Unit III

HCA 4301, Budgeting in Health Care 1

Course Learning Outcomes for Unit III Upon completion of this unit, students should be able to:

1. Analyze financial statements of healthcare organizations. 1.1 Recognize the five principles in accounting. 1.2 Compare the four financial statements.

Required Unit Resources Chapter 8: General Principles of Accounting Chapter 9: Financial Statements Unit Lesson Four primary statements are used in financial accounting, but, before we discuss these statements, it is important to understand the principles behind accounting itself. Accounting is the principles and processes for preparing and distributing financial information (Cleverley & Cleverley, 2018). Healthcare accounting is no different from other businesses in that the accounting process must come from a system that generates the financial data needed to make educated economic decisions regarding the organization. Two categories exist in accounting: financial accounting and managerial accounting. Financial accounting provides the four primary statements of accounting which include the balance statement, statement of operations, statement of cash flows, and the statement of changes in net assets. Managerial accounting typically is used internally to prepare financial information for specific purposes (Cleverley & Cleverley, 2018). The five principles of accounting consider both financial and managerial accounting.

The accounting entity is defined as the organization or facility in which the financial information is being gathered, recorded, and reported. This can get tricky when the legal entity is different from the accounting entity. What this means is a hospital could be part of a university system or government agency, or it could even be a situation where a physician owns a clinic as a sole proprietor (Cleverley & Cleverley, 2018). The accounting entity needs to be clearly defined before proceeding with any reporting.

UNIT III STUDY GUIDE Financial Statements in Health Care

(Cleverley & Cleverley, 2018)

HCA 4301, Budgeting in Health Care 2

UNIT x STUDY GUIDE Title

The second principle is money measurement. Money measurement refers to measuring the economic resources and obligations of the entity. You might be wondering, what are economic resources? Essentially, economic resources are the assets of the entity. The assets can include but are not limited to supplies, equipment, buildings, ownership interests in other enterprises, and everyone's favorite economic resource, money. The liabilities or economic obligations include the transfer of money (or assets) to provide services to other entities (Cleverley & Cleverley, 2018). Normally, assets exceed liabilities. Duality is the third principle of accounting — the value of assets must always equal the combined value of liabilities and residual interest. Residual interest is known as net assets.

This means the balance sheet will always balance. Principle number four is cost valuation. This principle helps determine the market value and replacement cost of the entity. Cost valuation takes the individual assets at their market value to determine worth if liquidation were to occur. Issues can occur in cost valuation due to it is completion by appraisers who may value the assets differently. Replacement cost valuation measures the amount of money it will take to replace assets in the event of a loss. The stable monetary unit in principle five is the dollar. The dollar, as you know, is the monetary unit of measure for the United States. No problems exist for principle five until inflation comes into play. Remember, patients are seen, but the healthcare organization is not paid immediately due to the third-party payer pay out. If employees are set to have the wages automatically adjusted to change with inflation, and they get paid as they perform, it could be months before the entity gets paid for the services performed to the patient. With the inflation, the healthcare organization’s cash flow could decrease, leaving them with a loss. Once you understand the five principles of accounting, you can start work on the four major financial statements. The Balance Sheet The balance sheet is a summary of the facilities’ assets, liabilities, and net assets as of a certain date (Cleverley & Cleverley, 2018). The balance sheet gives an overview of the financial condition of the healthcare organization. Liabilities and net assets describe how assets are financed. Organizations often use debt to purchase an asset; this is the liability. Net asset is the equity in the organization. The net asset is the remaining interest the owner or owners have after all the liabilities have been paid. The balance sheet is only good for one point in time. In order to fully understand the balance sheet, you should be familiar with some of the vocabulary on the sheet itself. Current assets: Assets that will be consumed or used within one year are considered current assets (Cleverley & Cleverley, 2018). For example, intravenous (IV) supplies are ordered for the neonatal intensive care unit monthly to be used by nursing. The IV order will be dated when received and used within a year. If new IV supplies are received, they will be placed behind the older supplies. Typically, a healthcare organization’s use-by dates are much shorter than one year. Remember a balance sheet is only good for a specific date.

Assets = Liabilities + Net Assets

(adapted from Cleverley & Cleverley, 2018)

HCA 4301, Budgeting in Health Care 3

UNIT x STUDY GUIDE Title

• Cash is just what it sounds like, good old-fashioned money. This can come in the form of personal

checks, cashier’s checks, money orders, certified checks, and bank drafts. All these are known as negotiable instruments and are a form of cash. Additionally, coins and currency count too.

• Cash equivalents are savings accounts, temporary marketable securities, and certificates of deposit. • Inventories are anything used in the delivery of health care. This could be office supplies, lab

supplies, chemicals for cleaning, pharmaceuticals or, basically, anything that is used at the facility. • Accounts receivable is the amounts that are due to the organization from services provided.

Remember, the accounts receivable department has four categories: charity allowance, courtesy allowance, doubtful allowance, and contractual allowance.

• Prepaid expenses: Think about a prepaid phone card. You have already paid for a service that you have not used yet. This is the same concept. Prepaid expenses are outlays already made for future services. Examples for a healthcare organization are items such as rent on leased equipment or insurance premiums (Cleverley & Cleverley, 2018).

• Fixed assets: An easy way to remember fixed assets is that fixed assets are typically non-movable. Items such as property, buildings, and equipment. The fixed assets are permanent and sometimes referred to as capital.

• Other assets are either investments or intangible assets. Other assets do not involve property or equipment.

• Current liabilities are the obligations that will require payment in cash during the current operating cycle or coming year (Cleverley & Cleverley, 2018).

• Accounts payable is bills: the money that is owed for goods and services provided. Other liabilities include accrued liabilities, money due to third-party payers, and current portions of long-term debt. Within the liability section of the balance sheet, there are also non-current liabilities, which include long- term debt that does not require repayment within 1 year. The statement of operations is all about the revenue and expenses. The statement of operations is also known as the income statement. “Show me the money!” Creditors use the statement of operations to determine the healthcare organization’s ability to pay their debts, both current and future. The revenue on the statement is gathered from the three sources of patient service revenue, other revenue, and nonoperating gains. The expenses are from the operating expenses including the following.

Statement of change in net assets is the third major financial statement. This statement explains the changes in net assets from one period to the next on the different balance sheets. The statement of changes in net assets is sometimes referred to as statement of changes in owner’s equity. This is used in a for-profit entity. Within the statement of change in net assets there can be changes to the net unrealized gains and losses in other areas. Typically, this is within equity investments with objective market values (Cleverley & Cleverley, 2018). The last of the final four major financial sheets is the statement of cash flows. This is the statement that answers the questions. What questions, you might be asking yourself. Where did the money come from, and

(adapted from Cleverley & Cleverley, 2018)

HCA 4301, Budgeting in Health Care 4

UNIT x STUDY GUIDE Title

where did it go during the accounting period (Cleverley & Cleverley, 2018)? Three activities occur during the accounting period. There are operating activities, meaning the day-to-day activities that keep the facility open. Next are the investment activities; investments can include property or equipment. Third is finance activities in which the healthcare organization reports on the borrowing and payback activities of loans. As a healthcare organization team leader, manager, director, or administrator, it is important to understand how the principles of accounting work along with the basics of the financial statements. Remember, the balance sheet gives a quick overview of what the facility is doing during a specific period of time. This is helpful in historic view of how the facility has done. The statement of operations gives a 1-year look at the facility and tells how the wealth has changed through the operations. Creditors use the statement of operations. The statement of changes in net assets lends information on changes in equity and is used in for- profit facilities. Lastly, the statement of cash flows shows how the money flows. All these statements are important to the health of the entity. It takes money to provide health care. Without cash flow, supplies cannot be ordered and delivered, and patients will not have the medications needed to get healthy or even the nutrition to build strength. Additionally, the employees cannot get paid without a positive cash flow, and the mortgages or leases may fall behind. A healthy financial outlook is as important as filling the beds with patients.

Reference

Cleverley, W. O., & Cleverley, J. O. (2018). Essentials of health care finance (8th ed.). Jones & Bartlett Learning.

Suggested Unit Resources In order to access the following resource, click the link below. This video from the CSU Online Library breaks down the components of financial statements, making them easier to understand. Cambridge Educational (Producer). (2002). Financial statements (Segment 8 of 8) [Video]. In Introductions

and definitions. Films on Demand. https://libraryresources.columbiasouthern.edu/login?auth=CAS&url=https://fod.infobase.com/PortalPl aylists.aspx?wID=273866&xtid=29652&loid=6372

The transcript for this video can be found by clicking on “Transcript” in the gray bar at the right of the video in the Films on Demand database. Appendix 9-A in your textbook contains an example of an audited financial statement of Harris Memorial Hospital and Harris Community Foundation. This example gives a breakdown of the financial statements and an explanation of the various financial statements involved. Cleverley, W. O., & Cleverley, J. O. (2018). Essentials of health care finance (8th ed.). Jones & Bartlett Learning. Learning Activities (Nongraded) Nongraded Learning Activities are provided to aid students in their course of study. You do not have to submit them. If you have questions, contact your instructor for further guidance and information. Read and answer the assignment at the end of Chapter 8 on pages 207–209. Read and answer the assignment at the end of Chapter 9 on pages 220–221.

HCA 4301, Budgeting in Health Care 1

Course Learning Outcomes for Unit III Upon completion of this unit, students should be able to:

1. Analyze financial statements of healthcare organizations. 1.1 Recognize the five principles in accounting. 1.2 Compare the four financial statements.

Required Unit Resources Chapter 8: General Principles of Accounting Chapter 9: Financial Statements Unit Lesson Four primary statements are used in financial accounting, but, before we discuss these statements, it is important to understand the principles behind accounting itself. Accounting is the principles and processes for preparing and distributing financial information (Cleverley & Cleverley, 2018). Healthcare accounting is no different from other businesses in that the accounting process must come from a system that generates the financial data needed to make educated economic decisions regarding the organization. Two categories exist in accounting: financial accounting and managerial accounting. Financial accounting provides the four primary statements of accounting which include the balance statement, statement of operations, statement of cash flows, and the statement of changes in net assets. Managerial accounting typically is used internally to prepare financial information for specific purposes (Cleverley & Cleverley, 2018). The five principles of accounting consider both financial and managerial accounting.

The accounting entity is defined as the organization or facility in which the financial information is being gathered, recorded, and reported. This can get tricky when the legal entity is different from the accounting entity. What this means is a hospital could be part of a university system or government agency, or it could even be a situation where a physician owns a clinic as a sole proprietor (Cleverley & Cleverley, 2018). The accounting entity needs to be clearly defined before proceeding with any reporting.

UNIT III STUDY GUIDE Financial Statements in Health Care

(Cleverley & Cleverley, 2018)

HCA 4301, Budgeting in Health Care 2

UNIT x STUDY GUIDE Title

The second principle is money measurement. Money measurement refers to measuring the economic resources and obligations of the entity. You might be wondering, what are economic resources? Essentially, economic resources are the assets of the entity. The assets can include but are not limited to supplies, equipment, buildings, ownership interests in other enterprises, and everyone's favorite economic resource, money. The liabilities or economic obligations include the transfer of money (or assets) to provide services to other entities (Cleverley & Cleverley, 2018). Normally, assets exceed liabilities. Duality is the third principle of accounting — the value of assets must always equal the combined value of liabilities and residual interest. Residual interest is known as net assets.

This means the balance sheet will always balance. Principle number four is cost valuation. This principle helps determine the market value and replacement cost of the entity. Cost valuation takes the individual assets at their market value to determine worth if liquidation were to occur. Issues can occur in cost valuation due to it is completion by appraisers who may value the assets differently. Replacement cost valuation measures the amount of money it will take to replace assets in the event of a loss. The stable monetary unit in principle five is the dollar. The dollar, as you know, is the monetary unit of measure for the United States. No problems exist for principle five until inflation comes into play. Remember, patients are seen, but the healthcare organization is not paid immediately due to the third-party payer pay out. If employees are set to have the wages automatically adjusted to change with inflation, and they get paid as they perform, it could be months before the entity gets paid for the services performed to the patient. With the inflation, the healthcare organization’s cash flow could decrease, leaving them with a loss. Once you understand the five principles of accounting, you can start work on the four major financial statements. The Balance Sheet The balance sheet is a summary of the facilities’ assets, liabilities, and net assets as of a certain date (Cleverley & Cleverley, 2018). The balance sheet gives an overview of the financial condition of the healthcare organization. Liabilities and net assets describe how assets are financed. Organizations often use debt to purchase an asset; this is the liability. Net asset is the equity in the organization. The net asset is the remaining interest the owner or owners have after all the liabilities have been paid. The balance sheet is only good for one point in time. In order to fully understand the balance sheet, you should be familiar with some of the vocabulary on the sheet itself. Current assets: Assets that will be consumed or used within one year are considered current assets (Cleverley & Cleverley, 2018). For example, intravenous (IV) supplies are ordered for the neonatal intensive care unit monthly to be used by nursing. The IV order will be dated when received and used within a year. If new IV supplies are received, they will be placed behind the older supplies. Typically, a healthcare organization’s use-by dates are much shorter than one year. Remember a balance sheet is only good for a specific date.

Assets = Liabilities + Net Assets

(adapted from Cleverley & Cleverley, 2018)

HCA 4301, Budgeting in Health Care 3

UNIT x STUDY GUIDE Title

• Cash is just what it sounds like, good old-fashioned money. This can come in the form of personal

checks, cashier’s checks, money orders, certified checks, and bank drafts. All these are known as negotiable instruments and are a form of cash. Additionally, coins and currency count too.

• Cash equivalents are savings accounts, temporary marketable securities, and certificates of deposit. • Inventories are anything used in the delivery of health care. This could be office supplies, lab

supplies, chemicals for cleaning, pharmaceuticals or, basically, anything that is used at the facility. • Accounts receivable is the amounts that are due to the organization from services provided.

Remember, the accounts receivable department has four categories: charity allowance, courtesy allowance, doubtful allowance, and contractual allowance.

• Prepaid expenses: Think about a prepaid phone card. You have already paid for a service that you have not used yet. This is the same concept. Prepaid expenses are outlays already made for future services. Examples for a healthcare organization are items such as rent on leased equipment or insurance premiums (Cleverley & Cleverley, 2018).

• Fixed assets: An easy way to remember fixed assets is that fixed assets are typically non-movable. Items such as property, buildings, and equipment. The fixed assets are permanent and sometimes referred to as capital.

• Other assets are either investments or intangible assets. Other assets do not involve property or equipment.

• Current liabilities are the obligations that will require payment in cash during the current operating cycle or coming year (Cleverley & Cleverley, 2018).

• Accounts payable is bills: the money that is owed for goods and services provided. Other liabilities include accrued liabilities, money due to third-party payers, and current portions of long-term debt. Within the liability section of the balance sheet, there are also non-current liabilities, which include long- term debt that does not require repayment within 1 year. The statement of operations is all about the revenue and expenses. The statement of operations is also known as the income statement. “Show me the money!” Creditors use the statement of operations to determine the healthcare organization’s ability to pay their debts, both current and future. The revenue on the statement is gathered from the three sources of patient service revenue, other revenue, and nonoperating gains. The expenses are from the operating expenses including the following.

Statement of change in net assets is the third major financial statement. This statement explains the changes in net assets from one period to the next on the different balance sheets. The statement of changes in net assets is sometimes referred to as statement of changes in owner’s equity. This is used in a for-profit entity. Within the statement of change in net assets there can be changes to the net unrealized gains and losses in other areas. Typically, this is within equity investments with objective market values (Cleverley & Cleverley, 2018). The last of the final four major financial sheets is the statement of cash flows. This is the statement that answers the questions. What questions, you might be asking yourself. Where did the money come from, and

(adapted from Cleverley & Cleverley, 2018)

HCA 4301, Budgeting in Health Care 4

UNIT x STUDY GUIDE Title

where did it go during the accounting period (Cleverley & Cleverley, 2018)? Three activities occur during the accounting period. There are operating activities, meaning the day-to-day activities that keep the facility open. Next are the investment activities; investments can include property or equipment. Third is finance activities in which the healthcare organization reports on the borrowing and payback activities of loans. As a healthcare organization team leader, manager, director, or administrator, it is important to understand how the principles of accounting work along with the basics of the financial statements. Remember, the balance sheet gives a quick overview of what the facility is doing during a specific period of time. This is helpful in historic view of how the facility has done. The statement of operations gives a 1-year look at the facility and tells how the wealth has changed through the operations. Creditors use the statement of operations. The statement of changes in net assets lends information on changes in equity and is used in for- profit facilities. Lastly, the statement of cash flows shows how the money flows. All these statements are important to the health of the entity. It takes money to provide health care. Without cash flow, supplies cannot be ordered and delivered, and patients will not have the medications needed to get healthy or even the nutrition to build strength. Additionally, the employees cannot get paid without a positive cash flow, and the mortgages or leases may fall behind. A healthy financial outlook is as important as filling the beds with patients.

Reference

Cleverley, W. O., & Cleverley, J. O. (2018). Essentials of health care finance (8th ed.). Jones & Bartlett Learning.

Suggested Unit Resources In order to access the following resource, click the link below. This video from the CSU Online Library breaks down the components of financial statements, making them easier to understand. Cambridge Educational (Producer). (2002). Financial statements (Segment 8 of 8) [Video]. In Introductions

and definitions. Films on Demand. https://libraryresources.columbiasouthern.edu/login?auth=CAS&url=https://fod.infobase.com/PortalPl aylists.aspx?wID=273866&xtid=29652&loid=6372

The transcript for this video can be found by clicking on “Transcript” in the gray bar at the right of the video in the Films on Demand database. Appendix 9-A in your textbook contains an example of an audited financial statement of Harris Memorial Hospital and Harris Community Foundation. This example gives a breakdown of the financial statements and an explanation of the various financial statements involved. Cleverley, W. O., & Cleverley, J. O. (2018). Essentials of health care finance (8th ed.). Jones & Bartlett Learning. Learning Activities (Nongraded) Nongraded Learning Activities are provided to aid students in their course of study. You do not have to submit them. If you have questions, contact your instructor for further guidance and information. Read and answer the assignment at the end of Chapter 8 on pages 207–209. Read and answer the assignment at the end of Chapter 9 on pages 220–221.