Appendix Two - Weber State University



Code Blue

Instructors Edition-- Discussion Questions and Practice Problems with Answers

Third Edition

Discussion questions and practice problems are organized by chapter. Due to the textbook/novel nature of Code Blue, not all chapters have questions or problems.

Chapter One

1. Hap Castleton and Del Cluff have different management styles, and this has caused some friction in their relationship. As assistant controller, what might Del have done to improve his credibility with Castleton?

Del Cluff has an accounting education, Hap does not. If he is to be effective Del must present the information in a manner that Hap will understand. Accountants (like physicians) sometimes use terminology that is difficulty for lay people to understand.

The experience of being a CEO is different than the experience of being an accountant. Hap probably has many departments to monitor. By necessity he has to be a generalist. Del’s job is to stay on top of the details.

People’s perceptions are driven by their personality, education, experience, and in this situation responsibilities. Hap is obviously an extrovert, he is probably more interested in people than Del Cluff. Del is probably a detail person, but we might infer that his communication and people skills are not as good as Hap’s

2. What message is conveyed when employees refer to accountants as “bean counters”? Why do you think accountants have such an unfavorable image with some managers? What might they do to change this?

It is obviously not a favorable characterization. The general dislike some managers have for accountants probably stems from: (a) their own insecurity in working with numbers, (2) a lack of appreciation for the importance of accounting data, (c) a lack of understanding for the amount of detail required in the preparation of financial reports, (d) a perception that accountants are only interested in numbers (as opposed to being interested in people, corporate strategies etc.).

Some accountants can increase their effectiveness by (a) improving communications skills—accountants are in the business of disseminating information, (b) learning to think more like managers (learning to project what information is necessary for a particular decision and what is not).

There is a difference between financial accounting and managerial accounting. Financial accounting is very structured, is debit/credit oriented, and is designed for outside users. Management accounting focuses on internal decision making. Sometimes accountants provide financial information to managers that is not useful for internal decision making.

Chapter Two

1. What is the role of the Finance Committee in a hospital?

The Financial Committee typically supervises the Treasury and Accounting functions of the hospital. The committee is responsible for raising capital through bonds or fund raising efforts, and for monitoring the expenditure of funds.

2. What is the role of the president of the medical staff in a hospital?

The President of the Medical Staff is usually elected by the medical staff. He or she represents the medical staff to administration and the board.

Chapter Three—Including Supplement One

1. Wycoff firmly believes in the diversification of management teams. Do you agree with him? If so, what factors would you look for in diversification?

Any business decision benefits by considering different points of view. Since business decisions involve product development, marketing, production process, strategic planning, financial reporting, and human resource management, it is important to have a team of individuals who collectively can address each of these functions. Critical to the success of any team is unity of purpose and the ability to communicate and work together for the success of the business. No one has all the answers, managers must diversify their management teams as to experience, education, disposition, and individual strengths and weaknesses.

2. How is it possible that hospitals didn’t know the costs of their products? Without accurate procedure costs, how did they determine prices?

Since hospitals did not compete on the basis of price, it was not necessary to know the actual costs of the specific goods and services provided. It was, of course necessary, that total revenues equal or exceed total costs, but prior to the 1980s it was common for hospitals to subsidize some services with the revenues from others.

The prices of goods and services were determined by what the market would bear, and what competition was charging.

Good cost data was usually available on a department basis, but not on an individual product basis.

3. What is a prospective payment system, and how did it change the need for cost accounting?

A prospective payment system is one where the price is established in advance of delivery of the good or service. In contractor terms, it is a fixed-price-contract. Prospective payment systems shift financial risk from the patient or payer to the healthcare provider. Prospective payment systems increased the need for cost accounting systems that can accurately provide costing data on individual products and services.

4. Evaluate the incentives for cost control under cost reimbursement and prospective reimbursement.

Cost reimbursement systems that guarantee full cost recovery, regardless of efficiency, provide few incentives for cost control. Prospective reimbursement systems, where the healthcare provider must absorb cost overruns in excess of the prospective price, provide greater incentives.

5. Do you believe there are any down sides to incentive reimbursement in healthcare?

Where the patient has a difficult time judging the necessity for (or quality of) healthcare services provided, there may be an incentive for the healthcare provider to provide a lower quality or quantity of goods and services than needed to save costs.

6. What is the difference between a financial accounting system and a cost accounting system?

A financial accounting system is principally used to prepare summary financial reports for external investors and creditors. The reports must conform to generally accepted accounting principles and are always reporting on past performance. A cost accounting system is looking at matching costs to activities. It provides information on costs for internal management to use in making decisions on what to do and to identify where changes need to be made. Cost accounting is generally future oriented.

7. A cost objective is defined as a function, organizational subdivision, contract, or other work unit for which cost data are desired, and for which provision is made to accumulate and measure the costs of contracts, products, etc. A final cost objective is a cost objective that has allocated to it both direct and indirect costs and is one of the final accumulation points. What were the final cost objectives under cost reimbursement? What would you speculate they might be under prospective reimbursement?

Under the old Medicare payment program, which paid “costs per patient day” the cost objective was the patient day. This was determined at year-end by Medicare auditors that would divide total costs by patient days (usually by category). Possible cost objectives under prospective reimbursement include specific products and diagnostic categories.

8. What problems was the lack of a cost accounting system causing for Peter Brannan Hospital?

The board blames the poor financial performance of the hospital on their inability to know the true costs of products and services provided. Under prospective reimbursement, cost data would allow them to control costs, negotiate higher prospective prices, or discontinue product lines that paid less than costs.

9. What is the difference between DRG and Capitation Payment reimbursement systems?

A DRG payments system pays a fixed, predetermined price, per admission per diagnosis. Capitation payment pays a predetermined fixed amount per month per enrollee, irregardless of whether the patient uses the system or not.

10. How a manager does something is often as important as what he or she does. Assuming Selman needed to be terminated, do you agree with the manner in which it was done?

Certainly the board didn’t appear to be comfortable with the manner in which Edward Wycoff handled the situation. If Selman had to be fired, it might have been done in a less public forum. Wycoff might have given some consideration to the timing, and the impact it would have on the employees on the same day that a new administrator was appointed.

11. Is there anything that Wycoff might have done to make Douglas’s transition into his new position less difficult?

There are several things that might have been done: These include:

• Handling the Selman situation more diplomatically.

• Allowing department heads to participate in the hiring of a new administrator.

Chapter Four

1. Why didn’t Douglas agree to meet with Ulman personally? Do you agree with his decision?

He was concerned about giving Ulman’s claim to authority credibility. He felt that he would rather deal directly with the department heads and their employees than with a potential union organizer.

2. Is it appropriate for a board member to assume line responsibility in an organization?

The function of the board is:

• To hire, supervise, and fire (if necessary) the hospital administrator.

• To raise the capital necessary to purchase plant and equipment and provide working capital.

• To grant medical staff membership and medical privileges.

• To providelong-term, strategic direction for the hospital.

The board should not be involved with day-to-day operations. To do so undermines the authority of the administrator, and gives the department heads and physicians conflicting signals as to who is running the operations. Many not-for-profit hospital administrators struggle with board members who own their own businesses and want to be involved in daily operations including the hiring and firing of hospital personnel.

3. The employees’ initial impression of Wes Douglas is not favorable. Why? Is his image that important given the hospital’s current situation? If you were the new administrator, would you do anything at this point to change the situation? What?

Possible reasons for the initial negative reaction include:

• The department heads had no input on the selection of a new CEO.

• The hospital is in a financial crisis, the employees might fear that the new administrator will be a “hatchet man.”

• The new administrator has no experience in healthcare management. His background is financial. Some apparently worry that he will give more attention to the bottom line than to the needs of employees and patients.

• He is identified with Edward Wycoff who is apparently not very popular with the staff.

Students can respond as to what they would do to improve the situation. If indeed he is a “hired gun,” (someone who is hired to take unpopular actions to save the hospital), then it may not be as important if he is like by the staff. Once he is done he can be replaced by a more popular administrator. If Wes has an interest in serving in his position over the long-term, then he may want to give more attention to his image and credibility. Certainly he must solve the financial problems of the hospital, and solve them quickly, or it won’t matter if he is popular or not

4. Wes refused Wycoff’s offer of help? Evaluate the strengths and weaknesses of this approach. What would you do in this situation?

At this point Wycoff may be his only ally. Certainly Wycoff has demonstrated that he has the power to fire members of the administrative team (i.e. Selman). Wes’ action possibly jeopardizes his relationship with Wycoff.

On the other hand, if Wes is to succeed then he must establish himself as the one responsible for operations. Distancing himself from Wycoff will possibly help him in his relationship with the employees and medical staff.

5. Prioritize the employees’ complaints in order of importance. Which would you work on first?

Students will probably differ as to the prioritization of complaints. The first issue has to be financial solvency which includes the problems raised concerning pricing, costing, and waste. To get the cooperation of the department heads and their employees, Wes must sell them on the actions he feels are necessary to turn the financial operation of the hospital around.

Chapter Five

1. How important is the credibility a CEO has with the bank? As CEO of Peter Brannan Hospital, what would you do to build credibility?

One important criteria banks look at when loaning companies money is management. Wes Douglas is disadvantaged in that he does not have experience in hospital administration. The hospital is suffering a financial crisis. Wes’s background in accounting is probably a plus with this problem. The credibility of both the CEO and CFO, which is built upon a history of performance and open communications, is very important in a banking relationship.

2. What do you think about the bank’s requirements for a line of credit?

If the bank is uncertain as to the true value of the accounts receivable, they will probably require additional security for the loan. In this negotiating situation, the bank has most of the power. It is doubtful that a new bank will step in and provide a line of credit, given the poor financial performance of the hospital.

3. What are the advantages and disadvantages of having a board member guarantee the hospital’s line of credit? In this situation, did they have any choice?

If Wycoff guarantees the line of credit, he certainly will increase the leverage he has with the administrator and the board.

For many years it was not uncommon for wealthy board members of rural hospital to subsidize hospital operations or to co-sign hospital notes. As hospitals affiliated themselves with chains, and were perceived to more like businesses and less like charities, this practice has declined.

If Wes Douglas had time, it would be nice to think about who he would rather hold the lien, the bank or William Wycoff. As it is, they may not have much choice.

Chapter Six

1. What is the danger of asking a supervisor to prepare a budget and then cutting it without the supervisor’s input? Is there a better way for management to reduce an unacceptable budget?

Dangers include:

• Department heads may not buy-in to a budget they have not participated in preparing.

• It might send a signal that the budget, regardless of its size will always be cut. In this event a logical strategy is to pad any budget submission.

A better approach might be to base the budget on workload standards the department heads feel they can realistically meet, or to at least discuss or negotiate reductions with department heads.

2. The supervisors’ complain that the Controller’s Office doesn’t have a service orientation. List the Controller’s Office customers. Why are some accountants not more service oriented? How important is it for the employees of the Controller’s Office to interact with employees outside of their own department?

Anyone who receives reports or information from the Controller’s office is a customer. Many accountants fail to realize that they are in the information business. If information is not conveyed in a manner that is understood by the user, it has no value.

3. Many accountants erroneously assume that the users of their statements have the ability to read and analyze these reports without additional explanation or training. What role must the Controller’s Office play in educating the people who use management reports?

Since many managers lack formal training in accounting, information must be tailored to the understanding of the user. One important role of the Controller is education. Supervisors must be trained (and continually retrained) on the use of financial reports.

Chapter Eight

1. Karisa Holyoak thinks Wes Douglas is in over his head. What is your opinion? Given Wes Douglas’s professional situation, do you think he should have accepted the interim appointment?

Obviously, it would be helpful if he knew more about the healthcare industry. The possibility exists that before he knows the right questions to ask, the game will be over. On the other hand, he does have a financial background, and as an outsider might bring a fresh viewpoint to the problems of Peter Brannan Community Hospital.

2. Assume you are the new interim administrator with the same background as Wes Douglas. What would you do to educate yourself?

Knowledge can be gained through:

• Interviewing board members, department managers, employees, and members of the medical staff.

• Professional organizations such as the American Hospital Association

• Continuing education through programs in healthcare administration that offer correspondence courses to executives.

• Professional healthcare journals.

• Consultants.

• The Internet.

Chapter Nine

1. What conditions must exist for a free market? Which of these were lacking in the traditional healthcare industry? Why?

Ideally, for a free market to exist, one must have (a) an informed customer, (b) who makes the purchase decision, (c) shops on the basis of quality and cost, and (d) negotiates an arms-length purchase price.

In healthcare, patients lack the technical background to judge the necessity and/or quality of the services rendered. It is the physician and not the patient who makes the purchase decision. The physician even selects the hospital to which the patient will be admitted.

Historically, patients have not been given access to the cost data necessary to shop on the basis of price. In addition, since quality has often been associated with high cost, they have been reticent to purchase “cheap” healthcare.

2. Do consumers shop on the basis of price in most industries? Why didn’t they shop on the basis of price for healthcare?

Price competition is common in most industries. As mentioned above, it didn’t usually happen in healthcare because of a disparity of information. Consumers lacked information on necessity, quality, and cost.

3. What factors mitigate against unnecessary capacity in most industries? Why didn’t these same factors prevent the duplication of expensive facilities and equipment in the traditional healthcare industry?

• Excess capacity generates higher than necessary fixed costs, which in turn increase prices.

• If someone else is paying the bill (i.e. the insurance company or the employer) or if price information is not available, or if price is the only way patients have of judging quality, then patients don’t shop on the basis of price.

4. What might regulators, insurance companies, employers, and accountants do to create a market mechanism in the healthcare industry?

They might:

• Educate consumers on the necessity and quality of healthcare services.

• Assume the role of the informed consumer for the patient. Review and approve the necessity and quality of healthcare products and services provided (i.e. pre-certification, peer review, utilization review).

• Assume the role of shopping for patients. Negotiate prices with hospitals and doctors.

• Provide financial incentives for physicians and hospitals to act in the best economic and medical interests of the patient.

These are the objectives of managed care.

5. What is price elasticity? How price elastic is the demand for healthcare services.

Price elasticity exists when demand is directly and proportionately influenced by price. The higher the price, the lower the demand and vice versa. Studies indicate that there is not a great deal of price elasticity for life-saving healthcare products and services,

6. Why do consumers have difficulty judging the quality of healthcare services? Should accountants be concerned with quality issues.

Consumers lack the technical background necessary to judge the necessity for, and quality of, medical goods and services. In many parts of the country, independent organizations are assuming the role of collecting and disseminating information on the comparative quality, as judged by morbidity and mortality, of competing physicians and hospitals.

One of the objectives of the Security and Exchange Commission (SEC) is reducing disparity of information between the sellers and buyers of securities. Many feel the same thing should happen in healthcare. Accountants are in the information business. In manufacturing, they are increasingly becoming involved in issues of total quality management. The same should be true in the healthcare industry.

7. Who was the hospital’s customer under the traditional fee-for-service and cost-reimbursement payment systems? Did this influence hospital cost behavior?

Many believe that the customer was not the patient, but the physician, as it was the physician who selected the hospital, and decided what goods and services would be purchased.

Chapter Ten

1. Studies have shown that physicians who own laboratories order more lab tests than physicians who do not. What might be the reason for this? Do you see any potential conflict of interest in physicians owning laboratories, pharmacies, or hospitals?

If the studies are accurate, they might indicate that financial incentives exist to order tests that are not necessary. If this occurs, there is a conflict of interest.

2. If indeed there were too many elective surgeries in the traditional healthcare industry, what might be done to address this problem?

The approach taken was patient education, and pre-certification for elective procedures

3. Under cost reimbursement, what were the incentives for physicians and hospitals with regard to patient length of stay?

The longer the length of stay, the more money the hospital made. Physicians were susceptible to pressures of hospital administrators to increase admission and length of stay during periods of low occupancy.

Chapter Eleven

1. During the 1960s and 1970s, the government attempted to control healthcare costs through regulation, using a utility industry model. Why didn’t this work?

The healthcare industry is too complex for any one individual or body to centrally regulate..

2. Why were most hospitals formed as not-for-profit organizations? Why was cost reimbursement the dominant payment system for healthcare for so many years?

Most hospitals were organized as charities, and consequently were not-for profit. Cost reimbursement was selected by payers who felt that since charities were not organized to make money, that they shouldn’t loose money either.

3. What is incentive reimbursement? How does it attempt to create a market mechanism?

Incentive reimbursement is a form of payment that provides incentives for cost control. It is a surrogate for price, a surrogate that provides an incentive to keep prices down in markets that have price elasticity.

4. From what you have learned, what do you think might be the advantages and disadvantages to physician incentive reimbursement?

Advantages include:

• The physician and hospital have an interest in the efficiency with which goods and services are provided.

Disadvantages include:

• Poorly designed incentive systems or incentives systems lacking an audit function may encourage physicians and hospitals to provide fewer services than needed, or services of a lower quality than required.

Chapter Thirteen

1. Charles Stoker had seen three revolutions in healthcare during his career. What were these, and how do you think they influenced hospital administrator behavior? How do you think they have changed the role of hospital controller?

The consolidation of hospitals into hospital chains reduced the autonomy of local management, provided opportunities for cost savings through centralized and shared services, and provided an incentive for the growth of for-profit hospitals. For controllers this caused greater standardization in accounting practices, and a movement away from fund accounting.

Prospective payment shifted economic risk from patients and payers to healthcare providers. It created incentives for cost control and for the design and implementation of cost accounting information systems. For controllers this mandated the installation of cost accounting systems.

The assumption of the insurance role by some hospital chains was an attempt to control admissions by having employers and insurance carriers mandate the providers that employees could use. For controllers of organizations that offered their own insurance programs, or direct contracted with employers, this injected elements of insurance accounting into healthcare.

2. What is a health maintenance organization (HMO) and how does it attempt to control healthcare costs?

The first health maintenance organizations employed their physicians, and contracted with employers on a capitation basis. HMOs attempted to control healthcare costs by controlling the behavior of member physicians. Today many HMOs contract with, rather than employ physicians, and contract with employers using a variety of payment systems including fee-for-service.

3. Henry Kaiser started one of the first HMOs in the country. If this program was successful in controlling costs, why didn’t HMOs initially flourish in other parts of the country?

Reasons HMOs did not flourish included:

• Opposition by the American Medical Association.

• Punitive legislation.

• Fewer incentives for cost control, when costs were lower.

4. Are there greater incentives for physicians to provide preventive medicine in an HMO than in a fee-for-service practice? Why?

In theory, there are stronger incentives for the provision of preventive medicine as it is cheaper to prevent an illness than to treat it, and as most illnesses are less expensive to treat in their early stages. One of the incentives for the formation of public health departments, was a lack of interest by private physicians in providing preventive medical services including immunizations.

There is some evidence that HMOs are successful in diagnosing some forms of cancer earlier than private physicians, but research on the provision of preventive medical services by health maintenance organizations is incomplete.

5. How has prospective reimbursement influenced hospital length of stay? Why?

When DRG reimbursement was first introduced, the average length of hospital stay declined dramatically. Under DRG reimbursement, the incentive is to admit the patient (as this initiates payment) but to discharge him or her as quickly as medically possible (since payment is fixed, and shorter stays result in lower costs).

6. What is a DRG reimbursement system, and how are its incentives different from cost reimbursement and capitation payment?

Under a DRG reimbursement system, illnesses are grouped based on diagnosis, procedures performed, age of the patient, and discharge status. Hospitals are reimbursed a fixed amount per DRG. If the hospital’s costs are less than the set reimbursement amounts, the hospital makes a profit. If the hospital’s costs are greater than the set reimbursement amount, the hospital has a loss.

DRG reimbursement provides an incentive for hospitals to control costs once the patient is admitted.

Compared to capitation payment, the hospital under DRG reimbursement still has an incentive to perform as many surgeries and services as possible, as long as reimbursement exceeds costs.

7. Stoker believes that DRG reimbursement is essentially a fixed price contract. Is he right?

DRG reimbursement is essentially a fixed-price-contract in that reimbursement per DRG is prospectively fixed, regardless of the quantity of services actually rendered.

8. Why are many physicians threatened by prospective reimbursement?

They seemed to be bothered by several issues:

• Corporate interference in the practice of medicine.

• Loss of autonomy.

• Reduced income.

• The possible negative influence of incentive reimbursement on quality.

9. In recent years, HMOs have come under fire by certain consumer groups. Are any of their criticisms related to physician incentive reimbursement? What might be done to address the problem?

The financial incentives an HMO provides physicians are felt, by some, to reduce a physician’s incentive to provide comprehensive, quality service. Indeed, many argue that in HMOs, the physicians have an incentive to do as little as possible—thus jeopardizing the quality of care received by the patient. Watchdog organizations or healthcare payers should track types services performed by each physician, number of repeat patients, complaints received, and other measures of performance to assure that the physician is providing quality healthcare. Mandatory training programs and peer reviews of performance might be instituted.

Chapter Fourteen

1. What are some of the concerns Wes Douglas is starting to have about managed care?

Wes is concerned about the tradeoff between controlling costs and providing quality healthcare.

2. Does the fact that most healthcare costs are paid by third-party payers (i.e. insurance companies or employers) rather than by the patient, influence patient attitudes and behavior?

Anytime a bill is paid by someone else costs become less important. Co-payments and deductibles are used by some insurance companies to partially address this problem.

Chapter Eighteen—Including Supplement Two

1. What is a variance and how is it calculated? How does Wes Douglas feel variances might help him understand the reasons for the losses that Peter Brannan Hospital is currently experiencing?

In accounting, a variance is the difference between budgeted and actual costs. Wes knows that there are losses at the hospital, but doesn’t know where or why they are occurring. Variance analysis can help him identify the causes of the problem.

2. Why was cost accounting a relatively rare practice in hospitals before the advent of managed care? Why has managed care created a need for cost accounting?

Under cost reimbursement, there was no need to identify individual product costs because reimbursement was based on cost per patient day. As long as total costs were covered by total charges, the hospital had no need to understand individual product cost. Cost accounting systems are expensive to install and maintain, and the cost wasn’t worth the information provided.

Managed care mandates the use of cost accounting through the use of prospective (i.e. fixed-price) contracts that place a ceiling on reimbursement thereby limiting the ability of hospitals to increase revenues through cost shifting, increases in patient charges, or increased volumes of products and service.

3. Define the terms external validity and internal consistency as used by Dr. Alma Cowdrey.

External validity means that a firm’s salaries are consistent with the market. Internal consistency means pay is consistent with responsibility. If a system is internally consistent, employees get equal pay for equal work.

4. Why does Wes Douglas want Alma Cowdrey to determine the standard labor rates for Peter Brannan hospital?

To establish a standard labor rate for cost accounting that is externally valid and internal consistent.

5. Other than the establishment of standard rates for cost accounting, what other factors might motivate large employers to contract for a compensation study?

• Difficulty in recruiting if the organization’s pay schedule is less than market

• Difficulty in competing on the basis of price if the pay schedule is greater than market.

• Employee morale problems if the system is not internally consistent (i.e. if the employees perceive that their wages are influenced by internal politics, or factors other than the difficulty of the work performed).

Supplement Two

1. What is the difference between a job task and a job characteristic? Which does Cowdrey plan on using in his compensation study? Why?

A job task is a job activity—an action that the employee must perform to do his or her job. Examples of job activities include changing a dressing, balancing a ledger, washing a window, or administering a medication.

A job characteristic is a skill or ability required to perform a job. For example, the ability to work with people, the need to work with numbers, or the supervision of other employees

Originally, job analysts attempted to quantify jobs for the purpose of compensation by identifying and classifying job tasks or activities. Since there are an infinite number of tasks in the world of work, this was found to be impossible. Job analysts then found that they could identify a dozen or so quantifiable characteristics that were directly correlated with pay, and that applied to all jobs within the world of work.

2. What is the difference between linear and multiple regression? Which technique does Cowdrey plan on using in his study? Why?

Linear regression is used to identify the relationship between one dependent and one independent variable. Multiple regression is used to identify the relationship between one dependent and multiple independent variables. Cowdrey plans to use multiple regression to study the relationship between pay (the dependent variable) and multiple job characteristics (the independent variables).

3. Explain the meaning of each of the following variables, as they relate to Cowdrey’s compensation study, in the following multiple regression equation:

Y = a + b1X1 + b2X2 + . . . bnXn

The Y is total compensation (a surrogate is total job points). The a is the fixed compensation an employee receives regardless of job characteristics (in the real world it might approximate minimum wage), the bs are the weights the market applies to the individual job characteristics, and the xs are the degree of the individual job characteristics within the particular job.

4. The formula for calculating job characteristic points for the Nursing Department of Charity Hospital is

Y = 55 + 12X1 + 22X2 +3X3

A consultant, who provided the following data, was hired to evaluate the position of Nurses Aide using a multiple regression methodology.

X1 = 3 points, X2 = 1 point, X3 = 5 points

Calculate the total job characteristic points for the position of Nurses Aide at Charity Hospital.

Y = 55 + 12(3) + 22(1) + 3(5) = 128 points.

5. The formula for calculating job characteristic points in the Business office of Medina Memorial Hospital is:

Y = a + b1X1+ b2X2 + b3X3 + . . . bnXn

Jeannine Cortez, personnel director, has determined that the constant a is 6.06 and the market betas for office workers are as follows:

|Beta |Job Characteristic |Beta Value |

|B1 |Decision making |.204 |

|B2 |Planning and scheduling |.081 |

|B3 |Job-related experience |.316 |

|B4 |Training |.012 |

|B5 |Physical exertion |-.109 |

|B6 |Number supervised |.216 |

|B7 |Supervision received |-.137 |

|B8 |Personal contact |.059 |

|B9 |Attention to detail |.220 |

|B10 |Updating job knowledge |.261 |

|B11 |Responsibility for Material Assets |.155 |

|B12 |Job Structure |.334 |

|B13 |Criticality of Position |.362 |

Ms. Cortez interviewed several employees in the Business Office using a multiple regression evaluation system and rated the above job characteristics for each of the jobs as follows (remember these are the x values).

|Job Characteristic |Accountant |Collector |Secretary |Insurance |Computer |

| | | | |Coordinator |Technician |

|Decision making |4.00 |2.20 |1.75 |3.20 |2.80 |

|Planning and scheduling |2.10 |3.10 |3.90 |2.00 |2.80 |

|Job-related experience |4.50 |2.00 |1.50 |3.40 |3.00 |

|Education and training |4.50 |2.50 |1.80 |3.00 |3.50 |

|Physical exertion |1.00 |1.00 |1.50 |1.00 |1.70 |

|Number supervised |5.00 |0.00 |0.00 |2.00 |2.00 |

|Supervision received |1.50 |4.00 |3.80 |2.50 |1.00 |

|Personal contact |2.60 |4.90 |4.00 |2.50 |1.00 |

|Attention to detail |3.90 |2.80 |3.00 |3.80 |3.50 |

|Updating job knowledge |4.30 |1.90 |1.00 |3.80 |2.80 |

|Responsibility for material|4.80 |1.00 |1.00 |1.60 |3.10 |

|assets | | | | | |

|Job structure |1.10 |4.80 |4.10 |2.50 |3.60 |

|Criticality of position |3.50 |1.90 |2.00 |2.80 |3.70 |

Calculate job points (a surrogate for compensation) for each position.

The job points for accountant are calculated as follows:

Y = 6.06 + (.204 x 4.00) + (.081 x 2.10) + (.316 x 4.50) + (.012 x 4.50) + (-.109 x 1.00) + (.216 x 5.00) + (-.137 x 1.50) + (.059 x 2.60) + (.220 x 3.90) + (.261 x 4.30) + (.155 x 4.80) + (.334 x 1.10) + (.362 x 3.50) = 13.7997

Job points for other positions are:

Collector -- 10.6119, Secretary -- 9.9498, Insurance Coordinator -- 12.0376, Computer Technician -- 12.5398

6. The position of assistant controller at Community Hospital has an entry rate of $20 per hour, a range of 50 percent, and six steps. Prepare a salary schedule for this position.

The salary schedule lane looks like this:

|Step |Wage |

|6 | $ 30.00 |

|5 | $ 27.67 |

|4 | $ 25.51 |

|3 | $ 23.52 |

|2 | $ 21.69 |

|1 | $ 20.00 |

How do we calculate the values? Enter $20.00 on step 1, and 1.5 x $20.00 = $30.00 on step six. How do we find the percentage increase for each step? One easy way is to use a financial calculator. Enter 5 as the number of payments, -$20.00 as the present value, 0 as the payment, +$30.00 as the future value and calculate for interest. The answer is 8.45%. You can then take $20.00 (step 1) and multiply it by 1.0845 to get $21.6, etc.

7. Hopkins Hospital has recently finished a study to determine the internal consistency of its present salary schedule using regression type methodology. When existing salaries are graphed against job characteristic points, the data points are as follows:

From these data, what can you conclude about the internal consistency of the hospital’s present salary schedule? Is it possible to calculate a salary line from these data?

Since the data points do not approximate a straight line, the model doesn’t work and we can conclude the present salary schedule lacks internal consistency, at least with this model. In other words, the dependent variable cannot accurately be estimated by the independent variable.

8. Hopkins Hospital then obtained salary information from competing hospitals, which it used to draw a salary line. It decided to adopt this salary line for establishing its internal salary schedules. Since the controller had bad eyesight and didn’t like reading charts, he used a linear regression methodology to determine that the constant was $4.50 per hour and the slope of the line was $.30 per job characteristic point.

A. What is the equation of the salary line?

B. The position of housekeeper has been evaluated as having 67 job characteristic points. What should the position pay per hour?

Y = 4.50 + 0.30X --- Y = $4.50 + 0.30(67) = $24.60

9. Mary Wycoff, assistant human resource director, is interested in determining the multiple regression formula for job characteristic points are for the hospitals in her region. She wants to use the betas from this formula to develop a salary formula for her own hospital.

| |Job Characteristic 1 |Job Characteristic 2 |Job Characteristic 3 |Wage |

|Housekeeper |1 |3 |2 |$6.58 |

|Lab Tech |3 |0 |5 |$11.09 |

|Accountant |2 |2 |3 |$8.46 |

|Ray Tech |5 |4 |1 |$10.90 |

|Respiratory Therapist |4 |5 |2 |$10.91 |

|Admin Secretary |3 |5 |4 |$11.60 |

|Grounds man |1 |2 |0 |$4.25 |

|In-service Supervisor |3 |5 |5 |$12.58 |

|Collector |3 |3 |1 |$8.07 |

|Registered Nurse |5 |5 |5 |$15.11 |

|LPN |3 |1 |5 |$11.39 |

|Hskp Supervisor |3 |4 |4 |$11.30 |

A. From the data given, calculate the constant and the betas for a new regression based salary evaluation program.

B. The position of Nurse aide has been evaluated and the evaluator has assigned the following points: Job Characteristic 1 = 2; Job Characteristic 2 = 1; Job Characteristic 3 = 2. From this data, calculate a proposed hourly wage.

You can solve part A with any multiple regression software package. We used Excel. First open up the “Analysis Toolpack” using the “Add-Ins” feature under “Tools”. From the menu select:

Tools

Data analysis

Regression

OK

Input Y range (block and enter the dollar or Y values, column five from the table)

Input X range (block and enter the three columns of X values which are Job Characteristic 1, Job Characteristic 2, and Job Characteristic 3)

The output looks like this. The intercept of 2.416930371 is the a in the equation Y = a + b1X1 + b2X2 + b3X3. The X variable 1, X variable 2, and X variable 3 coefficients are the betas (B1, B2, and B3).

|SUMMARY OUTPUT | | | | | |

| | | | | | | |

|Regression Statistics | | | | | |

|Multiple R |0.999982071 | | | | | |

|R Square |0.999964142 | | | | | |

|Adjusted R Square |0.999950695 | | | | | |

|Standard Error |0.020330399 | | | | | |

|Observations |12 | | | | | |

| | | | | | | |

|ANOVA | | | | | | |

| |df |SS |MS |F |Significance F | |

|Regression |3 |92.21076007 |30.73692002 |74364.99007 |4.06849E-18 | |

|Residual |8 |0.003306601 |0.000413325 | | | |

|Total |11 |92.21406667 | | | | |

| | | | | | | |

| |Coefficients |Standard Error |t Stat |P-value |Lower 95% |Upper 95% |

|Intercept |2.416930371 |0.018214776 |132.6906462 |1.16355E-14 |2.374926996 |2.458933747 |

|X Variable 1 |1.258682707 |0.005663055 |222.2621516 |1.87949E-16 |1.245623671 |1.271741743 |

|X Variable 2 |0.300130676 |0.004071928 |73.70726661 |1.2789E-12 |0.290740787 |0.309520564 |

|X Variable 3 |0.978896263 |0.003518267 |278.2325022 |3.11741E-17 |0.97078312 |0.987009407 |

Part B:

Y = 2.416930371 + (1.258682707 x 2) + (0.300130676 x 1) + (0.978896263 x 2) = $7.19 (rounded to two decimal places)

Supplement Three

1. Define and provide examples of primary, intermediate, and final hospital products.

Primary, intermediary, and final products are cost objectives—different levels of detail in the costing process. A primary product is the basic input such as direct labor and direct materials. An intermediate product is a summation of a set of primary products, such as a medical procedure. Each medical procedure is a summation of the materials and labor used in that procedure. Groups of intermediate products are summed up into a final product. Final products are assigned both direct and indirect costs and are the basis of bills submitted for reimbursement. For example, a number of medical procedures are summarized to get a DRG classification.

2. What is a cost roll-up?

The process to “roll-up” costs is the process of summarizing costs while moving from primary to intermediate to final products.

3. How does Nathan Stocks’ “quick and dirty” costing system differ from the one he eventually hopes to install? What is the reason for installing a quicker system?

The “quick and dirty system” will no depend upon cost roll-ups to more accurately determine final products. It will not define the final product as a DRG, an admission, or capitation day, but will use a simpler (and less accurate) final cost objective—the patient day. Wes feels that he needs some cost data immediately, and is temporarily willing to sacrifice detail for timeliness.

4. What methodologies are available to determine the standard time required to manufacture a product or service? What are the advantages and disadvantages of each?

Methodologies include:

• Hire an industrial engineer to follow employees around with a stop-watch and to determine the time it takes to perform procedures. The advantage of this methodology is accuracy, the disadvantage is cost. Some hospitals have spent in excess of a million dollars developing standards using this methodology.

• Borrow standards from other hospitals that have conducted industrial engineered standards. This is cheaper, the only concerns are how similar are the hospitals and is the data available?

• Determine how much time it now takes to perform each procedure, hoping to tighten the standards as time progresses. The advantage of this method is cost, one must have a methodology to determine what the historical standard has been, however, and this data might not be available

Chapters Twenty-One and Twenty-Two

1. What could Accounting have done to prevent the fraud that Ryan Raymer has engaged in?

Implemented a better system of internal controls, and performed periodic audits.

2. Hap Castleton told Amy that managed care attempts to control costs in three ways. List these, and explain the advantages and disadvantages of each from the standpoint of quality and cost.

• Precertification and review—this is an audit function performed by an independent third party (it may be the physician’s peers, or personnel within an insurance company). In checking for appropriateness of service, this tool attempts to compensate for disparity of information—the inability the patient has due to his or her lack of technical knowledge to determine the quality and necessity of the products and services ordered by the physician. Few people, physicians included, enjoy having others critique their work. Some physicians justifiably argue that the personnel used to audit physician behavior are not qualified to evaluate technical medical decisions.

• Gatekeeper Physicians—this is an attempt to restrict access to more expensive specialists. Patients object to gatekeeper physicians as it increases the number of visits, and therefore the number of physician office co-pays that they must make, to see a specialist. This, plus concerns that the extra visit to a gatekeeper when a specialist is needed eliminates savings due to reduced specialist utilization have caused many managed care organizations to back away from gatekeeper physicians.

• Incentive Reimbursement—this is an attempt to change physician cost behavior by shifting the risk of excess resource utilization to the physician or hospital. There is evidence that DRG and capitation payment do reduce utilization. Critics charge they also reduce quality.

3. Consider the following stakeholders: (1) physicians, (2) patients, (3) employers, (4) insurance companies, and (5) hospitals. Which of these are in the best position to monitor (1) quality, and (2) cost? Explain your reasoning.

Physicians are in the best position to monitor quality and resource utilization. Where it involves a peer, the question is “Will they?”

Patients lack the technical background to evaluate the necessity or quality of most services provided. If their medical bills are paid by employers or insurance companies, they may lack the incentive to audit cost. Patients have typically not been provided cost data they could use to shop and compare.

Employers have an advantage in that they pay the bill. They lack medical technical skills but can hire them.

Insurance companies are similar to the employer. They have leverage in that they pay the bill and they do have the ability to hire physicians and nurses to perform a review function.

Hospitals have access to cost data and medical data. They also have access to personnel with the knowledge and capability to evaluate that data. Traditionally hospitals did not do a good job of monitoring costs, as there was little financial incentive to do so.

Chapter Twenty-Three

1. How is Life Flight a marketing tool?

It enables a hospital to capture patients outside its normal marketing area.

2. Why are hospitals more concerned with marketing under prospective reimbursement than they were under cost reimbursement?

Prospective reimbursement has limited revenue growth through price increases. In some cases (DRG and capitation payment) it also limits the ability of a hospital to increase revenues by increasing the number of medical goods and services provided to a specific patient.

With these curtailments, the only way to increase revenues is to increase patient volume. If the number of potential patients in a market area are fixed, the only way to increase volume is by capturing market share from competing hospitals.

3. What are the principal causes of out-migration for rural hospitals?

• Better transportation systems (freeways, helicopters) have increased rural access to metropolitan medical centers.

• Bigger is Better Syndrome—patients feel that larger metropolitan medical centers can provider higher quality. It is true that smaller rural hospitals often lack the financial resources to pay the fixed costs of specialized equipment and facilities.

• More aggressive rural marketing by metropolitan hospitals.

Supplement Four

1. Explain how a hospital makes or looses money under the following payment systems: (a) billed charges, (b) cost reimbursement, (c) DRG payment, and (d) capitation payment.

|Payment System |Hospital makes money by |Hospital looses money by |

|Billed charges |Increasing hospital admissions |Failing to set prices at a level that cover |

| |Increasing number of billable products and |costs. |

| |services provided per admission |Failing to document and bill for all medical |

| |Increasing prices |goods and services provided. |

|Cost-plus reimbursement |Increasing hospital admissions |Failing to document costs |

| |Increasing number of billable products and |Failing to document goods and services provided|

| |services provided per admission | |

| |If the hospital receives a markup on costs, it | |

| |can increase profits by allowing costs to | |

| |increase. | |

|DRG payment |Increasing admissions in product lines where |Offering product lines where costs exceed the |

| |the established price exceeds actual product |predetermined price. |

| |cost. |Allowing costs to exceed standards. |

| |Reducing hospitalization costs. |Reducing admissions. |

| |Increasing the number of admissions, but |Increasing length of stays |

| |reducing the length of stay and the volume and |Increased intensity of services provided to |

| |cost of the medical goods and services provided|patients during the hospital length of stay |

| |during that stay. | |

|Capitation payment |Reducing expensive hospital admissions by |Admitting patients to the hospital |

| |keeping patients healthy, or finding less |Allowing inpatient and outpatient costs to |

| |costly treatment alternatives |exceed budgets |

| |Reducing costs of actual admissions |Insuring unhealthy populations |

| |Insuring healthy populations |Providing more medical goods and services |

| |Diagnosing illnesses earlier, when treatment is|necessary |

| |less costly |Losing enrollees to other plans because |

Supplement Six

1. Explain the difference between job-order costing and process costing.

Job order costing is used by firms that produce products that are unique one from another. A builder of custom homes would use a job order costing system as would an automobile repair shop. A process costing system is used by firms that produce homogeneous products such as paint or marbles.

2. Explain the differences between actual, normal and standard costing.

In actual costing actual direct labor, actual direct materials, and actual overhead are debited to the work-in-process account.

In normal costing, actual direct labor, actual direct materials, and overhead applied (through the use of an overhead rate) are applied to work-in-process.

In standard costing, standard direct labor, standard direct materials, and standard overhead are applied to work-in-process.

Supplement Seven

1. Using the outline provided by Nathan Stocks, identify the information needs under DRG costing.

How do we lose money under a DRG reimbursement contract?

• By not having as many admissions as budgeted.

• By keeping patients admitted longer than budgeted.

• By using more resources per admission than budgeted.

• By offering in our product line a DRG that’s fixed payment does not cover our total costs of providing that DRG.

What variables must management monitor to prevent losses under DRG reimbursement?

• Numbers of admissions by DRG.

• Average length of stay by DRG.

• Average length of stay by DRG by physician.

• Resource utilization by DRG.

• Resource utilization by DRG by physician.

• Fixed payment per DRG.

Supplement Eight

1. What are the three levels of cost detail proposed for the cost system to be developed for Peter Brannan Community Hospital?

Primary product, intermediate product, and final product cost detail.

2. What is the 80/20 Pareto Principle, and what is its application in hospital standard costing?

Eighty percent of a hospital’s revenue typically comes from twenty percent of its procedures. If more than one costing methodology is used, then these need to be costed using the most accurate costing methodology.

3. List three approaches to determining the standard time a procedure should take to perform. What are the advantages and disadvantages of each method?

• A study by an industrial engineer to determine the time it takes to perform each procedure. This is the most accurate method but is also the most costly.

• Borrowing standards from a hospital that has already conducted an industrial engineered study. Borrowing standards should be cheaper than developing them for ourselves but the standards might not be applicable to our hospital due to differences in size, product line, average case-mix intensity of care, etc.

• Determination of the current time it takes to perform each procedure through the use of relative value units (RVUs). This is cheaper than conducting an industrial engineered study, and will possibly provide standards that are more applicable to our own facility.

4. What is a relative value unit (RVU)?

An RVU is a measure of resource consumption. It is in essence a homogeneous work unit that can be used to compare across departments. Standards can be built on RVUs and then applied to all activities in the hospital on a common basis for every department. A procedure with an RVU of 2 consumes twice as much labor as a procedure with an RVU of 1.

5. In designing its costing system, why is it important for Peter Brannan Hospital to separate its costs into fixed and variable components?

Separating total costs into fixed and variable components will allow management to more accurately predict total costs at different levels of volume.

Supplement Nine

1. Explain the meaning of each symbol in the linear regression equation y = a + bx, when linear regression is used to separate total costs into fixed and variable components.

Y = total cost

a = fixed cost

b = variable cost per unit

x = number of units

2. Wally Hughes, director of housekeeping for St. Mary’s Hospital has accumulated the following data on the labor costs of housekeeping for the delivery room:

|Month |Deliveries |Labor Costs |

|January |82 |4,400 |

|February |70 |3,820 |

|March |98 |5,150 |

|April |77 |4,000 |

|May |69 |3,700 |

|June |75 |4,070 |

Required:

A. Calculate the estimated fixed and variable costs using

i. The high-low method.[1]

The formula for the high-low method is (Yhigh – Ylow)/(Xhigh – Xlow) =($5,150 – $3,700)/(98 – 69) = 1,450/29 = $50 per delivery. This is the b in the equation Y = a + bX; b of course is variable cost per unit. The fixed cost can be computed by subtracting the total variable costs at any level of production from the total costs at that level. Let’s use high costs.

High total costs ($5,150) – variable costs at high level of production ($50 x 98 = $4,900) = $250.

The cost equation, therefore, is Y = a + bx or, Y = 250 + 50x

ii. The least squares method (use the regression analysis option in Excel or some other spreadsheet program).

You can solve part A with any multiple regression software package. We used Excel. From the menu select:

Tools

Data analysis

Regression

OK

Input Y range (block and enter the dollar or Y values, from the third column in the table)

Input X range (block and enter the deliveries from the second column in the table)

OK

The output is shown in the following table. The intercept of is the a in the equation which of course is the fixed cost. The X variable 1 coefficient is the b, which is the variable cost per unit. The cost equation using regression analysis, therefore, is:

Y = $335.9877085 + $49.09569789X

|SUMMARY OUTPUT | | | | | |

| | | | | | | |

|Regression Statistics | | | | | |

|Multiple R |0.992621254 | | | | | |

|R Square |0.985296953 | | | | | |

|Adjusted R Square |0.981621192 | | | | | |

|Standard Error |71.56165953 | | | | | |

|Observations |6 | | | | | |

| | | | | | | |

|ANOVA | | | | | | |

| |df |SS |MS |F |Significance F | |

|Regression |1 |1372715.716 |1372715.716 |268.052461 |8.1468E-05 | |

|Residual |4 |20484.28446 |5121.071115 | | | |

|Total |5 |1393200 | | | | |

| | | | | | | |

| |Coefficients |Standard Error |t Stat |P-value |Lower 95% |Upper 95% |

|Intercept |335.9877085 |237.2042143 |1.416449153 |0.22959199 |-322.5981354 |994.5735524 |

|X Variable 1 |49.09569798 |2.998703587 |16.37230775 |8.1468E-05 |40.76994484 |57.42145112 |

B. What does the r2 tell us about the model?

An R squared of .985296953 tells us we have a good fit. Basically this R squared indicates that any change in the number of deliveries explains 98.5296953 of the change that will occur in the costs incurred. The closer R squared is to 1.0, the better the fit.

C. Using spreadsheet software, demonstrate the closeness of the fit by sorting the data in ascending order, then graph the data.

We used the graphics package of Excel. Highlight the second and third columns of data. Select the chart wizard on the menu bar, then select:

XY(Scatter)

Next

Finish

You should get the following graph:

[pic]

D. From preadmission information provided by the Admitting Department, Wally estimates that St. Mary’s Hospital will deliver 86 babies in July. Using the cost equation from your regression projection, what should the budget for labor be for the month of July?

Y = a + bX = 335.99 + 49.10(86) = $4,558.89

3. Tracy Hilliam, manager of the Carbon County Clinic, has collected the following data on the costs of providing black-lung x-rays to coal miners:

|X-rays |Cost |

|5 |$50 |

|10 |175 |

|15 |225 |

|20 |260 |

|25 |275 |

|30 |290 |

|35 |300 |

|40 |315 |

|45 |340 |

|50 |375 |

|55 |450 |

Required

A. Using spreadsheet software, prepare a scatter graph of the costs shown above.

C. What is the Y intercept? What does the graph tell you about the data? Can we use a linear function to model the data?

The Y intercept is negative, which is impossible—there is no such thing as negative fixed costs. The reason this occurs is that the data is not linear. If we still wish to use a model, we could break the graph into three segments (from 0 to 15, 20 to 40, and 45 to 60), then use regression or the high-low method to calculate three equations.

D. Use regression methodology to calculate the cost function i n the range from 20 to 40 x-rays.

You can solve part C with any multiple regression software package. We used Excel. From the menu select:

Tools

Data analysis

Regression

Ok

Input Y range (block and enter the dollar values).

Input X range (block and enter the number of x-rays).

OK

|SUMMARY OUTPUT | | | | | |

| | | | | | | |

|Regression Statistics | | | | | |

|Multiple R |0.997948716 | | | | | |

|R Square |0.995901639 | | | | | |

|Adjusted R Square |0.994535519 | | | | | |

|Standard Error |1.58113883 | | | | | |

|Observations |5 | | | | | |

| | | | | | | |

|ANOVA | | | | | | |

| |df |SS |MS |F |Significance F | |

|Regression |1 |1822.5 |1822.5 |729 |0.000111491 | |

|Residual |3 |7.5 |2.5 | | | |

|Total |4 |1830 | | | | |

| | | | | | | |

| |Coefficients |Standard Error |t Stat |P-value |Lower 95% |Upper 95% |

|Intercept |207 |3.082207001 |67.15966835 |7.27442E-06 |197.1910325 |216.8089675 |

|X Variable 1 |2.7 |0.1 |27 |0.000111491 |2.381755071 |3.018244929 |

The cost function, therefore, is Y = 207 + 2.70 x. Translated into English, the fixed costs are $207, the variable costs per unit are $2.70.

4. John Banaski, director of pharmacy at Huntington Memorial Hospital, has collected the following information on the labor costs of operating the pharmacy:

|Prescriptions |Labor costs |

|500 |$2,000 |

|1,000 |2,500 |

|1,500 |3,000 |

|2,000 |3,500 |

|2,500 |4,000 |

|3,000 |6,000 |

|3,500 |6,500 |

|4,000 |7,000 |

Required:

A. Using spreadsheet software, prepare a sactter diagram of the above data.

B. Analyze the data shown on the graph. What is the probable reason for the cost pattern shown?

The graph indicates that the cost function changes at about 3,500 units. The most likely explanation is that the relevant range for fixed costs if from 0 to 3,500 units. After that fixed costs increase.

5. Cullimore Hospital uses RVUs to determine standard labor rates for each of its lab tests. An RVU has been calculated to be equivalent to $8.50 of direct labor. Determine the standard labor costs for a test with 6 RVUs of labor.

Standard labor for the test would be 6 x $8.50 = $51.00.

6. McCormick Memorial Hospital uses industrial engineered studies to calculate standard labor costs. The laboratory uses a standard costing system. The standard labor to perform a white blood count (WBC) is four minutes. The standard labor rate for technicians is $15 per hour. What is the standard labor cost for a WBC?

$15/60 minutes = $0.25 per minute. 4 minutes x $0.25 = $1.00.

Supplement Ten

1. Differentiate between department overhead and general hospital overhead. How are both calculated and allocated to individual revenue-producing departments?

Department overhead includes the indirect costs of the department. For example, in the nursing department, the salary of the nursing director and her assistant nursing director are department overhead costs. General hospital overhead includes the cost of service departments. Examples include administration, human resources, the business office, medical records, and housekeeping.

Department overhead is allocated to products by dividing overhead by the total yearly relative value units in the department. This results in a department overhead rate using RVUs as the base. This number is then multiplied by the number of relative value units in each procedure.

General hospital overhead is allocated using the double apportionment allocation method.

2. The laboratory of St. Mary’s Hospital uses a standard costing system. The standard labor to perform a white blood count (WBC) is seven minutes. The standard labor rate for technicians is $15 per hour.

A. What would you propose as the standard labor cost for a WBC?

Part A The standard cost per minute is $15/60 = $0.25 per minutes. The standard cost per test is 7 x $0.25 = $1.75

B. During the month of March, the laboratory performed 1,000 WBCs. Laboratory technicians used 6,850 minutes of labor performing these tests. The average labor rate paid during the month was $14.85 per hour. Calculate the labor rate and labor efficiency variances for the month of March.

The actual labor rate per minute was $14.85/60 = $0.2475

|Actual quantity x actual price|6,850 minutes x $0.2475 = |$1,695.38 | |

|= | | | |

| | | |$17.12 favorable rate variance|

|Actual quantity x standard | 6,850 x $0.25 = |$1,712.50 | |

|price = | | | |

| | | |$37.50 favorable efficiency |

| | | |variance |

|Standard quantity x standard |(7 minutes x 1,000 tests) x |$1,750.00 | |

|price = |$.025 | | |

3. The Radiology Department of Fort Dodge Community Hospital performs three procedures:

|Test |Estimated number of |RVUs |

| |tests performed annually | |

|A |5,000 |4.00 |

|B |2,000 |1.00 |

|C |3,200 |2.50 |

The department’s direct labor budget for the year was $120,000. Material costs for each test were Test A = $12.50; Test B = $15.00; Test C = 13.50. Departmental and allocated overhead (amounting to $30,000) is allocated to procedures on the basis of RVUs, as is department direct labor. Assuming the hospital wants to earn a profit of 10 percent of the total direct and allocated cost of each test, what should it charge for each test?

First let’s calculate the total number of RVUs in the department for the year:

|Test |Estimated number of tests performed |RVUs |Total RVUs (Column 2 x |

| |annually | |Column 3) |

|A |5,000 |4.00 |20,000 |

|B |2,000 |1.00 |2,000 |

|C |3,200 |2.50 |8,000 |

|Total | | |30,000 |

Now we will calculate direct labor per RVU: $120,000/30,000 = $4.00 per RVU

Let’s do the same thing for allocated overhead: $30,000/30,000 = $1.00 per RVU

Now we will multiply the cost per RVU by the number of RVUs in each test, and plug the figures into the following table.

| |Test A |Test B |Test C |

|Direct labor |$16.00 |$4.00 |$10.00 |

|Direct materials |12.50 |15.00 |13.50 |

|Department and allocated overhead |4.00 |1.00 |2.50 |

|Subtotal |$32.50 |$20.00 |$26.00 |

|Profit |3.25 |2.00 |2.60 |

|Total charge |$35.75 |$22.00 |$28.60 |

4. The controller of Rose Hospital has provided you with the following data on service-department costs to be distributed to revenue-producing departments.

Service Department Costs and Hospital Statistics for Double Apportionment

| | Admin* | Hskp* | Laundry* | Nursing | Lab | X-ray | P.T. | O.R. | |Costs |

| |Admin |Hskp |Laundry |Nursing |Lab |X-ray |P.T. |O.R. |Base |Base |

| | | | | | | | | | | |

|Personnel |6 |8 |6 |56 |9 |6 |2 |11 |98 |98 |

|Sq ft | | | | | | | | | | |

| |1,800 |420 |2,500 |25,000 |1,800 |2,100 |3,000 |4,000 |40,200 |38,400 |

|Pounds of Laundry| | | | | | | | | | |

| |200 |1,500 |200 |18,000 |600 |1,000 |2,400 |4,000 |27,700 |26,000 |

| | | | | | | | | | | |

|First Allocation | | | | | | | | | | |

|Costs -- $ | 260,000 | 400,000 | 38,000 | | | | | | | |

|Allocate Admin |(260,000) | 21,224 | 15,918 | 148,571 | 23,877 | 15,918 | 5,306 | 29,183 | | |

| | | | | | | | | |0.00 | |

|Allocate Hskp | 18,860 |(421,224) |26,195 | 261,955 | 18,860 | 22,004 | 31,434 | 41,912 | $ | |

| | | | | | | | | |- | |

|Allocate Laundry | | 4,338 | (80,113) | 52,059 | 1,735 | 2,892 | 6,941 | 11,568 | $ | |

| |578 | | | | | | | |- | |

|Subtotal | 19,439 | 4,338 | | 462,586 | 44,473 | 40,814 | 43,682 | 82,665 |698,000 | |

|Second Allocation | | | | | | | | | |

|Allocate Admin | (19,439) | 1,586 | 1,190 | 11,108 | 1,785 | 1,190 | 396 | 2,181 | $ | |

| | | | | | | | | |- | |

|Allocate Hskp | | (5,925)| 385 | 3,857 | 277| 324 | 462 | 617 | $ | |

| | | | | | | | | |- | |

|Allocate Laundry | | | (1,575) | 1,091| | | 145 | 242 | $ | |

| | | | | |36 |60 | | |- | |

|Total cost allocated | | | 478,643 | 46,573 | 42,389 | 44,687 | 85,706 | 698,000 | |

| | | | | | | | | | | |

|First Allocation Base | | | | | | | | | |

|Administration | 2,653.06 |260,000 / 98 | | | | | | |

|Housekeeping | 10.48|421,224 / 40,200 | | | | | | |

|Laundry | |80,113 / 27,700 | | | | | | |

| |2.89 | | | | | | | |

| | | | | | | | | | | |

|Second Allocation Base | | | | | | | | | |

|Administration |198.36 |19,439 / 98 | | | | | | |

|Housekeeping | |5,925 / 38,400 | | | | | | |

| |0.15 | | | | | | | |

|Laundry | |1,575 / 26,000 | | | | | | |

| |0.06 | | | | | | | |

5. A statement of direct and indirect costs for Methodist Rural Hospital is shown below. Use the step-down (sequential) allocation method to allocate service department costs to revenue-producing centers. Allocate departments in the following order: (1) Administration, (2) Housekeeping, and (3) Dietary. Allocate administration costs on the basis of number of employees, housekeeping on the basis of square feet, and dietary on the basis of number of meals served.

| |Admin |Hskpng |Dietary |Nursing |Lab |

|# Empl |5 |18 |19 |64 |12 |

|Sq Ft |1,000 |900 |2,300 |22,500 |7,000 |

|# Meals |1,000 |7,000 |8,000 |99,000 |6,200 |

|OH Cst |$126,000 |$350,000 |$970,000 |$3,950,000 |$93,000 |

| | | | | | |

| | | | | | |

| | | | | | |

| | | | | | |

|Total | | | | | |

Answer

| | | | | | |Allocation |

| |Admin |Hskp |Dietary |Nursing |Lab |Base |

|# employees |5 |18 |19 |64 |12 |113 |

|Sq ft | 1,000 | 900 | 2,300 | 22,500 | 7,000 | 31,800 |

|# meals | 1,000 | 7,000 | 8,000 | 99,000 | 6,200 | 105,200 |

| | | | | | | |

| | | | | | | Total |

|OH cost | $ 126,000.00 | $ 350,000.00 | $ 970,000.00 | $3,950,000.00 | $93,000.00 | |

|Alloc Admin | $ (126,000.00) | $ 20,070.80 | $ 21,185.84 | $ 71,362.83 | $ 13,380.53 | $ - |

|Alloc Hskp | | $ (370,070.80) | $ 26,766.13 | $ 261,842.54 | $ 81,462.13 | $ - |

|Alloc Dietary | | | $(1,017,951.97) | $ 957,958.60 | $ 59,993.37 | $ - |

|Total | | | | $ 5,241,163.98 | $ 247,836.02 | |

| | | | | | | |

| | | | | | | |

| |Admin |Hskp |Dietary | | | |

|Rates: | $1,115.0442478 | $ 11.6374464 | $ 9.6763495 | | | |

Supplement Eleven

1. The laboratory of Memorial Hospital has decided to use RCC for calculating standard costs. Last year, the laboratory had $1,200,000 in revenue, $600,000 in direct department costs, and $300,000 in department overhead and allocated overhead. The current charge for a urinalysis is $15. What would be the RCC standard cost?

Total costs = $600,000 + $300,000 = $900,000.

The ratio of costs to charges is 900,000/1,200,000 = .75

The standard cost for a urinalysis using the RCC methodology would be

.75 x $15 = $11.25.

Supplement Twelve

1. Data on two competing hospitals is given below. Calculate (1) each hospital’s case-mix index, (2) each hospital’s average charge, and (3) each hospital’s adjusted average charge. Which hospital appears to have the lowest charges? Which has the lowest average charge? Which is most cost efficient?

ST. JOSEPH’S HOSPITAL

|DRG |Case Mix Index |Number of Cases |Hospital Charge |

|1 |1.5 |1,000 |$3,100 |

|2 |2.9 |2,000 |$6,350 |

|3 |3.0 |500 |$5,100 |

|4 |4.0 |2,500 |$7,850 |

ST. LUKE’S HOSPITAL

|DRG |Case Mix Index |Number of Cases |Hospital Charge |

|1 |1.5 |3,000 |$3,600 |

|2 |2.9 |1,000 |$6,100 |

|3 |3.0 |1,100 |$4,800 |

|4 |4.0 |2,000 |$8,050 |

|St. Joseph's Hospital | | | | |

| | | | | | |

|A |B |C |D |E |F |

| |Case Mix |Number of |Hospital |Case Mix |Total |

|DRG |Index |Cases |Charge |Units |Revenue |

| | | | |(B x C) |(C x D) |

|1 | 1.50 | 1,000 | $ 3,100 | 1,500 | $ 3,100,000 |

|2 | 2.90 | 2,000 | $ 6,350 | 5,800 | $ 12,700,000 |

|3 | 3.00 | 500 | $ 5,100 | 1,500 | $ 2,550,000 |

|4 | 4.00 | 2,500 | $ 7,850 | 10,000 | $ 19,625,000 |

| | | 6,000 | | 18,800 | $ 37,975,000 |

| | | | | | |

|18,800/6,000 = 3.13 case mix index | | |

|$37,975,000/6,000 cases = $6,329.17 average charge per case |

|$6,329.17/3.13 = $2,022.10 | | | |

| | | | | |

|St. Luke's Hospital | | | | |

| | | | | | |

|A |B |C |D |E |F |

| |Case Mix |Number of |Hospital |Case Mix |Total |

|DRG |Index |Cases |Charge |Units |Revenue |

| | | | |(B x C) |(C x D) |

|1 | 1.50 | 3,000 | $ 3,600 | 4,500 | $ 10,800,000 |

|2 | 2.90 | 1,000 | $ 6,100 | 2,900 | $ 6,100,000 |

|3 | 3.00 | 1,100 | $ 4,800 | 3,300 | $ 5,280,000 |

|4 | 4.00 | 2,000 | $ 8,050 | 8,000 | $ 16,100,000 |

| | | 7,100 | | 18,700 | $ 38,280,000 |

| | | | | | |

|18,700/7,100 = 2.63 case mix index | | |

|$38,280,000/7,100 cases = $5,391.55 average charge per case |

|$5,391.55/2.63 = $2,050.02 | | | |

| | | | | | |

2. The reimbursement at St. Anthony’s hospital for DRG 152 is $4,100. At a volume of 1,200 DRG 152 procedures, St. Anthony’s fixed costs are $2,000,000. Variable costs per procedure are $2,183. At a production volume of 1,200, how much will the hospital make or lose in total on DRG 152?

The cost equation is Y = a + bX where Y is total cost, a is fixed cost, b is variable cost per unit and X is the number of units. Plugging the data given into this equation:

Y = 2,000,000 + $2,183(1200) = $$4,619,600

Revenue at his volume will be $4,100 x 1,200 = 4,920,000

The hospital will make 4,920,000 – $4,619,600 =$300,300

Supplement Thirteen

1. The following standard costs have been provided to you by the controller. An internal study indicates that the resource profile for DRG 7 is:

3 acuity 1 patient days

1 acuity 2 patient day

1 radiology procedure 1

3 radiology procedure 4

2 lab test 1

1 lab test 2

1 lab test 3

3 lab test 5

Operating room minutes = 35

The standard costs for each of the above procedures are:

| | Standard |

| | Cost |

|Department--Nursing | |

|Workunit--Patient Day | |

| | |

|Acuity Level 1 | $ 250.00 |

|Acuity Level 2 | $ 275.00 |

|Acuity Level 3 | $ 350.00 |

|Acuity Level 4 | $ 470.00 |

|Acuity Level 5 | $ 610.00 |

| | |

|Department--Radiology | |

|Workunit--Procedure | |

| | |

|Procedure 1 | $ 25.00 |

|Procedure 2 | $ 50.00 |

|Procedure 3 | $ 100.00 |

|Procedure 4 | $ 230.00 |

|Procedure 5 | $ 75.00 |

|Procedure 6 | $ 35.00 |

|Procedure 7 | $ 650.00 |

| | |

|Department--Laboratory |

|Workunit--Test | |

| | |

|Test 1 | $ 145.00 |

|Test 2 | $ 28.00 |

|Test 3 | $ 55.00 |

|Test 4 | $ 32.00 |

|Test 5 | $ 250.00 |

|Test 6 | $ 58.00 |

|Test 7 | $ 22.00 |

| | |

|Department--Operating Room |

|Workunit--OR Minute | |

| | |

|Basic Minute | $ 45.00 |

|Total Standard Cost | |

Required:

A. Calculate the standard cost for DRG 7.

| | Standard | |Total |

| | Cost |Number |Cost |

|Department--Nursing | | | |

|Workunit--Patient Day | | | |

| | | | |

|Acuity Level 1 | $ 250.00 |3 |$750.00 |

| | | | |

|Acuity Level 2 | $ 275.00 |1 | $ 275.00 |

|Acuity Level 3 | $ 350.00 | | |

|Acuity Level 4 | $ 470.00 | | |

|Acuity Level 5 | $ 610.00 | | |

| | | | |

|Department--Radiology | | | |

|Workunit--Procedure | | | |

| | | | |

|Procedure 1 | $ 25.00 |1 | $ 25.00 |

|Procedure 2 | $ 50.00 | | |

|Procedure 3 | $ 100.00 | | |

|Procedure 4 | $ 230.00 |3 |$690.00 |

|Procedure 5 | $ 75.00 | | |

|Procedure 6 | $ 35.00 | | |

|Procedure 7 | $ 650.00 | | |

| | | | |

|Department--Laboratory | | |

|Workunit--Test | | | |

| | | | |

|Test 1 | $ 145.00 |2 | $ 290.00 |

|Test 2 | $ 28.00 |1 | $ 28.00 |

|Test 3 | $ 55.00 |1 | $ 55.00 |

|Test 4 | $ 32.00 | | |

|Test 5 | $ 250.00 |3 | $ 750.00 |

|Test 6 | $ 58.00 | | |

|Test 7 | $ 22.00 | | |

| | | | |

|Department--Operating Room | | |

|Workunit--OR Minute | | | |

| | | | |

|Basic Minute | $ 45.00 |35 | $1,575.00 |

|Total Standard Cost | | |$4,438.00 |

| | | | |

B. The reimbursement for DRG 7 is $4,250. How much does the hospital make or lose on each DRG 7?

$4,250 - $4,438 = loss of $188

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[1] For a review of the high-low and least-squares methods, see any introductory managerial accounting textbook.

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