practice has the facilities, staff, and supplies necessary to meet this demand. He does so primarily by creating budgets that use forecasted future volume to estimate the resources needed to meet expected patient demand. As the future unfolds, the practice manager must monitor operations to see if the volume estimates were correct. If not, supplies and staffing requirements must be adjusted to reflect variations from forecasts. Finally, he must constantly review the resources used to ensure that they are being acquired at the lowest possible costs.
All of these activities require information—a great deal of it. Furthermore, it has to be compiled in a format that facilitates analysis, interpretation, and decision making. Without timely and relevant information, healthcare managers would be making decisions essentially in the dark. Of course, accurate information does not ensure good decision making, but without it the chances of making good decisions are almost nil.
The foundation of a good information system is the manager’s ability to estimate costs with confidence. This is not an easy task. You may be able to precisely estimate the cost of your college education—just add up the costs of tuition, books and supplies, room and board, and so on—but what about the costs of healthcare organizations? Their overall (total) costs can be measured with some precision, such as the total costs of running a hospital or a medical practice. But what about the costs of running the emergency department, or the costs associated with Medicare patients, or the costs of treating patients who have had heart attacks? Estimating these costs with confidence is essential to sound management, yet many factors complicate the estimation process.
Although cost estimation comes with a multitude of problems, it is far too important to the financial well-being of healthcare providers to do in a sloppy way. Thus, organizations put a lot of time and effort into doing the best possible job at it.
4.2 The basics OF managerial accounting
Cost estimation is an accounting function, so our coverage begins with some accounting basics. Accounting is split into two primary areas: managerial accounting and financial ac- counting. Whereas financial accounting (discussed in Chapters 11 and 12) focuses on the reporting of operational and financial results to outsiders, managerial accounting focuses on the development of information used internally for managerial decision making.
Managerial accounting information is used in routine budgeting processes, to allocate managerial bonuses, and to make pricing and service decisions, all of which deal with subunits of an organization. In addition, managerial accounting data can be
compiled for special purposes, such as assessing alternative modes of delivery or projecting the profitability of a particular reimbursement contract.
Because managers are more concerned with what will happen in the future than with what has happened in the past, managerial ac- counting is for the most part forward looking. But because most of the future is unknown, compiling managerial accounting information requires making many assumptions about future events. For example, as managers create budgets, they often must make assumptions regarding utilization (volume), reimbursement rates, and costs.
A critical part of managerial accounting is the measurement of costs. One issue that makes this task difficult is the fact that no single definition of the term cost exists. Rather, different costs exist for different purposes. As a general rule for healthcare providers, a cost involves a resource use associated with providing, or supporting, a specific service. However, the cost per service identified for pricing purposes can differ from the cost per service used for management control purposes. Also, the cost per service used for long-range planning purposes may differ from the cost per service defined for short-term purposes. Thus, when dealing with costs, managers have to under- stand the context so that the correct cost is identified. To further complicate matters, costs do not necessarily reflect actual cash outflows.
Costs are classified in two primary ways: by their relationship to the volume (amount) of services provided and by their relationship to the unit (i.e., department) being analyzed. This chapter focuses on these two cost classifications. In Chapter 5, we add revenues to the mix and show how to convert cost estimates into profit estimates.
Cost
A resource use associated with providing, or supporting, a specific service.
4.3 cost classification I: Fixed versus variable costs
One way to define (classify) costs is on the basis of their relationship to the amount of services provided, often referred to as volume or utilization. Future volume—the number of patient days, visits, enrollees, laboratory tests, and so on—is almost always uncertain.
Volume may be forecasted in a number of ways. One way is to review historical
trends, say, over the past five to ten years. In many situations, the past is a good predictor of the future. If the manager believes this to be the case, then he can apply statistical analysis (linear regression) to the historical data to predict future volumes. If past data are not available or if significant changes in the operating environment are taking place, then volume forecasting becomes more difficult. In that situation, the manager must evaluate population and disease trends in the service area, actions of competitors, pricing strategies, the impact of new contracts with insurers, and a whole host of additional factors that influence future volume.
If a provider’s volume forecast turns out to be inaccurate, the consequences can be severe. First, if the market for any particular service expands more than expected and planned for, then the provider will not be able to meet its patients’ needs. Potential patients will go elsewhere, and the business will lose market share and perhaps miss a major opportunity to maintain or grow its business. On the other hand, if projections are overly optimistic, the provider could end up with excess equipment, supplies, and staff, and hence costs that are higher than necessary.
In spite of the difficulties in forecasting volume with precision, managers typically have some idea of the potential range. For example, the manager of Northside Clinic, a small walk-in clinic, might estimate that the total number of patient visits for next year will likely range from 12,000 to 14,000 or from about 34 to 40 per day. If utilization is not likely to fall outside of these bounds, then the range of 12,000 to 14,000 annual visits defines the clinic’s relevant range. Note that the relevant range pertains to a particular time period—in this case, next year. For other time periods, the relevant range might differ from this estimate.
Fixed costs
Some costs, called fixed costs, are more or less known with certainty, regardless of the level of volume within the relevant range. For example, Northside Clinic’s labor force would be increased or decreased only under unusual circumstances. Thus, as long as volume falls within the relevant range of 12,000 to 14,000 patient visits, labor costs at the clinic are fixed for the coming year. The actual number of visits might turn out to be 12,352 or 13,877, but labor costs will remain at their forecasted level as long as volume falls within the relevant range. Other examples of the clinic’s fixed costs include expenditures on facilities (e.g., rent, property taxes, utilities), diagnostic equipment, and information systems. After an organization has acquired these assets, it typically is locked into them for some period of time regardless of volume fluctuations, so these costs are known beforehand.
Of course, no costs are fixed over the long run or over large volume changes. At some point of increasing volume, healthcare businesses must incur additional fixed costs for new facilities and equipment, additional staffing, and so on. Likewise, if volume decreases by a substantial amount, an organization likely would reduce fixed costs by shedding part of its facilities and equipment and labor base.
Variable Cost
Whereas some costs are fixed regardless of volume (within the relevant range), other re- sources are more or less consumed as volume dictates. Costs that are related to (depend on) volume are called variable costs. For example, the costs of the clinical supplies (e.g., rubber gloves, tongue depressors, hypodermics, and bandages) used by Northside would be classified as variable costs. Also, some of the clinic’s diagnostic equipment is leased on a per use basis (a fixed payment each time the equipment is used), which converts the cost of the equipment from a fixed cost to a variable cost. Finally, some healthcare organizations pay their employees on the basis of the amount of work performed, which would convert labor costs from fixed to variable. The bottom line is that fixed costs are independent of the volume of services delivered (within the relevant range), while variable costs depend on volume.
Underlying cost structure
Healthcare managers are vitally interested in how costs are affected by changes in the amount of services supplied. The relationship between costs and volume, called underlying cost structure (or just cost structure), is used by managers in planning, control, and decision making. The primary reason for defining an organization’s cost structure is to provide managers with a tool for forecasting costs (and ultimately profits) at different volume levels.
To illustrate the concept, consider the hypothetical cost data presented in Exhibit 4.1 for a hospital’s clinical laboratory. The cost structure consists of both fixed and variable costs—that is, some of the costs are expected to be volume sensitive and some are not. This structure of both fixed and variable costs is typical in health services organizations as well as most other businesses. For illustrative purposes, let’s assume the relevant range is from zero to 20,000 tests. (Of course, the actual relevant range might be from 15,000 to 20,000 tests.)
As noted in Exhibit 4.1, the laboratory has $150,000 in fixed costs that consist primar- ily of labor, facilities, and equipment costs. (We have purposely kept the numbers unrealistically small for ease of illustration.) These costs will occur even if the laboratory does not perform one test, assuming it is kept open. In addition to the fixed costs, each test, on average, requires $10 in laboratory supplies, such as glass slides, blood test tubes, and reagents.
The per unit (per test, in this example) variable cost of $10 is defined as the variable cost rate. If laboratory volume doubles—for example, from 500 to 1,000 tests—total variable costs will double from $5,000 to $10,000. However, the variable cost rate of $10 per test
remains the same whether the test is the first, the hundredth, or the thousandth. Total
variable costs, therefore, increase or decrease proportionately as volume changes, but the variable cost rate remains constant.
Fixed costs, in contrast to total variable costs, remain unchanged as the volume varies. When volume doubles from 500 to 1,000 tests, fixed costs remain at $150,000. Because all costs in this example are either fixed or variable, total costs are merely the sum of the two. For example, at 5,000 tests, total costs are Fixed costs + Total variable costs = $150,000 + (5,000 × $10) = $150,000 + $50,000 = $200,000. Because variable costs are tied to volume, total variable costs, and hence total costs, increase as the volume increases, even though fixed costs remain constant.
The rightmost column in Exhibit 4.1 contains average cost per unit of volume, which in this example is average cost per test. It is calculated by dividing total costs by experiences 10,000
volume. For example, at 5,000 tests, with total costs of $200,000, the average cost per test is $200,000 ÷ 5,000 = $40. Because fixed costs are spread over more tests as volume
increases, the average cost per test declines as volume increases. For example, when volume doubles from 5,000 to 10,000 tests, fixed costs remain at $150,000, but fixed cost per test declines from $150,000 ÷ 5,000 = $30 to $150,000 ÷ 10,000 = $15.
With fixed cost per test declining from $30 to $15, the average cost per test goes down from $30 + $10 = $40 to $15 + $10 = $25. The fact that higher volume reduces average fixed cost and average cost per unit of volume has important implications for profitability related to volume changes. (In economics, the state of declining average cost as volume increases is called economies of scale.)
The cost behavior presented in Exhibit 4.1 in tabular format is presented in graphical format in Exhibit 4.2. Here, costs are shown on the vertical ( y) axis, and volume (number of tests) is shown on the horizontal (x) axis. Because fixed costs are independent of volume, they are shown as a horizontal dashed line at $150,000. Total variable costs appear as an upward-sloping dotted line that starts at the origin (0 tests, $0 costs) and rises at a rate of $10 for each additional test. When fixed and total variable costs are combined to obtain total costs, the result is the upward-sloping solid line parallel to the total variable costs line but beginning at the y-axis at a value of $150,000 (the fixed costs amount). In effect, the total costs line is nothing more than the total variable costs line shifted upward by the amount of fixed costs.
Note that Exhibit 4.2 is not drawn to scale. Furthermore, the relevant range
is unrealistically large. The intent here is to emphasize the general shape of a cost
structure graph and not its exact position. Also, note that total variable costs plot as a
straight line (linear), because the variable cost rate is assumed to be constant over the relevant range. We assume throughout the book that the variable cost rate is constant, and hence total variable costs are linear, at least within the relevant range. For most healthcare organizations in most situations, such an assumption is not unreasonable.
Before we leave this illustration of underlying cost structure, we should mention that fixed and variable costs represent two ends of the volume classification spectrum. Here, within the relevant range, the costs are either independent of volume (fixed) or directly related to volume (variable). A third classification, semi-fixed costs, falls between the two extremes. To illustrate, assume that the actual relevant range of volume for the clinical laboratory is 15,000 to 20,000 tests. However, the laboratory’s current workforce can only handle up to 17,500 tests per year, so an additional technician, at an annual cost of $35,000, would be required if volume exceeds that level. Now, labor costs are fixed from 15,000 to 17,500 tests and again fixed at a higher level from 17,500 to 20,000 tests, but they are not fixed at the same level throughout the entire relevant range of 15,000 to 20,000 tests. Semi-fixed costs are fixed within ranges of volume, but multiple ranges of semi-fixed costs occur within the relevant range. To keep the illustrations manageable, we do not include semi-fixed costs in our examples in this book.
4.4 cost classification ii: Direct versus indirect (Overhead) costs
The second major cost classification is by relationship to the unit being analyzed. Some costs—about 50 percent of a large healthcare organization’s cost structure—are unique to the reporting subunit and hence usually can be identified with relative certainty. To illustrate, again think in terms of a hospital’s clinical laboratory. Certain costs are unique to the laboratory, for example, the salaries and benefits for the technicians who work there and the costs of the equipment and supplies used to conduct the tests. These costs, which would not occur if the laboratory were closed, are classified as the direct costs of the department.
Direct costs constitute only a portion of the laboratory’s total costs. The remaining resources used by the laboratory are not unique to the laboratory; the laboratory shares many resources of the hospital. For example, the laboratory shares the hospital’s physical space as well as its infrastructure, which includes information systems, utilities, house- keeping, maintenance, medical records, and general administration. The costs not borne solely by the laboratory but shared by all of the hospital’s departments are called indirect (overhead) costs.
Indirect costs, in contrast to direct costs, are more difficult to measure at the department level because they arise from shared resources—that is, if the laboratory were closed, the indirect costs would not disappear. Perhaps some indirect costs could be reduced, but the hospital still requires a basic infrastructure to operate its remaining departments. Note that the direct/indirect classification has relevance only at the subunit level. When the entire organization is considered, all costs are direct.
4.5 cost allocation
A critical part of cost measurement at the department level is the assignment, or allocation, of overhead costs. Cost allocation is a process within a health services organization whereby managers allocate the costs of one department to other departments. Because this process does not occur in a marketplace setting, no observable prices exist for the transferred services. Thus, cost allocation must, to the extent possible, establish prices that mimic those that would be set under market conditions.
What costs within a health services organization must be allocated? Typically, the costs associated with facilities and support personnel, such as land and buildings, administrators, financial staffs, and housekeeping and maintenance personnel, must be allocated to those departments that generate revenues for the organization (generally, patient services departments). The allocation of support costs to patient services departments is necessary because there would be no need for support costs if there were no patient services departments. Thus, decisions regarding pricing and service offerings by the patient services departments must be based on the total (full) costs associated with each service, including both direct and overhead costs. Clearly, the proper allocation of overhead costs is essential to good decision making within healthcare organizations.
The goal of cost allocation is to assign all of the costs of an organization to the activities that cause them to be incurred. Ideally, healthcare managers track and assign costs by individual patient, physician, diagnosis, reimbursement contract, and so on. With complete cost data available in the organization’s managerial accounting system, managers can make informed decisions regarding how to control costs, what services to offer, and how to price those services. Of course, the more data needed, the higher the costs of developing, implementing, and operating the system. As in all situations, the benefits associated with more accurate cost data must be weighed against the costs required to develop such data.
cost pools
The first step in allocating costs is to identify the cost pools and drivers. Typically, a cost pool consists of all the direct costs of one support department. However, if the services of a single support department differ substantially, and if the patient services departments use the different services in varying proportions, the costs of that support department may need to be separated into multiple pools.
The two cost classifications (fixed/ variable and direct/indirect) overlay one an- other. That is, fixed costs typically include both direct and indirect costs, while variable costs generally include only direct costs. For example, the fixed costs of a hospital laboratory include both labor (direct) and facilities (overhead) costs, but the variable costs (re- agents and other supplies) are all direct costs. Conversely, direct costs usually include fixed and variable costs, while indirect costs typically include only fixed costs.
Although this mixing of cost classifications can give anyone a headache, the good news is that the classifications typically are used independent of one another.
To illustrate multiple cost pools, suppose a hospital’s Financial Services Department pro- vides two significantly different services: patient billing and managerial budgeting. Furthermore, assume that the Routine Care Department uses proportionally more patient billing services than the Laboratory Department does, but Laboratory proportionally uses more budgeting services than Routine Care does. In this situation, it would be best to create two cost pools for one support department. The total costs of Financial Services would be divided into a billing pool and a budgeting pool. Then, cost drivers would be chosen for each pool and the costs allocated to the patient services departments as described in the following sections.
cost Drivers
One of the most important steps in the cost al- location process is the identification of proper cost drivers. The theoretical basis for identifying cost drivers is the extent to which the costs from a pool actually vary as the value of the driver changes. A good cost driver provides the most accurate cause-and-effect relationship between the use of services and the costs of the department using those services. For example, does a department with 10,000 square feet of space use twice the amount of housekeeping services as a department with only 5,000 square feet of space? The closer the relationship (correlation) between actual overhead resource expenditures at each patient services department and the value of the cost driver, the better is the cost driver and hence the better are the resulting cost allocations.
Effective cost drivers possess two primary characteristics. The first is fairness—that is, do the cost drivers chosen result in an allocation that is equitable to the patient services departments? The second, and perhaps more important, characteristic is cost reduction—that is, do the cost drivers chosen
create incentives for departments to use fewer overhead services? For example, inpatient department managers can do little to influence overhead cost allocations if the cost driver for administrative support is patient days. In fact, the action needed to reduce the overhead allocation—reduction in patient days—would likely lead to negative financial consequences for the organization. An effective cost driver encourages patient services department managers to take overhead cost reduction actions that do not have negative implications for the organization.
The allocation process
The steps involved in allocating overhead costs are summarized in Exhibit 4.3, which illustrates how Prairie View Clinic allocated its housekeeping costs for the 2013 budget.
First, the cost pool must be established. In this case, the clinic is allocating house- keeping costs, so the cost pool is the projected total costs of the Housekeeping Department, $100,000.
Second, the most effective cost driver must be identified. After considerable investigation, Prairie View’s managers conclude that the best cost driver for housekeeping costs is labor hours—that is, the number of hours of housekeeping services required by the clinic’s departments is the measure most closely related to the actual cost of providing these services. The intent here, as explained earlier, is to pick the cost driver that (1) provides the most ac- curate cause-and-effect relationship between the use of housekeeping services and the costs of the Housekeeping Department and (2) creates an incentive to use less housekeeping services.
Step One: Determine the cost pool.
The departmental costs to be allocated are for the Housekeeping Department, which has total budgeted costs of $100,000.
Step Two: Determine the cost driver.
The best cost driver was judged to be the number of hours of housekeeping services provided. An expected total of 10,000 hours of such services will be provided to those departments that will receive the allocation.
Step Three: Calculate the allocation rate.
$100,000/10,000 hours = $10 per hour of housekeeping services provided.
Step Four: Determine the allocation amount.
Physical Therapy Department uses 3,000 hours of housekeeping services, so its allocation of Housekeeping Department overhead is $10 × 3,000 = $30,000.
Third, the allocation rate must be calculated. For 2013, Prairie View’s managers estimate that Housekeeping will provide 10,000 hours of service to the departments that will receive the allocation. Now that the cost pool and cost driver have been defined and measured, the allocation rate is established by dividing the expected total overhead cost
(the cost pool) by the expected total volume of the cost driver: $100,000 ÷ 10,000 hours = $10 per hour of services provided. (Note that different allocation methods can identify different departments as the ones that will receive the allocation. In the example here, the relevant departments [the patient services departments] receive 10,000 hours of house- keeping service. If we had included the Financial Services Department in the allocation, the amount of service allocated might be 10,500 hours.)
Fourth, the allocation must be made to each department. To illustrate the allocation, consider the Physical Therapy (PT) Department, one of Prairie View’s patient services departments. For 2013, PT is expected to use 3,000 hours of housekeeping services, so the dollar amount of housekeeping overhead allocated to PT is $10 × 3,000 = $30,000.
Other departments within the clinic will also use housekeeping services, and their al- locations will be made in a similar manner. The $10 allocation rate per hour of services used is multiplied by the amount of each department’s utilization of housekeeping services to obtain the dollar allocation. When all patient services departments are considered, the entire clinic is projected to use 10,000 hours of housekeeping services, so the total amount allocated must be $10 × 10,000 = $100,000, which is the amount in the cost pool. For any department, the amount allocated depends on both the allocation rate and the amount of overhead services utilized.
cost allocation methods
Mathematically, cost allocation can be accomplished in a variety of ways, and the method used is somewhat discretionary. No matter what method is chosen, all support department costs eventually must be allocated to the departments (primarily patient services departments) that create the need for those costs.
The key differences among the methods are how support services provided by one department are allocated to other support departments. Exhibit 4.4 summarizes the three primary allocation methods as applied to Prairie View Clinic. To simplify the illustration, the clinic has only three support departments (Human Resources, Housekeeping, and Administration) and two patient services departments (PT and Internal Medicine).
Under the direct method, shown in the top section of Exhibit 4.4, each sup- port department’s costs are allocated directly to the patient services departments that use the services. In the illustration, both PT and Internal Medicine use the services of all three support departments, so the costs of each support department are allocated to both patient services departments. The key feature of the direct method, and the feature that makes it relatively simple to apply, is that none of the costs of providing support services are allocated to other support departments. In effect, under the direct method, only the direct costs of the support departments are allocated to the patient services departments because no indirect costs have been created by intrasupport department allocations.
As shown in the center section of Exhibit 4.4, the reciprocal method recognizes the support department interdependencies among Human Resources, Housekeeping, and Administration, and hence the reciprocal method generally is considered to be more ac- curate and objective than the direct method. The reciprocal method derives its name from the fact that it recognizes all services that departments provide to and receive from other departments. The good news is that this method captures all of the intrasupport department relationships, so no information is ignored and no biases are introduced into the cost allocation process. The bad news is that the reciprocal method relies on the simultaneous solution of a series of equations representing the utilization of intrasupport department services. Thus, it is relatively complex, which makes explaining it to department heads difficult and implementing it costly.
The step-down method, which is shown in the lower section of Exhibit 4.4, rep- resents a compromise between the simplicity of the direct method and the complexity of the reciprocal method. It recognizes some of the intrasupport department effects that the direct method ignores, but it does not recognize the full range of interdependencies. The step-down method derives its name from the sequential, stair-step pattern of the allocation process, which requires that the allocation take place in a specific sequence.
Here is how it works. First, all the direct costs of Human Resources are allocated to both the patient services departments and the other two support departments. Human Resources is then closed out because all its costs have been allocated. Next, Housekeeping costs, which now consist of both direct and indirect costs (the allocation from Human Resources), are allocated to the patient services departments and the remaining support department—Administration. Finally, the direct and indirect costs of Administration are allocated to the patient services departments. The final allocation includes Human Re- sources, Housekeeping, and Administration costs because a portion of these support costs have been “stepped down” to Administration.
The critical difference between the step-down and reciprocal methods is that after each allocation is made in the step-down method, a support department is removed from the process. Even though Housekeeping and Administration provide support services back to Human Resources, these indirect costs are not recognized because Human Resources is removed from the allocation process after the initial allocation. Such costs are recognized in the reciprocal method.
4.6 activity-based costing
Activity-based costing (ABC) is a totally different approach to costing that uses an up- stream approach to cost allocation. Its premise is
that all costs within an organization stem from activities, hence its name. In ABC, because activities are considered to be the basic building blocks of costs, costs can be more easily assigned to individual patients, individual physicians, particular diagnoses, reimbursement contracts, managed care populations, and so on than in traditional costing.
The steps required to implement ABC are as follows:
· Identify the relevant activities.
· Determine the cost of each activity, including equipment and supplies and both direct and overhead costs.
· Determine the cost drivers for the activity.
· Collect activity data for each service.
· Calculate the total cost of the service by aggregating activity costs.
To illustrate ABC, suppose that seven activities are performed at a family practice clinic: (1) patient check-in, including insurance verification; (2) preliminary assessment; (3) diagnosis; (4) treatment; (5) prescription writing; (6) patient checkout; and (7) third- party payer billing. Furthermore, assume that the clinic has 10,000 visits annually split evenly between two services: A and B. (Before we go further, note that this example is highly simplified. Its purpose is merely to give you a flavor for how ABC works.)
Exhibit 4.5 contains the initial data and allocation rate calculations. For example, the annual costs of patient check-in, consisting of clerical labor and supplies (direct costs) plus space and other overhead (indirect costs), are $50,000 to support 10,000 total visits, giving an allocation rate of $5 per visit. Also, the total (direct labor by a nurse and overhead) costs required to conduct the initial assessment is $75,000, spread over (5,000 visits × 5 minutes for A) + (5,000 visits × 10 minutes for B) = 25,000 + 50,000 = 75,000 minutes annually, giving an allocation rate of $1 per minute.
As shown in Exhibit 4.6, the final step is to aggregate the activity costs for each service. Note that this step is performed on a per visit basis. For example, for Service A, the cost of check-in is 1 visit × $5.00 = $5.00, the cost of assessment is 5 minutes per visit × $1.00 = $5.00, and the cost of diagnosis is 10 minutes per visit × $2.00 = $20.00. Other activity costs for the two services are calculated in a similar manner.
The end result of summing the individual activity costs associated with each service is a total cost of $75.10 for Service A and $130.40 for Service B. The ability of the family practice to estimate the costs of its individual services allows the services to be priced properly (on the basis of costs). In addition, cost control is made easier because the activities, and hence resource expenditures, associated with each service have been clearly identified.
Note that the total annual costs of providing Service A are 5,000 visits × $75.10 = $375,500, while the total costs for Service B are 5,000 visits × $130.40 = $652,000.
exhibit 4.6
Because we only have two services in this simple example, the total costs of the practice are $375,500 + $652,000 = $1,027,500, which equals the total cost amount identified in Exhibit 4.5.
ABC allows managers to estimate the costs of individual services and hence pro- vides managers with information that can be used in pricing and contract negotiations. However, the data and resource requirements to establish an ABC system far exceed those required for traditional costing. For this reason, traditional costing still dominates the healthcare arena, but ABC is becoming more prevalent as the need for better cost data becomes increasingly important and providers invest in newer and more powerful managerial accounting systems.
