Literature week 2 – Financial Management
Young, D. (2014) Management accounting in health care
organizations.
Chapter 2 – Essentials of full-cost accounting
The information obtained from a full-cost calculation is used for:
- Pricing decisions – a hospital needs to know the full cost of a product in negotiating
and setting prices, otherwise it is at a disadvantage.
- Profitability assessments – many organizations are price takers, they must accept the
set prices by other parties. Full costing is useful then for senior management to
check whether a product is financially viable. If it doesn’t cover full cost, it is a loss
leader. Full costing shows where cross-subsidization is taking place, and then senior
management decides where corrective action needs to be taken.
- Comparative analyses – comparing a product/service with another organization’s can
be useful. However, it can not be completely accurate as not all organizations
measure their costs in the same way. When comparing, a company must decide
what to focus on; an illness or something else. Also needs to check what costs it
wants to take into account (outpatient, home care etc). Because of these difficulties
in comparing, organizations often just compare their own costs over time.
If full-cost calculations aren’t used for the abovementioned reasons, then senior
management can let the accounting staff calculate it. But when a hospital contracts with the
federal government to do research, then senior management will want to be more involved
in the full-cost accounting (because they have to be prepared according to special
principles). These principles provide for reimbursement of direct costs plus and ‘equitable
share’ of overhead costs. These overhead costs include depreciation of
buildings/equipment, plant operation and maintenance, general administration,
departmental administration, student administration and services and library services.
When senior management wants to be involved in the full-cost accounting, it works with the
accounting staff. This is important, because it can be computed in different ways which give
different results. Also, in hc it is more complicated as there is variety in patient/service mix,
standby capacity, and alternative treatment modalities. There needs to be proper rules for
the information to be of managerial use. The Generally Accepted Accounting Principles
(GAAP) are used in financial accounting.
The fundamental issue cost accounting addresses is the use of resources. These are the
classic ones:
- Land: it is the site where the organization is located. If it has multiple sites, it is
divided between mission (used for delivering services to patients and research) and
support (for administrative purposes) facilities.
- Labor: mission (professional) or support (administrative) labor. Mission labor
consists of people who actually deliver the services and are directly associated with
the organization’s main mission. Support labor is everyone else in the organization.
Can be divided in direct and general. Direct support can be scheduling
patients/secretarial assistance in research project. General support could be
1
, maintenance or cleaning or general administration (office work, not directly related
to the org’s services).
- Capital: mission is all capital resources needed to provide direct support to the org’s
service delivery activities. Can be short-lived (in one year or less used) or long-lived
(used up in several years). Short-lived mission capital – direct materials like syringes,
food in inpatient ward, pharmaceuticals. Long-lived mission capital – equipment
used in service-related activities. Support capital is short or long lived, including
items that provide general support and not directly related to service. E.g. supplies in
CEO’s office, or fax machines/computes.
Measuring these units: land in rent, labor in wages and capital in factor price /depreciation.
Limitations: the principal objective of full-cost accounting effort is to measure as accurately
as possible the consumption of resources associated with producing a particular good or
delivering a particular service. Measuring it can be difficult, esp in hc where there are
multiple products provided. To do this, factors which influence the use of resources are
costs, these need to be identified to be able to measure it properly.
Cost drivers are organizational activities that can be linked directly to costs. Can be divided
into two parts: efficiency and factor prices.
To address this more complex process (of determining the cost of each unit sold, when
there are multiple units being produced), an organization must make six full-cost accounting
decisions:
1. Defining the final cost objects: the final cost object is the unit for which we wish to
know the cost. The more specific the CO, the more complex the accounting
methodology. An example can be an all-inclusive day of care. But now more specific
CO are being used, like laboratory tests. Other examples: discharge day, particular
illnesses. To compute the full cost of each CO, hospitals have identified what they
call intermediate CO – the various services that a patient receives while in the
hospital (called patient needs), like tests, radiology procedures, laundry services.
2
Young, D. (2014) Management accounting in health care
organizations.
Chapter 2 – Essentials of full-cost accounting
The information obtained from a full-cost calculation is used for:
- Pricing decisions – a hospital needs to know the full cost of a product in negotiating
and setting prices, otherwise it is at a disadvantage.
- Profitability assessments – many organizations are price takers, they must accept the
set prices by other parties. Full costing is useful then for senior management to
check whether a product is financially viable. If it doesn’t cover full cost, it is a loss
leader. Full costing shows where cross-subsidization is taking place, and then senior
management decides where corrective action needs to be taken.
- Comparative analyses – comparing a product/service with another organization’s can
be useful. However, it can not be completely accurate as not all organizations
measure their costs in the same way. When comparing, a company must decide
what to focus on; an illness or something else. Also needs to check what costs it
wants to take into account (outpatient, home care etc). Because of these difficulties
in comparing, organizations often just compare their own costs over time.
If full-cost calculations aren’t used for the abovementioned reasons, then senior
management can let the accounting staff calculate it. But when a hospital contracts with the
federal government to do research, then senior management will want to be more involved
in the full-cost accounting (because they have to be prepared according to special
principles). These principles provide for reimbursement of direct costs plus and ‘equitable
share’ of overhead costs. These overhead costs include depreciation of
buildings/equipment, plant operation and maintenance, general administration,
departmental administration, student administration and services and library services.
When senior management wants to be involved in the full-cost accounting, it works with the
accounting staff. This is important, because it can be computed in different ways which give
different results. Also, in hc it is more complicated as there is variety in patient/service mix,
standby capacity, and alternative treatment modalities. There needs to be proper rules for
the information to be of managerial use. The Generally Accepted Accounting Principles
(GAAP) are used in financial accounting.
The fundamental issue cost accounting addresses is the use of resources. These are the
classic ones:
- Land: it is the site where the organization is located. If it has multiple sites, it is
divided between mission (used for delivering services to patients and research) and
support (for administrative purposes) facilities.
- Labor: mission (professional) or support (administrative) labor. Mission labor
consists of people who actually deliver the services and are directly associated with
the organization’s main mission. Support labor is everyone else in the organization.
Can be divided in direct and general. Direct support can be scheduling
patients/secretarial assistance in research project. General support could be
1
, maintenance or cleaning or general administration (office work, not directly related
to the org’s services).
- Capital: mission is all capital resources needed to provide direct support to the org’s
service delivery activities. Can be short-lived (in one year or less used) or long-lived
(used up in several years). Short-lived mission capital – direct materials like syringes,
food in inpatient ward, pharmaceuticals. Long-lived mission capital – equipment
used in service-related activities. Support capital is short or long lived, including
items that provide general support and not directly related to service. E.g. supplies in
CEO’s office, or fax machines/computes.
Measuring these units: land in rent, labor in wages and capital in factor price /depreciation.
Limitations: the principal objective of full-cost accounting effort is to measure as accurately
as possible the consumption of resources associated with producing a particular good or
delivering a particular service. Measuring it can be difficult, esp in hc where there are
multiple products provided. To do this, factors which influence the use of resources are
costs, these need to be identified to be able to measure it properly.
Cost drivers are organizational activities that can be linked directly to costs. Can be divided
into two parts: efficiency and factor prices.
To address this more complex process (of determining the cost of each unit sold, when
there are multiple units being produced), an organization must make six full-cost accounting
decisions:
1. Defining the final cost objects: the final cost object is the unit for which we wish to
know the cost. The more specific the CO, the more complex the accounting
methodology. An example can be an all-inclusive day of care. But now more specific
CO are being used, like laboratory tests. Other examples: discharge day, particular
illnesses. To compute the full cost of each CO, hospitals have identified what they
call intermediate CO – the various services that a patient receives while in the
hospital (called patient needs), like tests, radiology procedures, laundry services.
2
