Code Blue

1
Code Blue

• Chapters 15 through 18
• Includes Supplements 1, 2 and 3
• Accounting Version

2
Chapter 18

• Wes Douglas eventually needs a system that
  provides costs by product
• Products will have to be defined in some level of
  detail
• Until he gets that he will probably define his
  product as a patient day
• Today we will talk about two systems, the interim
  (temporary) and final costing system

3
Costing Information

• Currently Available
• Total costs per department
• Total costs per patient day

• Not Not Available
• Individual procedure costs
• Average cost per DRG
• Cost per DRG per physician
• Costs by product line
• Costs by employer

4
The final costing system will need to provide
information for many types of fixed price
contracts

• DRG reimbursement
• Capitation payment
• Other contracts

He needs a system that is flexible, that will
allow him to capture costs on some elementary
level, then roll those costs up to more complex
cost objectives.
5
We are not there yet, however

• It takes time to design and implement a complete
  costing system
• We need something we can use to make decisions
  todayan interim system

6
Interim Cost Objective

• Since Wes Douglas needs data now
• He is willing to sacrifice level of detail for
  timeliness
• He decides that his interim cost objective will
  be patient day since the hospital association
  has data on nursing labor costs per patient day

7
He can now calculate . . .

• Direct labor variances
• Direct materials variances
• Overhead variances

Per patient day
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Formula for labor rate variances
AH x AR X1 AH x SR X2 SH x SR X3 AH
Actual Hours SH Standard Hours AR Actual
Labor Rate SR Standard Labor Rate
X1 - X2 Labor rate variance X2 - X3 Labor
efficiency variance
9
How will he determine?

• Standard labor rate (SR)
• He will take the rates established by Alma
  Cowdrey
• Standard labor hours (SH)
• Industrial engineer study
• Borrow standards from other hospitals
• Adopt current actual figures as standard, tighten
  standards with time

10
We have reviewed the interim costing system that
Wes can use until he gets something better. Now
lets talk about the final (ultimate) costing
system.
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Should the final system be . . .

• A job costing system?
• A process costing system?
• A combination of job costing and process costing

12
Should the final system be . . .

• An actual cost accounting system?
• Debit WIP for actual direct labor, actual direct
  materials, and actual overhead
• A normal cost accounting system?
• Debit WIP for actual direct labor, actual direct
  materials, but use overhead rate
• A standard cost accounting system?
• Debit WIP for standard direct labor, standard
  direct materials, and standard overhead

13
Possible advantages of standard costing system

• More accurate information on why the hospital is
  losing money
• Easier methodology for assigning costs to patients

• Mechanism for involving employees in cost savings
  through bonuses
• Better methodology for implementation of
  responsibility accounting

14
What is the difference between data and
information?

• Data are numbers processed by the accounting
  system
• Information is data that is useful for decision
  making

15
The information needed is different to manage
each of these contracts

• Prospective payment contracts
• DRG Reimbursement
• Capitation Payment
• Retrospective payment contracts
• Billed Charges
• Cost Reimbursement

16
Questions to ask in designing management reports

• How does the hospital make or lose money on this
  particular type of contract?
• What variables, therefore, should the manager
  monitor?
• What information must be sent on these variables?

17
Questions to ask in designing management reports

• How will we gather the data to prepare the
  reports?
• What format should the information take?
• How timely must the information be?

18
The information needed is different to manage
each of these contracts

• Prospective payment contracts
• DRG Reimbursement
• Capitation Payment
• Retrospective payment contracts
• Billed Charges
• Cost Reimbursement

19
Supplement Two

• Calculating accurate labor rate variances
• Labor rate variances tell how much a company or
  made (or lost) because the labor rate was lower
  (or higher) than budgeted
• Labor efficiency variances tell how much a
  company made (or lost) because they used fewer
  (or greater) hours than budgeted

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The Compensation Study

• Designed to establish standard labor rates that
  are
• Internally consistent--this means that pay is
  fair, that pay is based upon the characteristics
  of the work done
• Externally valid--pay is consistent with market

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The Compensation Study

• Based on job tasks and job characteristics
• Job tasks Activities performed by the job
  incumbent (balancing a ledger, administering a
  medication)
• Job characteristics An attribute the employee
  must have to perform the job (i.e. a college
  education, ability with math, manual dexterity,
  ability to supervise people).

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History of Job Analysis
Quantitative job analysis is approximately 55
years old. The first companies to use it were
defense companies during World War II. Their
objective was to determine what the pay should be
for jobs that had no equivalent in the civilian
workforce (i.e. what do you pay a bomb loader?).
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History of Job Analysis

• The objective was to quantify jobs by assigning
  them job points that could be directly correlated
  with pay
• Initially they tried to quantify job tasks. This
  was impossible as there is are and unlimited
  number of tasks in the world of work.
• The next attempt was to quantify job
  characteristics.

24
History of Job Analysis

• Using multiple regression, researchers identified
  13 to 16 job basic job characteristics that were
  correlated with pay.

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Job Characteristics that Correlate with Pay

• Level of decision making
• Amount of planning and scheduling
• Job related experience and training
• Job required personal contact
• Supervision of other personnel
• Supervision received
• Amount of frustration/stress created by the job

26
Job Characteristics that Correlate with Pay

• Attention to detail
• Updating job knowledge
• Responsibility for material assets
• General responsibility
• Job structure
• Criticality of position

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Formula Used
Y a b1X1 b2X2 . . . bnXn where Y
total job points a constant b weight applied
by the market to the particular job
characteristic X the amount of that
characteristic that must be evidenced by the job
incumbent
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Example

• For the purpose of simplification assume that
  there are only 3 job characteristics in the world
  of work that correlate with pay
• Level of education required
• Level of decision making required
• Level of supervision over other employees

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Example

• Lets assume a study was conducted, and the b
  values assigned to these job characteristics by
  the market are
• Education (b1) 1
• Decision making (b2) 3
• Supervision (B3) 2
• Lets also assume that the constant was found to
  be 5.

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The formula therefore is
Y 5 (1)X1 (3)X2 (2)X3
31
Example

• Now assume that the analyst, armed with the
  formula and methodology interviews each job
  incumbent to determine how much of each job
  characteristic is required by the particular job.

32
Example

• The results are
• Education (X1) 5
• Decision making (X2) 3
• Supervision (X3) 4

How do they come up with these values? Through
scales developed by the industry.
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Substituting these values into the formula we get
Y 5 (1)(5) (3)(3) (2)(3) 25 job
points How do we interpret this? A job with 25
job points should be paid twice that as a job
with 12.5 points.
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Graph of Salary Line
In this example, the secretary is currently paid
too much if we are to achieve internal consistency
Hourly Wage
Secretary
Present Wage
Correct Wage as Determined by Model
Salary line dictated by the model of the market
Job Points for Secretary
Job Characteristic Points
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Supplement Three

• Calculating Labor Variances

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In a service industry what is the product?

• We need to have a cost objective or product to
• Establish standard costs for
• Calculate variances for
• The product is sometimes more difficult to define
  in service industries than it is in manufacturing

37
Three levels products (review)

• Primary Products
• Intermediate Products
• Final products

38
Primary Products

• These are the most basic services rendered
• Component costs include direct labor, direct
  materials, and overhead
• Examples of primary products
• Changing a dressing
• Suturing a wound
• Giving an injection

39
Calculating the cost of a primary product
Primary Product (i.e changing a dressing)
Direct Labor
Direct Materials
Overhead
40
Intermediate Products
Intermediate Product (i.e. major
surgical procedure)
Primary Product
Primary Product
Primary Product
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Intermediate Products

• Consist of services that have as components two
  or more primary products
• An example might be a major surgical procedure
  such as an appendectomy

42
Primary and intermediate products are cost
objectives
A cost objective is a function, organizational
subdivision, contract, or other work unit for
which cost data are desired and for which
provision is made to accumulate costs.
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Purpose of cost objectives

• Decision making
• Control

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Final Products
Intermediate Product
Final Product (i.e. DRG, Capitation Day, Patient
Day)
Intermediate Product
45
Final Products

• Are made up of two or more intermediate products
• Final products are final cost objectives

46
Examples of Final Products

• A Diagnostic Related Group
• A capitation day for a specific employee group
• A patient day
• Medical
• Surgical
• Obstetric
• Etc.

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Interim Cost Objective

• Wes Douglas needs data now
• He is willing to sacrifice level of detail for
  timeliness
• He decides that his interim cost objective will
  be patient day since the hospital association has
  data on nursing labor costs per patient day

48
He can now calculate . . .

• Direct labor variances
• Direct materials variances
• Overhead variances

49
Labor Variances

• Labor rate variance
• Formula (AH x AR) - (AH x SR)
• Labor efficiency variance
• Formula (AH x SR) - (SH x SR)

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The End!