Code Blue

Chapters 15 through 18Includes Supplements 1, 2 and 3

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

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

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.

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 today—an interim system

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

He can now calculate . . .

• Direct labor variances• Direct materials variances• Overhead variances

Per patient day

Formula for labor rate variancesAH x AR = X1

AH x SR = X2

SH x SR = X3

AH = Actual HoursSH = Standard HoursAR = Actual Labor RateSR = Standard Labor Rate

X1 - X2 = Labor rate variance

X2 - X3 = Labor efficiency variance

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

We have reviewed the interim costing system that Wes can use until he gets something better. Now let’s talk about the final (ultimate) costing system.

Should the final system be . . .• A job costing system?• A process costing system?• A combination of job costing and

process costing

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

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

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

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

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?

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?

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

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

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

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).

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?).

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.

History of Job Analysis

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

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

Job Characteristics that Correlate with Pay

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

Formula Used:

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

where:

Y = total job pointsa = constantb = weight applied by the market to the particular job characteristicX = the amount of that characteristic that must be evidenced by the job incumbent

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

Example

• Let’s 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.

The formula therefore is:

Y = 5 + (1)X1 + (3)X2 + (2)X3

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.

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.

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.

Graph of Salary Line

Salary line dictated by the model of the market

Hourly Wage

Job Characteristic Points

Present Wage

Correct Wage asDetermined by Model

Job Points forSecretary

Secretary

In this example, the secretary is currently paid too much if we are to achieve internal consistency

Supplement Three

• Calculating Labor Variances

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

Three levels products (review)• Primary Products• Intermediate Products• Final products

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

Calculating the cost of a primary product

Direct Labor

Direct Materials

Overhead

Primary Product

(i.e changinga dressing)

Intermediate Products

Primary Product

Primary Product

Primary Product

Intermediate Product(i.e. major surgical

procedure)

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

Primary and intermediate products are cost objectivesA 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.

Purpose of cost objectives

• Decision making• Control

Final Products

Intermediate Product

Intermediate Product

Final Product(i.e. DRG, Capitation

Day, Patient Day)

Final Products

• Are made up of two or more intermediate products

• Final products are final cost objectives

Examples of Final Products• A Diagnostic Related Group• A capitation day for a specific

employee group• A patient day

– Medical– Surgical– Obstetric– Etc.

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

He can now calculate . . .

• Direct labor variances• Direct materials variances• Overhead variances

Labor Variances

• Labor rate variance– Formula: (AH x AR) - (AH x SR)

• Labor efficiency variance– Formula: (AH x SR) - (SH x SR)

The End!