The generic answer goes something like this:
“Make sure you implement the system in a way that will give you only the valuable, useful information needed and at the appropriate level of detail to meet your objectives.”
A typical mistake: Unnecessary detail in your cost accounting structure
Sounds pretty straightforward doesn’t it? But we stress that you only work with information that you need. Getting too little or too much detail can stifle meeting your objectives. Getting unnecessary details leads to complex implementations and maintenance. All of it amounts to extra work, frustration and higher costs without producing additional benefits. Further, it severely compromises the value of the system short and long term.
In cost accounting, decisions that appear obvious may have undesirable consequences that are not obvious and can harm your efforts for many years; they can come back to bite you. In cost accounting, “common sense” without expert advice or deep personal experience can prove very damaging to meeting your objectives.
True expert advice must be specific to your unique needs. Consider the following scenarios.
Scenario 1: Should I create cost types for labor based on skill set (e.g., job codes)?
The answer to this question seems simple: “Of course we should. More information is better, isn’t it?” But what you would likely get is information that:
- You cannot act on
- Is irrelevant (maybe meaningless) for most costing uses
- Adds no value to the cost information
- Takes time to gather, maintain and verify
- Will slow down your implementation and ongoing regular system maintenance, perhaps jeopardizing its maintenance altogether.
Why? Because what one can do with this information is primarily within the purview of a “productivity” effort, not cost accounting. Conducting a productivity effort in a cost accounting system is, bluntly, wrong because it is the wrong system in which to do it. Trying to get skill set cost information will require the breaking of labor into more finite detail than needed to determine cost. That will force the determination of several additional sets of RVUs for each charge item studied, multiplying the work required to pick up RVUs several fold (i.e., by the number of labor skill sets to track). And for what? Simply to obtain a “cost breakdown” that is at best fictitious and at worse wrong.
Further, using skill sets costing also requires the split of the skill sets dollars in ways that are very subjective at best.
Consider the case when several employees in the job code are not all acting in the same capacity or fashion. The result is a varied fixed/variable split that is not uniform to the job code across departments or even across shifts within the same department. The huge amount of extra work yields no additional benefit due to its tremendous subjectivity and likely inaccuracy. In fact, other than having the total labor cost broken down between variable/fixed, direct/indirect, you do not need any more detail for the purposes of good, usable cost accounting data.
Scenario 2: Should I add more detail in the general ledger to improve cost accuracy?
In trying to get more “accurate cost,” some organizations engage in a level of general ledger data capture that amounts to almost doing cost accounting in the general ledger. This pollutes the general ledger with more detail than needed for its main purpose: keeping track of assets, liabilities, revenue and expense. It saddles you with a level of detail accounting hard to maintain. It virtually guarantees years of “maintenance misery” as you try to maintain a busy general ledger structure that can be essentially unsustainable without significant extra work. A lot of effort will go into it until it finally is abandoned as a goal.
The compelling examples above are presented to illustrate how easily one can step into a trap if the consequences of a “common sense” decision are not fully understood. The cost accounting implementation effort is somewhat deceiving in its simplicity or lack of it, but expert advice can make all the difference.
Now, let us discuss some of the milestones of cost accounting implementations and explore how to ensure they are best achieved.
Basic cost accounting structures and concepts
At best, healthcare “cost accounting” yields a close approximation of the expense “expected to be incurred” (which is different than “standard cost,” which is what an item should cost to produce) in making a particular “product” (we will define “product” below). The “expense expected to be incurred” is the adequate expectation for healthcare cost accounting data. Anything more, such, as time and motion studies, that intend to determine “how much a product should cost” is not only not appropriate for costing healthcare services; it is dangerous because it can lead you into a “Neverland” of work with no achievable reasonable goal. Consider the following:
- A lot of the components (i.e., intermediate products) of case costs are “made from scratch” (think of a “patient day” for example), and vary greatly from patient to patient, thus, the “average” cost is a much better measure; and
- The final product (a cared case) is almost always unique, thus an inadequate target for standardization. Think of a patient treated for a particular condition; then think of the same patient treated by a different provider for the same condition; or even another patient with the same condiction but with different co-morbidities treated by either provider. Each case will have a slightly different care.
Therefore, providers’ focus should be on cost “accountability,” rather than “standard” costing.
The reasons why it is critical to know your costs in healthcare are outside the scope of this writing, yet they deserve serious attention and a separate discussion. Cost accounting is a very valuable activity that can greatly aid in decision-making; however, cost accounting requires a keen understanding of your data, of cost management concepts and how to use both.
Here are a few cost accounting concepts that are important to understand:
- In general, there are two recognized types of cost accounting: “process” and “job order.” Provider healthcare uses both.
- Account structure is the part of the cost accounting effort where each expense is routed to its “rightful place” for allocation.
- Product structure relates to the “activity” (what was done to the patient) and it helps place this activity in its “rightful place” so that it can receive portions of the expense gathered by the account structure referred to above.
- In healthcare costing (whether hospital or medical group), a product is a “cared case” or a “cared patient.” Everything else that goes into making this final product should be considered an “intermediate product.” Thus knowing your institution’s intermediate products and what they cost is essential to be able to build the case cost. Anything that does not get to this level amounts to proxies that attempt to simplify the costing process by assuming uniform patterns of cost “usage” by condition, DRG, etc… something that we know, as explained before, is not the case.
- Allocation structure refers to the process by which non-direct departmental expenses are routed to other non-direct and direct departments and finally to the revenue producing departments. While allocations are important, they should not be the larger focus of a cost accounting effort. Identification of true direct expense is more important.
Where cost accounting efforts fail
Often, providers fall into the trap of purchasing cost accounting software without really understanding or identifying their goals for cost accounting. If you don’t know what your objectives are with a cost accounting system, then you’re really not ready to make the leap to buying software. Instead, consider first working with a cost accounting expert to help you define your goals. An expert can show you what cost accounting can do for a healthcare organization like yours, help you define high-return objectives and educate you about various options in achieving those objectives.
An expert should be able to readily define each of the core cost accounting concepts discussed above and share how he or she might help you apply them to your needs. Can the experts explain these terms and show their practical application to your situation? For example, are there different ways they propose to handle your “indirect” costs so that they reflect their true impact in your organization? Can they show how these costs are absorbed in other departments, directly allocated, or dead-ended, etc.? For example, if you have expense associated to the amortization of a prior bankruptcy, does it belong in your costs structure?
The value of expert cost accounting implementation and utilization advice cannot be overstated. If you are going to invest time and money into a sophisticated system, you certainly want to get the most out of it. Whatever your current cost accounting status, you need expertise to get the greatest value from your system.
Hopefully, the concepts and points discussed in this paper will prove useful to you. Happy costing!
Cesar Fernandez-Mansilla, managing director for Integrated Medical Organization Systems, brings 25 years of passion and commitment to healthcare decision support, particularly to the implementation, operation and use of cost accounting systems. He has personally conducted over 30 cost accounting implementations and previously served as CFO for a teaching hospital and as a consultant to the management of several large medical groups.
David Clingo, founder and financial transformation authority for Fiscal Medics, previously served as vice president of finance for Bayview Hospital and Villa View Community Hospital and as a controller for Scripps Memorial Hospital. He began his career as a certified public accountant at Arthur Anderson & Co.
