Healthcare financial managers determine appropriate charges for patient care and
services by allocating indirect to direct costs through cost classifications and financial resources.
According to Nowicki (2022), costs that can be directly traced to a provided service, equipment,
or department are called direct costs. In contrast, indirect costs cannot be traced and are called
overhead costs (Nowicki, 2022). Direct costs, such as nursing care and supplies, are less
complex to assign to patient charges than indirect costs, such as heating and cooling, and the
indirect costs are not charged to the patient. Healthcare financial managers assign the indirect
costs to departments that provide patient services, such as radiology and physical therapy, so
patients are only charged for the services used (Nowicki, 2022). Financial managers have
multiple cost allocation methods that increase complexity and fairness, and financial resources
are required to allocate costs efficiently and effectively. As applicable, organizational charts
identify each department's cost and revenue center.
Cost allocation methods that include multiple allocations within the first step provide
the fairest charge to the patient. The easiest method involves taking the costs from
departments that do not create revenue and distributing it to departments that create revenue
(Nowicki, 2022). This method is called direct apportionment. Third-party payers disapprove of
this method as it can lead to unfair distribution of costs from non-revenue departments
providing work for other non-revenue departments (Nowicki, 2022). The second method, step-
down apportionment, offers a correction to the disadvantage of direct apportionment. In this
method, all costs from non-revenue departments are distributed to other non-revenue
departments; then, the costs are reallocated to departments that charge patients. Double
apportionment is the method that involves all costs being allocated from non-revenue
departments to other non-revenue departments while allocating costs from revenue-generating
departments to other revenue-generating departments. Then the costs are reallocated to
departments that charge patients. Double apportionment considers value and is considered the
most practical method (Nowicki, 2022). The most accurate method is multiple apportionments,
which involve multiple, simultaneous distributions of costs in the first step before reallocating
costs to departments that charge patients.
According to Carroll & Lord (2016), traditional costing allocates indirect costs through
pre-determined rates and is generally inaccurate. Activity-based costing allocates indirect costs
to identified activities and resources (Carroll & Lord, 2016). This costing method is commonly
used and is considered most accurate if updated regularly. Time-driven activity-based costing is
similar to activity-based costing, but it uses time as the activity measure (Carroll & Lord, 2016).
This method may be more beneficial to smaller organizations. Performance-focused activity-
based costing is different from the other activity-based costing methods. The activity
measurements for performance-based costing are determined through utilization and other
performance assessments (Carroll & Lord, 2016). Unique to the healthcare industry and
outdated is the ratio of cost to charges. This method determines the cost related to its charge
(Nowicki, 2022). Organizations have multiple options to allocate indirect costs and determine
patient charge amounts. Financial managers must choose the most appropriate methods for
healthcare organizations.
Utilization and volume play a vital role in generating revenue. According to Dexter et al.
(2001), hospitals with high utilization of resources that encounter an increase in volume of
patients experience an additional need to increase utilization leading to a decrease in revenue.
The utilization of resources must meet the volume demand to generate revenue to cover
expenses and meet reimbursement requirements.
References
Carroll, N., & Lord, J. C. (2016). The Growing Importance of Cost Accounting for Hospitals.
Journal of health care finance, 43(2), 172-185.
https://www.ncbi.nlm.nih.gov/pmc/articles/PMC6910125/
Dexter, F., Macario, A., & Lubarsky, D. A. (2001). The impact on revenue of increasing patient
volume at surgical suites with relatively high operating room utilization. Anesthesia &
Analgesia, 92(5), 1215-1221. https://doi.org/10.1097/00000539-200105000-00025
Nowicki, M. (2022). Introduction to the financial management of healthcare organizations (8th
ed.). Gateway to Healthcare Management.
