At a Glance
Hospitals should consider five approaches to costing over the next three years as they prepare for reform:
- Moving from a strategic to an operational cost-finding model
- Adopting job costing over standards costing whenever possible
- Reviewing working classifications of cost with managers and administrators
- Evaluating current cost bucketing definitions and reviewing the expenses assigned to these buckets
- Increasing the use of microcosting
Learn how reform will change hospital costing systems-and five strategies to help your organization adapt.
Although most of the media attention given to healthcare reform legislation has focused on its anticipated effects in the marketplace, reform will have an effect on hospital costing systems as well. Costing systems will have to be redesigned, repositioned, and re-implemented as providers create new, innovative organizational structures and relationships to capture market opportunities, update transactional systems, and make decisions based on data that went relatively unexamined before.
Because the majority of legislated reforms do not kick in for three more years, the need for change may feel far away. As time ticks by, however, accounting staffs likely will face many competing demands in an era of reform. That's why it is essential to assess the potential impact of reform on hospital costing systems now, focusing on five specific actions that can help ensure that the organization is ready to adapt to change.
Changes to Costing Systems Under Reform
The choice of what actions organizations should take in response to changes to costing systems will vary by hospital, driven by the complexity and cost of implementation against the benefits that healthcare leaders perceive could be gained.
The exhibit below highlights relevant decision factors. Hospitals falling into the "low" column would benefit less from costing system enhancements, and may choose to adopt only actions that could be accomplished easily and without incurring significant new costs. Hospitals in the "high" column should adopt as many of these changes as possible, as quickly as possible, with less consideration for the total cost, because the risks they will face in the emerging marketplace will be greater.
As reforms take effect, costing systems will face changes on two fronts.
Inputs from which costs are derived. For example, new organizational structures, such as joint ventures, may break cost center-level matching of revenues and expenses. Payment models involving bundling or per member, per month expenditures may break the period-by-period matching of revenues and expenses. New feeder systems may evolve to capture new transactional data, resulting in a need to assign cost to new objects. At the very least, new forms of doing business will present the need for new inputs to the costing system and will raise barriers to accurately assigning costs until the system can be adapted.
The way managers use costing data. Organizations that have used costing data to evaluate market trends and profitability by payer and product line will suddenly find it advantageous to drill down from that "big picture" view into specific services, such as radiology or surgery. These examinations will serve a dual purpose. On one hand, organizations will be looking for ways to improve efficiency of care delivery (how much it costs to deliver one unit of care). On the other hand, organizations will want to evaluate the financial outcomes of different care alternatives. These new demands for costing information will require more frequent cost finding. In extreme cases, organizations may want to be able to measure cost during a patient stay and use that information to script customized, cost-minimized, outcome-optimized, "on-the-fly" care plans.
Preparation Will Pay Off
By thoughtfully anticipating changes that will result from reform and communicating with managers about specific issues that should be addressed, hospital cost accountants can proactively prepare for the challenges of the new healthcare marketplace and position their services as an invaluable resource for decision making in an evolving economy.
To this end, they should consider five approaches to costing over the next three years as their organizations prepare for reform.
Move from a strategic to an operational cost-finding model. A strategic model takes a large period, such as a full operating year, and computes cost for that period, which then becomes the "standard" cost used for decision making for the following year. An operational model re-computes the cost of services after each monthly general ledger close.
Although the operational model is a good way to improve the timeliness of the cost finding, it will place additional stress on cost accounting staff, most likely requiring additional staffing and/or changes to feeder subsystems. To obtain meaningful results from an operational model, cost accounting staff will need to review all of the inputs-general ledger expenses, payroll hours, and patient volume statistics-and correct "errors" and interperiod fluctuations unrelated to patient volume that would otherwise distort the results of the cost-finding calculation.
For example, if the surgery department takes inventory once a year and expenses the difference between book inventory and actual inventory, a strategic cost-finding model is unlikely to be negatively affected, because the adjustment is spread over a year of activity. But if the cost-finding calculations are performed quarterly, and the surgery department's annual inventory process takes place during the quarter, the challenge is keeping the cost of a full year of shrinkage from overstating the quarter's cost at the patient service level.
Some inputs must be adjusted permanently-such as a prior-year adjustment-but many inputs adjusted in the current period will require reversals in future periods, leading to additional accounting workload.
Adopt job costing over standards costing whenever possible. In a job costing system, costs are measured as they are incurred. For example, let's say that a nurse spends 30 minutes with a patient, resulting in a cost assigned to that patient based on the exact number of minutes spent with the patient. This would result in different costs being assigned to patients with similar diagnosis or treatments. In a standards costing model, nursing time might be categorized into one of three acuity levels. Each level would be assigned a "standard," or average range of time, and cost would be assigned on that basis. For instance, 30 minutes of nursing time might represent acuity level 3, and acuity level 3 might be assigned a cost of $65 irrespective of the actual time spent with the patient.
Historically, organizations have chosen standards costing because they could not justify the cost of acquiring the additional detail needed to support the job costing method. Advances in technology, such as radio frequency identification, will allow organizations to capture the actual resources consumed by patients and to record specific events affecting individual patient care relatively cheaply.
Review working classifications of cost with managers and administrators. Sharing a common definition of costing terms and classifications across the organization is essential to a successful program. Cost accountants need clear working definitions of fixed, variable, incremental, direct, and indirect costs so they can accurately classify them according to leaders' expectations.
A related discussion should occur around the emphasis managers and administrators would like to see in the costing system. Although many organizations will want to allocate overhead, the focus of healthcare leaders' decision making will likely be on incremental, and then variable, costs. Clarifying the importance of these different cost definitions will enable effective allocation of scarce accountant time to those areas of greatest benefit to management.
Evaluate current cost bucketing definitions and review the expenses assigned to these buckets. Cost buckets are the categories of accounts for costing systems and define the detail for reporting. Based on the working definition of cost classifications to be used and knowledge of hospital leaders' preferences for the cost-finding process, hospital accounting staff should review the current definitions to make sure they are in line with management's wishes.
Cost accounting for labor is an area that hospitals often treat casually, and for good reason: Most hospitals set staffing levels by location and shift. But as the focus of cost accounting shifts to variable and incremental costing systems, accounting for labor cost by job class may no longer provide the information needed. New job classes may be needed, or alternative methods of identifying fixed and variable hours may need to be devised. If a required change has to come through a hospital's payroll or human resource systems, additional time will be required for implementation and to accumulate sufficient operating history.
The cost accountant will need to confirm how managers will be establishing staffing levels at different levels of volume, because the costing system should be set up to mirror the management model.
For example, one hospital uses a labor costing model that gives managers insight into how labor costs really behave. The model, known as a "higher of fixed or variable model," recognizes that until volume reaches a certain point, all labor costs are fixed due to minimum staffing. As volume increases and minimum staffing levels are fully utilized, additional volume above that transition point creates variable cost.
A sophisticated costing system can model fluctuations in volume during a specific period and can accurately classify the labor costs during this period as either fixed or variable based on minimum staffing and volumes for that period. This gives hospital leaders a more true-to-life measure of the actual cost of varying case volumes.
Some organizations have tried to perform operational cost finding and have sidestepped the laborious input adjustment process by attempting to force the general ledger to conform to the needs of costing. This is a complex undertaking-both politically and from a system perspective-and is not recommended.
It is also important that a representative from cost accounting be assigned to any teams developing new organizational structures. That way, as new ventures and accounting systems are added, the requirements for solid costing information can be built into new structures from the start.
Increase the use of microcosting. Microcosting involves creating a detailed list-sometimes called a bill of materials-of every resource used in rendering a service, including the quantity used, frequency of use, part number or job class, and the unit cost. The sum of the costs of all the items on the list becomes the "standard cost" and should represent the actual or expected resource consumption to perform a service.
Microcosting provides hospital leaders with a more precise and stable measure of variable cost because it does not mix the cost of waste and excess capacity with the true cost of rendering service. Relative value unit (RVU) costing, on the other hand, assigns 100 percent of the period cost to the units of service rendered.
Knowing where and how much excess capacity exists in a department is critical to improving staffing efficiency and to properly evaluating market opportunities that increase volume. One common challenge is that staffing is determined by shift, but collection of production volumes takes place by week or day.
The exhibit above left demonstrates the importance of computing staffing capacity versus utilization by specific shifts, rather than by day or week. Reviewing capacity versus utilization only on a daily or weekly level could mask opportunities to reduce labor costs. For example, imagine that a department is overstaffed during the night shift, but understaffed during the morning shift. A daily overview of staffing would represent the average staffing capacity and utilization of the three shifts combined, and would not reflect the variation among shifts.
One hospital painlessly shaved millions from its payroll by eliminating the excess capacity built into staffing plans for evening and weekend shifts. Doing so required an analysis of staffing and utilization by shift. Capturing these data will require revisions to a hospital's payroll and billing system interfaces to incorporate shift-level detail, but it is clearly a worthwhile exercise for most hospitals.
Is Microcosting the Right Approach for Your Organization?
The decision to begin microcosting can have dramatic consequences for an organization that does not have experience in microcosting, and careful consideration should be given to the mechanics of this process.
First, there is the question of whether a hospital's current costing system will support microcosting, and if so, whether microcosting would take place at the department level, charge code level, or some level below these levels. If the system allows a hospital to mix methods at the department or charge code level, how will the remainder of the activity or categories be costed?
Then there are questions related to the mechanics of the bill of materials (labor): Does the system provide the ability to record assemblies, not just individual parts? How are costs assigned when assemblies or parts are used in "either/or" versus "always used" versus "always subject to a certain frequency" situations?
Finally, there are policy issues related to how the initial standards will be validated and what kind of validation will occur prior to releasing the periodic cost findings.
With microcosting, existing interfaces will need to be reevaluated for content adequacy, and new interfaces may need to be developed. For example, a provider that applies RVU costs to its supply expenses only needs to identify materials costs once to set the RVU. After that, a simple general ledger expense feed is adequate. But if materials and pharmaceuticals, which may represent more than 50 percent of the variable costs of a hospital, are going to be subject to microcosting, updating these costs will require an interface to the materials management system.
One approach that has proven successful in tying the parts listed in the costing system to the actual purchase costs is to use the same item number for both purchase orders and chargemaster charges. This approach requires a major effort-both politically and clerically-because it involves redesigning the account number scheme for either the chargemaster or the purchasing item master. But the benefit is a reduction or elimination of ongoing interface maintenance costs for all billable supplies.
Overall, the materials interface is probably the most complex interface to establish and requires extensive thought and careful coordination from may areas within the hospital to be successful.
Finally, staffing will be a consideration: An increase in staffing would be required to support a microcosting approach at a time when hospitals are seeking ways to reduce costs. Exactly how much additional expense would be involved with this approach is difficult to quantify. Although estimates haven't been published recently, one study, published in 1986 by hfm, predicted that microcosting would, on average, cost at least times two times more than RVU costing.
Typically, department heads have not shown much interest in helping to develop cost standards because they don't see any benefit to doing so. However, if the cost standards could also be used to monitor labor productivity, department heads would quickly become helpful allies. With proper training and oversight, this strategy can result in considerable savings.
Paul Selivanoff, CPA, is manager of financial systems, St. Helena Hospital, St. Helena, Calif. (selivaPG@ah.org).
Cost Accounting in an Era of Reform
The exhibit below summarizes the predominant application of cost accounting, along with the anticipated post-reform application grouped along three domains: focus, data usage, and costing approach.
Focus refers to the overall objective of hospital leaders in using cost data. The exhibit concludes that one impact of reform will be to require analysis of smaller population segments at greater levels of detail.
This shift in focus drives change in the data usage domain. The exhibit shows that reports change from strategic to tactical. For tactical uses, it is likely that hospital management will require costs to be available on a more "real time" basis, necessitating more frequent cost-finding updates.
One consequence of the shift to tactical uses will be that hidden inaccuracies-the variance in the costs between true cost and system-generated cost-that presently exist will become more apparent. This will encourage a shift in the costing approach, with the approach shifting away from ratio of cost to charges and RVU methodologies to microcosting. There will be a shift toward costing methods that produce more accurate results over shorter time periods.
By carefully analyzing labor capacity versus utilization by shift, hospitals can better identify opportunities to adjust staffing where needed-potentially reducing labor costs while ensuring that patients' needs are met.
Publication Date: Monday, May 02, 2011