Costing and Managerial Accounting

Cost Accounting: Bridging the Gap Between Where You Are and Where You Should Be

October 10, 2018 7:57 am

From Our Sponsor, Kaufman Hall

Start with the end goal in mind.

“Cost accounting is your friend.” Five years ago, Michael Porter and Thomas Lee, MD, included that statement in their popular Harvard Business Review article “ The Strategy that Will Fix Health Care.” Their argument was that when true costs are understood, clinicians will work with administrators to improve the value of care. The flip side of their argument was that when organizations don’t understand their true costs of care, they are flying blind when it comes to improving value.

Jump forward five years. Has the cost transformation described by Porter and Lee resulted in sophisticated and effective hospital cost accounting systems? Kaufman Hall’s 2018 survey of nearly 190 healthcare executives indicates that while 86 percent say that cost transformation is a significant to very significant need in their organizations, 71 percent of respondents do not have a high degree of confidence in the accuracy of results produced by their current cost accounting solutions.

Without trust in cost information, transformation initiatives do not benefit from the visibility of critical data used by executives to make key decisions, such as what service lines merit more or less investment and which physician enterprise expense items warrant additional analysis.

From Traditional to Best Practice

When evaluating what hospitals need from their cost accounting systems, starting with the end goal in mind is beneficial. The cost accounting system end goal is a system that enables reporting across the care continuum, as well as across multiple financial functions, that hospital executives can stand by and take action on.

There are differences between traditional, hospital-centric cost accounting systems and best practice accounting systems (see exhibit below). The former lack the flexibility needed to accommodate changing environments and organizations. Professional and payer billing activity and other data from across the care continuum often are not incorporated into costing, and while processes may be efficient, resulting analytics may be less meaningful. The hallmarks of best practice cost accounting systems—reliable, repeatable, transparent, flexible, extendable, and accurate—address traditional solution limitations and help organizations reach the end goal of actionable reporting to drive operational and strategic decision-making in today’s complex environments.

Traditional Versus Best Practice Cost Accounting

The MultiCare Journey

To help maintain its successful trajectory created by rapid growth through acquisitions and cost-reduction initiatives of $100 million per year, MultiCare Health System required a costing approach focused on analytics. The Tacoma-based system’s seven adult hospitals, one pediatric hospital, and more than 200 clinics serve the greater Puget Sound and Spokane regions.

Similar to other hospitals across the country, MultiCare wanted to integrate multiple legacy platforms, including budgeting, management reporting, rolling forecasting, costing, decision support, financial planning, and capital planning/tracking to access merged data. By creating a single source of truth, MultiCare aimed to have coordinated oversight of all financial data, including security and design, and provide a consistent training curriculum for its finance team. Ultimately, its goal was to prepare data for distribution across the organization, knowing that formerly disparate systems were fully integrated.

MultiCare’s new costing process reflects the high-level steps the system uses to determine unit cost, which is then applied to the patient encounter level (see the exhibit below). The end result is patient-level cost, with analytics and reporting drawn from a single source.

MultiCare Health System’s Costing Process

The quarterly cost calculation process includes several data preparation activities—determining account and department types, grouping accounts into cost categories, preparing departmental costs, and assigning methods for cost assignments.

MultiCare splits accounts into fixed and variable groups and the department types into direct and indirect groups to facilitate accurate costing and informative reporting. Next, accounts are grouped into summarized cost categories to help with reporting.

Once this preliminary work is complete, MultiCare processes needed expense reclassificationses and indirect allocations (see exhibit below). For detailed RVU-based costing, MultiCare focuses on labor, supplies, implants, drugs, and purchased services. These areas provide the biggest return on the costing team’s time investment. The resulting unit cost calculations are reliable and reflect MultiCare’s operational structure. They are then applied to encounters for the end goal of reporting.

MultiCare Health System’s Approach to Preparing for Quarterly Cost Processing

With costing data for the full organization in a single database and a consistent and detailed costing approach, MultiCare also can apply cost data to strategic reporting to assess organizational initiatives. For example, with the ability to examine implant costs, which are variable among providers, decision support reports can be created to inform physicians of the profitability of their procedures, using accurate and consistent data across entities and providers instead of apples-to-oranges comparisons using inconsistent methodologies.

In addition, MultiCare can track costs in both clinic and hospital settings so that profitability across the care continuum is evaluated. Most important, MultiCare is not just calculating costs, but actually using the data to inform decisions. The system’s decision support team creates timely and effective routine and ad hoc reports. They are able to leverage a costing solution with the hallmarks of best practice cost accounting systems and then use the reporting to drive strategic decision-making.

Catherine Savage is assistant vice president, Kaufman Hall, and a member of HFMA’s Georgia Chapter.

Curtis Bryan is director decision support, MultiCare Health System, and a member of HFMA’s Washington Alaska Chapter.


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