Code Blue
Instructors Edition-- Discussion Questions and Practice
Problems with Answers
Third Edition
Discussion questions and practice problems are organized by chapter. Due to the textbook/novel
nature of Code Blue, not all chapters have questions or problems.
Chapter One
1.
Hap Castleton and Del Cluff have different management styles, and this has caused some friction
in their relationship. As assistant controller, what might Del have done to improve his credibility
with Castleton?
Del Cluff has an accounting education, Hap does not. If he is to be effective Del must present the
information in a manner that Hap will understand. Accountants (like physicians) sometimes use
terminology that is difficulty for lay people to understand.
The experience of being a CEO is different than the experience of being an accountant. Hap
probably has many departments to monitor. By necessity he has to be a generalist. Del’s job is
to stay on top of the details.
People’s perceptions are driven by their personality, education, experience, and in this situation
responsibilities. Hap is obviously an extrovert, he is probably more interested in people than Del
Cluff. Del is probably a detail person, but we might infer that his communication and people
skills are not as good as Hap’s
2.
What message is conveyed when employees refer to accountants as “bean counters”? Why do
you think accountants have such an unfavorable image with some managers? What might they
do to change this?
It is obviously not a favorable characterization. The general dislike some managers have for
accountants probably stems from: (a) their own insecurity in working with numbers, (2) a lack of
appreciation for the importance of accounting data, (c) a lack of understanding for the amount of
detail required in the preparation of financial reports, (d) a perception that accountants are only
interested in numbers (as opposed to being interested in people, corporate strategies etc.).
Some accountants can increase their effectiveness by (a) improving communications skills—
accountants are in the business of disseminating information, (b) learning to think more like
managers (learning to project what information is necessary for a particular decision and what is
not).
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There is a difference between financial accounting and managerial accounting. Financial
accounting is very structured, is debit/credit oriented, and is designed for outside users.
Management accounting focuses on internal decision making. Sometimes accountants provide
financial information to managers that is not useful for internal decision making.
Chapter Two
1.
What is the role of the Finance Committee in a hospital?
The Financial Committee typically supervises the Treasury and Accounting functions of the
hospital. The committee is responsible for raising capital through bonds or fund raising efforts,
and for monitoring the expenditure of funds.
2.
What is the role of the president of the medical staff in a hospital?
The President of the Medical Staff is usually elected by the medical staff. He or she represents
the medical staff to administration and the board.
Chapter Three—Including Supplement One
1.
Wycoff firmly believes in the diversification of management teams. Do you agree with him? If
so, what factors would you look for in diversification?
Any business decision benefits by considering different points of view. Since business decisions
involve product development, marketing, production process, strategic planning, financial
reporting, and human resource management, it is important to have a team of individuals who
collectively can address each of these functions. Critical to the success of any team is unity of
purpose and the ability to communicate and work together for the success of the business. No
one has all the answers, managers must diversify their management teams as to experience,
education, disposition, and individual strengths and weaknesses.
2.
How is it possible that hospitals didn’t know the costs of their products? Without accurate
procedure costs, how did they determine prices?
Since hospitals did not compete on the basis of price, it was not necessary to know the actual
costs of the specific goods and services provided. It was, of course necessary, that total revenues
equal or exceed total costs, but prior to the 1980s it was common for hospitals to subsidize some
services with the revenues from others.
The prices of goods and services were determined by what the market would bear, and what
competition was charging.
Good cost data was usually available on a department basis, but not on an individual product
basis.
3.
What is a prospective payment system, and how did it change the need for cost accounting?
A prospective payment system is one where the price is established in advance of delivery of the
good or service. In contractor terms, it is a fixed-price-contract. Prospective payment systems
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shift financial risk from the patient or payer to the healthcare provider. Prospective payment
systems increased the need for cost accounting systems that can accurately provide costing data
on individual products and services.
4.
Evaluate the incentives for cost control under cost reimbursement and prospective
reimbursement.
Cost reimbursement systems that guarantee full cost recovery, regardless of efficiency, provide
few incentives for cost control. Prospective reimbursement systems, where the healthcare
provider must absorb cost overruns in excess of the prospective price, provide greater incentives.
5.
Do you believe there are any down sides to incentive reimbursement in healthcare?
Where the patient has a difficult time judging the necessity for (or quality of) healthcare services
provided, there may be an incentive for the healthcare provider to provide a lower quality or
quantity of goods and services than needed to save costs.
6.
What is the difference between a financial accounting system and a cost accounting system?
A financial accounting system is principally used to prepare summary financial reports for
external investors and creditors. The reports must conform to generally accepted accounting
principles and are always reporting on past performance. A cost accounting system is looking at
matching costs to activities. It provides information on costs for internal management to use in
making decisions on what to do and to identify where changes need to be made. Cost accounting
is generally future oriented.
7.
A cost objective is defined as a function, organizational subdivision, contract, or other work unit
for which cost data are desired, and for which provision is made to accumulate and measure the
costs of contracts, products, etc. A final cost objective is a cost objective that has allocated to it
both direct and indirect costs and is one of the final accumulation points. What were the final
cost objectives under cost reimbursement? What would you speculate they might be under
prospective reimbursement?
Under the old Medicare payment program, which paid “costs per patient day” the cost objective
was the patient day. This was determined at year-end by Medicare auditors that would divide
total costs by patient days (usually by category). Possible cost objectives under prospective
reimbursement include specific products and diagnostic categories.
8.
What problems was the lack of a cost accounting system causing for Peter Brannan Hospital?
The board blames the poor financial performance of the hospital on their inability to know the
true costs of products and services provided. Under prospective reimbursement, cost data would
allow them to control costs, negotiate higher prospective prices, or discontinue product lines that
paid less than costs.
9.
What is the difference between DRG and Capitation Payment reimbursement systems?
A DRG payments system pays a fixed, predetermined price, per admission per diagnosis.
Capitation payment pays a predetermined fixed amount per month per enrollee, irregardless of
whether the patient uses the system or not.
10.
How a manager does something is often as important as what he or she does. Assuming Selman
needed to be terminated, do you agree with the manner in which it was done?
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Certainly the board didn’t appear to be comfortable with the manner in which Edward Wycoff
handled the situation. If Selman had to be fired, it might have been done in a less public forum.
Wycoff might have given some consideration to the timing, and the impact it would have on the
employees on the same day that a new administrator was appointed.
11.
Is there anything that Wycoff might have done to make Douglas’s transition into his new position
less difficult?
There are several things that might have been done: These include:

Handling the Selman situation more diplomatically.

Allowing department heads to participate in the hiring of a new administrator.
Chapter Four
1.
Why didn’t Douglas agree to meet with Ulman personally? Do you agree with his decision?
He was concerned about giving Ulman’s claim to authority credibility. He felt that he would
rather deal directly with the department heads and their employees than with a potential union
organizer.
2.
Is it appropriate for a board member to assume line responsibility in an organization?
The function of the board is:

To hire, supervise, and fire (if necessary) the hospital administrator.

To raise the capital necessary to purchase plant and equipment and provide working capital.

To grant medical staff membership and medical privileges.

To providelong-term, strategic direction for the hospital.
The board should not be involved with day-to-day operations. To do so undermines the authority
of the administrator, and gives the department heads and physicians conflicting signals as to who
is running the operations. Many not-for-profit hospital administrators struggle with board
members who own their own businesses and want to be involved in daily operations including the
hiring and firing of hospital personnel.
3.
The employees’ initial impression of Wes Douglas is not favorable. Why? Is his image that
important given the hospital’s current situation? If you were the new administrator, would you do
anything at this point to change the situation? What?
Possible reasons for the initial negative reaction include:

The department heads had no input on the selection of a new CEO.

The hospital is in a financial crisis, the employees might fear that the new administrator will
be a “hatchet man.”

The new administrator has no experience in healthcare management. His background is
financial. Some apparently worry that he will give more attention to the bottom line than to
the needs of employees and patients.

He is identified with Edward Wycoff who is apparently not very popular with the staff.
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Students can respond as to what they would do to improve the situation. If indeed he is a “hired
gun,” (someone who is hired to take unpopular actions to save the hospital), then it may not be as
important if he is like by the staff. Once he is done he can be replaced by a more popular
administrator. If Wes has an interest in serving in his position over the long-term, then he may
want to give more attention to his image and credibility. Certainly he must solve the financial
problems of the hospital, and solve them quickly, or it won’t matter if he is popular or not
4.
Wes refused Wycoff’s offer of help? Evaluate the strengths and weaknesses of this approach.
What would you do in this situation?
At this point Wycoff may be his only ally. Certainly Wycoff has demonstrated that he has the
power to fire members of the administrative team (i.e. Selman). Wes’ action possibly jeopardizes
his relationship with Wycoff.
On the other hand, if Wes is to succeed then he must establish himself as the one responsible for
operations. Distancing himself from Wycoff will possibly help him in his relationship with the
employees and medical staff.
5.
Prioritize the employees’ complaints in order of importance. Which would you work on first?
Students will probably differ as to the prioritization of complaints. The first issue has to be
financial solvency which includes the problems raised concerning pricing, costing, and waste. To
get the cooperation of the department heads and their employees, Wes must sell them on the
actions he feels are necessary to turn the financial operation of the hospital around.
Chapter Five
1.
How important is the credibility a CEO has with the bank? As CEO of Peter Brannan Hospital,
what would you do to build credibility?
One important criteria banks look at when loaning companies money is management. Wes
Douglas is disadvantaged in that he does not have experience in hospital administration. The
hospital is suffering a financial crisis. Wes’s background in accounting is probably a plus with
this problem. The credibility of both the CEO and CFO, which is built upon a history of
performance and open communications, is very important in a banking relationship.
2.
What do you think about the bank’s requirements for a line of credit?
If the bank is uncertain as to the true value of the accounts receivable, they will probably require
additional security for the loan. In this negotiating situation, the bank has most of the power. It
is doubtful that a new bank will step in and provide a line of credit, given the poor financial
performance of the hospital.
3.
What are the advantages and disadvantages of having a board member guarantee the hospital’s
line of credit? In this situation, did they have any choice?
If Wycoff guarantees the line of credit, he certainly will increase the leverage he has with the
administrator and the board.
For many years it was not uncommon for wealthy board members of rural hospital to subsidize
hospital operations or to co-sign hospital notes. As hospitals affiliated themselves with chains,
and were perceived to more like businesses and less like charities, this practice has declined.
If Wes Douglas had time, it would be nice to think about who he would rather hold the lien, the
bank or William Wycoff. As it is, they may not have much choice.
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Chapter Six
1.
What is the danger of asking a supervisor to prepare a budget and then cutting it without the
supervisor’s input? Is there a better way for management to reduce an unacceptable budget?
Dangers include:

Department heads may not buy-in to a budget they have not participated in preparing.

It might send a signal that the budget, regardless of its size will always be cut. In this event a
logical strategy is to pad any budget submission.
A better approach might be to base the budget on workload standards the department heads feel
they can realistically meet, or to at least discuss or negotiate reductions with department heads.
2.
The supervisors’ complain that the Controller’s Office doesn’t have a service orientation. List the
Controller’s Office customers. Why are some accountants not more service oriented? How
important is it for the employees of the Controller’s Office to interact with employees outside of
their own department?
Anyone who receives reports or information from the Controller’s office is a customer. Many
accountants fail to realize that they are in the information business. If information is not
conveyed in a manner that is understood by the user, it has no value.
3.
Many accountants erroneously assume that the users of their statements have the ability to read
and analyze these reports without additional explanation or training. What role must the
Controller’s Office play in educating the people who use management reports?
Since many managers lack formal training in accounting, information must be tailored to the
understanding of the user. One important role of the Controller is education. Supervisors must
be trained (and continually retrained) on the use of financial reports.
Chapter Eight
1.
Karisa Holyoak thinks Wes Douglas is in over his head. What is your opinion? Given Wes
Douglas’s professional situation, do you think he should have accepted the interim appointment?
Obviously, it would be helpful if he knew more about the healthcare industry. The possibility
exists that before he knows the right questions to ask, the game will be over. On the other hand,
he does have a financial background, and as an outsider might bring a fresh viewpoint to the
problems of Peter Brannan Community Hospital.
2.
Assume you are the new interim administrator with the same background as Wes Douglas. What
would you do to educate yourself?
Knowledge can be gained through:

Interviewing board members, department managers, employees, and members of the medical
staff.

Professional organizations such as the American Hospital Association
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
Continuing education through programs in healthcare administration that offer
correspondence courses to executives.

Professional healthcare journals.

Consultants.

The Internet.
Chapter Nine
1.
What conditions must exist for a free market? Which of these were lacking in the traditional
healthcare industry? Why?
Ideally, for a free market to exist, one must have (a) an informed customer, (b) who makes the
purchase decision, (c) shops on the basis of quality and cost, and (d) negotiates an arms-length
purchase price.
In healthcare, patients lack the technical background to judge the necessity and/or quality of the
services rendered. It is the physician and not the patient who makes the purchase decision. The
physician even selects the hospital to which the patient will be admitted.
Historically, patients have not been given access to the cost data necessary to shop on the basis
of price. In addition, since quality has often been associated with high cost, they have been
reticent to purchase “cheap” healthcare.
2.
Do consumers shop on the basis of price in most industries? Why didn’t they shop on the basis of
price for healthcare?
Price competition is common in most industries. As mentioned above, it didn’t usually happen in
healthcare because of a disparity of information. Consumers lacked information on necessity,
quality, and cost.
3.
4.
What factors mitigate against unnecessary capacity in most industries? Why didn’t these same
factors prevent the duplication of expensive facilities and equipment in the traditional healthcare
industry?

Excess capacity generates higher than necessary fixed costs, which in turn increase prices.

If someone else is paying the bill (i.e. the insurance company or the employer) or if price
information is not available, or if price is the only way patients have of judging quality, then
patients don’t shop on the basis of price.
What might regulators, insurance companies, employers, and accountants do to create a market
mechanism in the healthcare industry?
They might:

Educate consumers on the necessity and quality of healthcare services.

Assume the role of the informed consumer for the patient. Review and approve the necessity
and quality of healthcare products and services provided (i.e. pre-certification, peer review,
utilization review).
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
Assume the role of shopping for patients. Negotiate prices with hospitals and doctors.

Provide financial incentives for physicians and hospitals to act in the best economic and
medical interests of the patient.
These are the objectives of managed care.
5.
What is price elasticity? How price elastic is the demand for healthcare services.
Price elasticity exists when demand is directly and proportionately influenced by price. The
higher the price, the lower the demand and vice versa. Studies indicate that there is not a great
deal of price elasticity for life-saving healthcare products and services,
6.
Why do consumers have difficulty judging the quality of healthcare services? Should
accountants be concerned with quality issues.
Consumers lack the technical background necessary to judge the necessity for, and quality of,
medical goods and services. In many parts of the country, independent organizations are
assuming the role of collecting and disseminating information on the comparative quality, as
judged by morbidity and mortality, of competing physicians and hospitals.
One of the objectives of the Security and Exchange Commission (SEC) is reducing disparity of
information between the sellers and buyers of securities. Many feel the same thing should happen
in healthcare. Accountants are in the information business. In manufacturing, they are
increasingly becoming involved in issues of total quality management. The same should be true
in the healthcare industry.
7.
Who was the hospital’s customer under the traditional fee-for-service and cost-reimbursement
payment systems? Did this influence hospital cost behavior?
Many believe that the customer was not the patient, but the physician, as it was the physician who
selected the hospital, and decided what goods and services would be purchased.
Chapter Ten
1.
Studies have shown that physicians who own laboratories order more lab tests than physicians
who do not. What might be the reason for this? Do you see any potential conflict of interest in
physicians owning laboratories, pharmacies, or hospitals?
If the studies are accurate, they might indicate that financial incentives exist to order tests that
are not necessary. If this occurs, there is a conflict of interest.
2.
If indeed there were too many elective surgeries in the traditional healthcare industry, what might
be done to address this problem?
The approach taken was patient education, and pre-certification for elective procedures
3.
Under cost reimbursement, what were the incentives for physicians and hospitals with regard to
patient length of stay?
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The longer the length of stay, the more money the hospital made. Physicians were susceptible to
pressures of hospital administrators to increase admission and length of stay during periods of
low occupancy.
Chapter Eleven
1.
During the 1960s and 1970s, the government attempted to control healthcare costs through
regulation, using a utility industry model. Why didn’t this work?
The healthcare industry is too complex for any one individual or body to centrally regulate..
2.
Why were most hospitals formed as not-for-profit organizations? Why was cost reimbursement
the dominant payment system for healthcare for so many years?
Most hospitals were organized as charities, and consequently were not-for profit. Cost
reimbursement was selected by payers who felt that since charities were not organized to make
money, that they shouldn’t loose money either.
3.
What is incentive reimbursement? How does it attempt to create a market mechanism?
Incentive reimbursement is a form of payment that provides incentives for cost control. It is a
surrogate for price, a surrogate that provides an incentive to keep prices down in markets that
have price elasticity.
4.
From what you have learned, what do you think might be the advantages and disadvantages to
physician incentive reimbursement?
Advantages include:

The physician and hospital have an interest in the efficiency with which goods and services
are provided.
Disadvantages include:

Poorly designed incentive systems or incentives systems lacking an audit function may
encourage physicians and hospitals to provide fewer services than needed, or services of a
lower quality than required.
Chapter Thirteen
1.
Charles Stoker had seen three revolutions in healthcare during his career. What were these, and
how do you think they influenced hospital administrator behavior? How do you think they have
changed the role of hospital controller?
The consolidation of hospitals into hospital chains reduced the autonomy of local management,
provided opportunities for cost savings through centralized and shared services, and provided an
incentive for the growth of for-profit hospitals. For controllers this caused greater
standardization in accounting practices, and a movement away from fund accounting.
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Prospective payment shifted economic risk from patients and payers to healthcare providers. It
created incentives for cost control and for the design and implementation of cost accounting
information systems. For controllers this mandated the installation of cost accounting systems.
The assumption of the insurance role by some hospital chains was an attempt to control
admissions by having employers and insurance carriers mandate the providers that employees
could use. For controllers of organizations that offered their own insurance programs, or direct
contracted with employers, this injected elements of insurance accounting into healthcare.
2.
What is a health maintenance organization (HMO) and how does it attempt to control healthcare
costs?
The first health maintenance organizations employed their physicians, and contracted with
employers on a capitation basis. HMOs attempted to control healthcare costs by controlling the
behavior of member physicians. Today many HMOs contract with, rather than employ
physicians, and contract with employers using a variety of payment systems including fee-forservice.
3.
Henry Kaiser started one of the first HMOs in the country. If this program was successful in
controlling costs, why didn’t HMOs initially flourish in other parts of the country?
Reasons HMOs did not flourish included:
4.

Opposition by the American Medical Association.

Punitive legislation.

Fewer incentives for cost control, when costs were lower.
Are there greater incentives for physicians to provide preventive medicine in an HMO than in a
fee-for-service practice? Why?
In theory, there are stronger incentives for the provision of preventive medicine as it is cheaper to
prevent an illness than to treat it, and as most illnesses are less expensive to treat in their early
stages. One of the incentives for the formation of public health departments, was a lack of
interest by private physicians in providing preventive medical services including immunizations.
There is some evidence that HMOs are successful in diagnosing some forms of cancer earlier
than private physicians, but research on the provision of preventive medical services by health
maintenance organizations is incomplete.
5.
How has prospective reimbursement influenced hospital length of stay? Why?
When DRG reimbursement was first introduced, the average length of hospital stay declined
dramatically. Under DRG reimbursement, the incentive is to admit the patient (as this initiates
payment) but to discharge him or her as quickly as medically possible (since payment is fixed,
and shorter stays result in lower costs).
6.
What is a DRG reimbursement system, and how are its incentives different from cost
reimbursement and capitation payment?
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Under a DRG reimbursement system, illnesses are grouped based on diagnosis, procedures
performed, age of the patient, and discharge status. Hospitals are reimbursed a fixed amount per
DRG. If the hospital’s costs are less than the set reimbursement amounts, the hospital makes a
profit. If the hospital’s costs are greater than the set reimbursement amount, the hospital has a
loss.
DRG reimbursement provides an incentive for hospitals to control costs once the patient is
admitted.
Compared to capitation payment, the hospital under DRG reimbursement still has an incentive to
perform as many surgeries and services as possible, as long as reimbursement exceeds costs.
7.
Stoker believes that DRG reimbursement is essentially a fixed price contract. Is he right?
DRG reimbursement is essentially a fixed-price-contract in that reimbursement per DRG is
prospectively fixed, regardless of the quantity of services actually rendered.
8.
Why are many physicians threatened by prospective reimbursement?
They seemed to be bothered by several issues:
9.

Corporate interference in the practice of medicine.

Loss of autonomy.

Reduced income.

The possible negative influence of incentive reimbursement on quality.
In recent years, HMOs have come under fire by certain consumer groups. Are any of their
criticisms related to physician incentive reimbursement? What might be done to address the
problem?
The financial incentives an HMO provides physicians are felt, by some, to reduce a physician’s
incentive to provide comprehensive, quality service. Indeed, many argue that in HMOs, the
physicians have an incentive to do as little as possible—thus jeopardizing the quality of care
received by the patient. Watchdog organizations or healthcare payers should track types services
performed by each physician, number of repeat patients, complaints received, and other
measures of performance to assure that the physician is providing quality healthcare. Mandatory
training programs and peer reviews of performance might be instituted.
Chapter Fourteen
1.
What are some of the concerns Wes Douglas is starting to have about managed care?
Wes is concerned about the tradeoff between controlling costs and providing quality healthcare.
2.
Does the fact that most healthcare costs are paid by third-party payers (i.e. insurance companies
or employers) rather than by the patient, influence patient attitudes and behavior?
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Anytime a bill is paid by someone else costs become less important. Co-payments and deductibles
are used by some insurance companies to partially address this problem.
Chapter Eighteen—Including Supplement Two
1.
What is a variance and how is it calculated? How does Wes Douglas feel variances might help
him understand the reasons for the losses that Peter Brannan Hospital is currently experiencing?
In accounting, a variance is the difference between budgeted and actual costs. Wes knows that
there are losses at the hospital, but doesn’t know where or why they are occurring. Variance
analysis can help him identify the causes of the problem.
2.
Why was cost accounting a relatively rare practice in hospitals before the advent of managed
care? Why has managed care created a need for cost accounting?
Under cost reimbursement, there was no need to identify individual product costs because
reimbursement was based on cost per patient day. As long as total costs were covered by total
charges, the hospital had no need to understand individual product cost. Cost accounting
systems are expensive to install and maintain, and the cost wasn’t worth the information
provided.
Managed care mandates the use of cost accounting through the use of prospective (i.e. fixedprice) contracts that place a ceiling on reimbursement thereby limiting the ability of hospitals to
increase revenues through cost shifting, increases in patient charges, or increased volumes of
products and service.
3.
Define the terms external validity and internal consistency as used by Dr. Alma Cowdrey.
External validity means that a firm’s salaries are consistent with the market. Internal consistency
means pay is consistent with responsibility. If a system is internally consistent, employees get
equal pay for equal work.
4.
Why does Wes Douglas want Alma Cowdrey to determine the standard labor rates for Peter
Brannan hospital?
To establish a standard labor rate for cost accounting that is externally valid and internal
consistent.
5.
Other than the establishment of standard rates for cost accounting, what other factors might
motivate large employers to contract for a compensation study?

Difficulty in recruiting if the organization’s pay schedule is less than market

Difficulty in competing on the basis of price if the pay schedule is greater than market.

Employee morale problems if the system is not internally consistent (i.e. if the employees
perceive that their wages are influenced by internal politics, or factors other than the
difficulty of the work performed).
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Supplement Two
1.
What is the difference between a job task and a job characteristic? Which does Cowdrey plan on
using in his compensation study? Why?
A job task is a job activity—an action that the employee must perform to do his or her job.
Examples of job activities include changing a dressing, balancing a ledger, washing a window,
or administering a medication.
A job characteristic is a skill or ability required to perform a job. For example, the ability to
work with people, the need to work with numbers, or the supervision of other employees
Originally, job analysts attempted to quantify jobs for the purpose of compensation by identifying
and classifying job tasks or activities. Since there are an infinite number of tasks in the world of
work, this was found to be impossible. Job analysts then found that they could identify a dozen or
so quantifiable characteristics that were directly correlated with pay, and that applied to all jobs
within the world of work.
2.
What is the difference between linear and multiple regression? Which technique does Cowdrey
plan on using in his study? Why?
Linear regression is used to identify the relationship between one dependent and one independent
variable. Multiple regression is used to identify the relationship between one dependent and
multiple independent variables. Cowdrey plans to use multiple regression to study the
relationship between pay (the dependent variable) and multiple job characteristics (the
independent variables).
3.
Explain the meaning of each of the following variables, as they relate to Cowdrey’s compensation
study, in the following multiple regression equation:
Y = a + b1X1 + b2X2 + . . . bnXn
The Y is total compensation (a surrogate is total job points). The a is the fixed compensation
an employee receives regardless of job characteristics (in the real world it might
approximate minimum wage), the bs are the weights the market applies to the individual
job characteristics, and the xs are the degree of the individual job characteristics within
the particular job.
4.
The formula for calculating job characteristic points for the Nursing Department of Charity
Hospital is
Y = 55 + 12X1 + 22X2 +3X3
A consultant, who provided the following data, was hired to evaluate the position of Nurses Aide
using a multiple regression methodology.
X1 = 3 points, X2 = 1 point, X3 = 5 points
Calculate the total job characteristic points for the position of Nurses Aide at Charity Hospital.
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Y = 55 + 12(3) + 22(1) + 3(5) = 128 points.
5.
The formula for calculating job characteristic points in the Business office of Medina Memorial
Hospital is:
Y = a + b1X1+ b2X2 + b3X3 + . . . bnXn
Jeannine Cortez, personnel director, has determined that the constant a is 6.06 and the market
betas for office workers are as follows:
Beta
Job Characteristic
Beta
Value
B1
Decision making
.204
B2
Planning and scheduling
.081
B3
Job-related experience
.316
B4
Training
.012
B5
Physical exertion
B6
Number supervised
B7
Supervision received
B8
Personal contact
.059
B9
Attention to detail
.220
B10
Updating job knowledge
.261
B11
Responsibility for Material Assets
.155
B12
Job Structure
.334
B13
Criticality of Position
.362
-.109
.216
-.137
Ms. Cortez interviewed several employees in the Business Office using a multiple regression
evaluation system and rated the above job characteristics for each of the jobs as follows
(remember these are the x values).
Revised 8/25/2010
Page 14
Job Characteristic
Accountant
Collector
Secret
Insurance
aCoordinator
r
y
3.20
Computer
Technician
Decision making
4.00
2.20
1.75
Planning and
scheduling
2.10
3.10
3.90
2.00
2.80
Job-related
experience
4.50
2.00
1.50
3.40
3.00
Education and
training
4.50
2.50
1.80
3.00
3.50
Physical exertion
1.00
1.00
1.50
1.00
1.70
Number
supervised
5.00
0.00
0.00
2.00
2.00
Supervision
received
1.50
4.00
3.80
2.50
1.00
Personal contact
2.60
4.90
4.00
2.50
1.00
Attention to detail
3.90
2.80
3.00
3.80
3.50
Updating job
knowledge
4.30
1.90
1.00
3.80
2.80
Responsibility for
material assets
4.80
1.00
1.00
1.60
3.10
Job structure
1.10
4.80
4.10
2.50
3.60
Criticality of
position
3.50
1.90
2.00
2.80
3.70
2.80
Calculate job points (a surrogate for compensation) for each position.
The job points for accountant are calculated as follows:
Y = 6.06 + (.204 x 4.00) + (.081 x 2.10) + (.316 x 4.50) + (.012 x 4.50) + (-.109 x 1.00) + (.216
x 5.00) + (-.137 x 1.50) + (.059 x 2.60) + (.220 x 3.90) + (.261 x 4.30) + (.155 x 4.80) + (.334 x
1.10) + (.362 x 3.50) = 13.7997
Job points for other positions are:
Collector -- 10.6119, Secretary -- 9.9498, Insurance Coordinator -- 12.0376, Computer
Technician -- 12.5398
Revised 8/25/2010
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6.
The position of assistant controller at Community Hospital has an entry rate of $20 per hour, a
range of 50 percent, and six steps. Prepare a salary schedule for this position.
The salary schedule lane looks like this:
Step
6
5
4
3
2
1
Wage
$ 30.00
$ 27.67
$ 25.51
$ 23.52
$ 21.69
$ 20.00
How do we calculate the values? Enter $20.00 on step 1, and 1.5 x $20.00 = $30.00 on step six.
How do we find the percentage increase for each step? One easy way is to use a financial
calculator. Enter 5 as the number of payments, -$20.00 as the present value, 0 as the payment,
+$30.00 as the future value and calculate for interest. The answer is 8.45%. You can then take
$20.00 (step 1) and multiply it by 1.0845 to get $21.6, etc.
7.
Hopkins Hospital has recently finished a study to determine the internal consistency of its present
salary schedule using regression type methodology. When existing salaries are graphed against
job characteristic points, the data points are as follows:
Hopkins Hospital
Hourly Rate
$20
19
18
17
16
15
14
13
12
11
10
9
8
7
6
5
4
3
2
1
0
0
10
20
30
40
50
60
70
80
Job Characteristic Points
From these data, what can you conclude about the internal consistency of the hospital’s present
salary schedule? Is it possible to calculate a salary line from these data?
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Since the data points do not approximate a straight line, the model doesn’t work and we can
conclude the present salary schedule lacks internal consistency, at least with this model. In other
words, the dependent variable cannot accurately be estimated by the independent variable.
8.
Hopkins Hospital then obtained salary information from competing hospitals, which it used to
draw a salary line. It decided to adopt this salary line for establishing its internal salary
schedules. Since the controller had bad eyesight and didn’t like reading charts, he used a linear
regression methodology to determine that the constant was $4.50 per hour and the slope of the
line was $.30 per job characteristic point.
A.
What is the equation of the salary line?
B.
The position of housekeeper has been evaluated as having 67 job characteristic points.
What should the position pay per hour?
Y = 4.50 + 0.30X --- Y = $4.50 + 0.30(67) = $24.60
9.
Mary Wycoff, assistant human resource director, is interested in determining the multiple
regression formula for job characteristic points are for the hospitals in her region. She wants to
use the betas from this formula to develop a salary formula for her own hospital.
Job
Job
Job
Wage
Characteristic 1 Characteristic 2 Characteristic 3
Housekeeper
1
3
2
$6.58
Lab Tech
3
0
5
$11.09
Accountant
2
2
3
$8.46
Ray Tech
5
4
1
$10.90
Respiratory
Therapist
4
5
2
$10.91
Admin Secretary
3
5
4
$11.60
Grounds man
1
2
0
$4.25
In-service
Supervisor
3
5
5
$12.58
Collector
3
3
1
$8.07
Registered Nurse
5
5
5
$15.11
LPN
3
1
5
$11.39
Hskp Supervisor
3
4
4
$11.30
A.
From the data given, calculate the constant and the betas for a new regression based
salary evaluation program.
B.
The position of Nurse aide has been evaluated and the evaluator has assigned the
following points: Job Characteristic 1 = 2; Job Characteristic 2 = 1; Job Characteristic 3
= 2. From this data, calculate a proposed hourly wage.
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You can solve part A with any multiple regression software package. We used Excel. First open
up the “Analysis Toolpack” using the “Add-Ins” feature under “Tools”. From the menu select:
Tools
Data analysis
Regression
OK
Input Y range (block and enter the dollar or Y values, column five from the table)
Input X range (block and enter the three columns of X values which are Job Characteristic 1, Job
Characteristic 2, and Job Characteristic 3)
The output looks like this. The intercept of 2.416930371 is the a in the equation Y = a + b1X1 +
b2X2 + b3X3. The X variable 1, X variable 2, and X variable 3 coefficients are the betas (B1, B2, and
B3).
SUMMARY OUTPUT
Regression Statistics
Multiple R
0.999982071
R Square
0.999964142
Adjusted R Square 0.999950695
Standard Error
0.020330399
Observations
12
ANOVA
df
Regression
Residual
Total
Intercept
X Variable 1
X Variable 2
X Variable 3
3
8
11
SS
MS
F
Significance F
92.21076007 30.73692002 74364.99007 4.06849E-18
0.003306601 0.000413325
92.21406667
Coefficients Standard Error
2.416930371 0.018214776
1.258682707 0.005663055
0.300130676 0.004071928
0.978896263 0.003518267
t Stat
P-value
132.6906462 1.16355E-14
222.2621516 1.87949E-16
73.70726661 1.2789E-12
278.2325022 3.11741E-17
Lower 95%
2.374926996
1.245623671
0.290740787
0.97078312
Upper 95%
2.458933747
1.271741743
0.309520564
0.987009407
Part B:
Y = 2.416930371 + (1.258682707 x 2) + (0.300130676 x 1) + (0.978896263 x 2) = $7.19 (rounded to
two decimal places)
Revised 8/25/2010
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Supplement Three
1.
Define and provide examples of primary, intermediate, and final hospital products.
Primary, intermediary, and final products are cost objectives—different levels of detail in the
costing process. A primary product is the basic input such as direct labor and direct materials.
An intermediate product is a summation of a set of primary products, such as a medical
procedure. Each medical procedure is a summation of the materials and labor used in that
procedure. Groups of intermediate products are summed up into a final product. Final products
are assigned both direct and indirect costs and are the basis of bills submitted for reimbursement.
For example, a number of medical procedures are summarized to get a DRG classification.
2.
What is a cost roll-up?
The process to “roll-up” costs is the process of summarizing costs while moving from primary to
intermediate to final products.
3.
How does Nathan Stocks’ “quick and dirty” costing system differ from the one he eventually
hopes to install? What is the reason for installing a quicker system?
The “quick and dirty system” will no depend upon cost roll-ups to more accurately determine
final products. It will not define the final product as a DRG, an admission, or capitation day, but
will use a simpler (and less accurate) final cost objective—the patient day. Wes feels that he
needs some cost data immediately, and is temporarily willing to sacrifice detail for timeliness.
4.
What methodologies are available to determine the standard time required to manufacture a
product or service? What are the advantages and disadvantages of each?
Methodologies include:

Hire an industrial engineer to follow employees around with a stop-watch and to determine
the time it takes to perform procedures. The advantage of this methodology is accuracy, the
disadvantage is cost. Some hospitals have spent in excess of a million dollars developing
standards using this methodology.

Borrow standards from other hospitals that have conducted industrial engineered standards.
This is cheaper, the only concerns are how similar are the hospitals and is the data
available?

Determine how much time it now takes to perform each procedure, hoping to tighten the
standards as time progresses. The advantage of this method is cost, one must have a
methodology to determine what the historical standard has been, however, and this data
might not be available
Chapters Twenty-One and Twenty-Two
1.
What could Accounting have done to prevent the fraud that Ryan Raymer has engaged in?
Implemented a better system of internal controls, and performed periodic audits.
Revised 8/25/2010
Page 19
2.
3.
Hap Castleton told Amy that managed care attempts to control costs in three ways. List these,
and explain the advantages and disadvantages of each from the standpoint of quality and cost.

Precertification and review—this is an audit function performed by an independent third
party (it may be the physician’s peers, or personnel within an insurance company). In
checking for appropriateness of service, this tool attempts to compensate for disparity of
information—the inability the patient has due to his or her lack of technical knowledge to
determine the quality and necessity of the products and services ordered by the physician.
Few people, physicians included, enjoy having others critique their work. Some physicians
justifiably argue that the personnel used to audit physician behavior are not qualified to
evaluate technical medical decisions.

Gatekeeper Physicians—this is an attempt to restrict access to more expensive specialists.
Patients object to gatekeeper physicians as it increases the number of visits, and therefore the
number of physician office co-pays that they must make, to see a specialist. This, plus
concerns that the extra visit to a gatekeeper when a specialist is needed eliminates savings
due to reduced specialist utilization have caused many managed care organizations to back
away from gatekeeper physicians.

Incentive Reimbursement—this is an attempt to change physician cost behavior by shifting
the risk of excess resource utilization to the physician or hospital. There is evidence that
DRG and capitation payment do reduce utilization. Critics charge they also reduce quality.
Consider the following stakeholders: (1) physicians, (2) patients, (3) employers, (4) insurance
companies, and (5) hospitals. Which of these are in the best position to monitor (1) quality, and
(2) cost? Explain your reasoning.
Physicians are in the best position to monitor quality and resource utilization. Where it involves
a peer, the question is “Will they?”
Patients lack the technical background to evaluate the necessity or quality of most services
provided. If their medical bills are paid by employers or insurance companies, they may lack the
incentive to audit cost. Patients have typically not been provided cost data they could use to shop
and compare.
Employers have an advantage in that they pay the bill. They lack medical technical skills but can
hire them.
Insurance companies are similar to the employer. They have leverage in that they pay the bill
and they do have the ability to hire physicians and nurses to perform a review function.
Hospitals have access to cost data and medical data. They also have access to personnel with the
knowledge and capability to evaluate that data. Traditionally hospitals did not do a good job of
monitoring costs, as there was little financial incentive to do so.
Chapter Twenty-Three
1.
How is Life Flight a marketing tool?
It enables a hospital to capture patients outside its normal marketing area.
Revised 8/25/2010
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2.
Why are hospitals more concerned with marketing under prospective reimbursement than they
were under cost reimbursement?
Prospective reimbursement has limited revenue growth through price increases. In some cases
(DRG and capitation payment) it also limits the ability of a hospital to increase revenues by
increasing the number of medical goods and services provided to a specific patient.
With these curtailments, the only way to increase revenues is to increase patient volume. If the
number of potential patients in a market area are fixed, the only way to increase volume is by
capturing market share from competing hospitals.
3.
What are the principal causes of out-migration for rural hospitals?

Better transportation systems (freeways, helicopters) have increased rural access to
metropolitan medical centers.

Bigger is Better Syndrome—patients feel that larger metropolitan medical centers can
provider higher quality. It is true that smaller rural hospitals often lack the financial
resources to pay the fixed costs of specialized equipment and facilities.

More aggressive rural marketing by metropolitan hospitals.
Supplement Four
1.
Explain how a hospital makes or looses money under the following payment systems: (a) billed
charges, (b) cost reimbursement, (c) DRG payment, and (d) capitation payment.
Payment System
Billed charges
Cost-plus reimbursement
Revised 8/25/2010
Hospital makes money by
 Increasing hospital
admissions
 Increasing number of
billable products and
services provided per
admission
 Increasing prices
 Increasing hospital
admissions
 Increasing number of
billable products and
services provided per
admission
 If the hospital receives a
markup on costs, it can
increase profits by allowing
costs to increase.
Hospital looses money by
 Failing to set prices at a
level that cover costs.
 Failing to document and bill
for all medical goods and
services provided.


Failing to document costs
Failing to document goods
and services provided
Page 21
DRG payment



Capitation payment




Increasing admissions in
product lines where the
established price exceeds
actual product cost.
Reducing hospitalization
costs.
Increasing the number of
admissions, but reducing the
length of stay and the volume
and cost of the medical
goods and services provided
during that stay.
Reducing expensive hospital
admissions by keeping
patients healthy, or finding
less costly treatment
alternatives
Reducing costs of actual
admissions
Insuring healthy populations
Diagnosing illnesses earlier,
when treatment is less costly










Offering product lines where
costs exceed the
predetermined price.
Allowing costs to exceed
standards.
Reducing admissions.
Increasing length of stays
Increased intensity of
services provided to patients
during the hospital length of
stay
Admitting patients to the
hospital
Allowing inpatient and
outpatient costs to exceed
budgets
Insuring unhealthy
populations
Providing more medical
goods and services necessary
Losing enrollees to other
plans because
Supplement Six
1.
Explain the difference between job-order costing and process costing.
Job order costing is used by firms that produce products that are unique one from another. A
builder of custom homes would use a job order costing system as would an automobile repair
shop. A process costing system is used by firms that produce homogeneous products such as
paint or marbles.
2.
Explain the differences between actual, normal and standard costing.
In actual costing actual direct labor, actual direct materials, and actual overhead are debited to
the work-in-process account.
In normal costing, actual direct labor, actual direct materials, and overhead applied (through the
use of an overhead rate) are applied to work-in-process.
In standard costing, standard direct labor, standard direct materials, and standard overhead are
applied to work-in-process.
Supplement Seven
1.
Using the outline provided by Nathan Stocks, identify the information needs under DRG costing.
How do we lose money under a DRG reimbursement contract?
Revised 8/25/2010
Page 22

By not having as many admissions as budgeted.

By keeping patients admitted longer than budgeted.

By using more resources per admission than budgeted.

By offering in our product line a DRG that’s fixed payment does not cover our total costs of
providing that DRG.
What variables must management monitor to prevent losses under DRG reimbursement?

Numbers of admissions by DRG.

Average length of stay by DRG.

Average length of stay by DRG by physician.

Resource utilization by DRG.

Resource utilization by DRG by physician.

Fixed payment per DRG.
Supplement Eight
1.
What are the three levels of cost detail proposed for the cost system to be developed for Peter
Brannan Community Hospital?
Primary product, intermediate product, and final product cost detail.
2.
What is the 80/20 Pareto Principle, and what is its application in hospital standard costing?
Eighty percent of a hospital’s revenue typically comes from twenty percent of its procedures. If
more than one costing methodology is used, then these need to be costed using the most accurate
costing methodology.
3.
List three approaches to determining the standard time a procedure should take to perform. What
are the advantages and disadvantages of each method?

A study by an industrial engineer to determine the time it takes to perform each procedure.
This is the most accurate method but is also the most costly.

Borrowing standards from a hospital that has already conducted an industrial engineered
study. Borrowing standards should be cheaper than developing them for ourselves but the
standards might not be applicable to our hospital due to differences in size, product line,
average case-mix intensity of care, etc.

Determination of the current time it takes to perform each procedure through the use of
relative value units (RVUs). This is cheaper than conducting an industrial engineered study,
and will possibly provide standards that are more applicable to our own facility.
Revised 8/25/2010
Page 23
4.
What is a relative value unit (RVU)?
An RVU is a measure of resource consumption. It is in essence a homogeneous work unit that
can be used to compare across departments. Standards can be built on RVUs and then applied to
all activities in the hospital on a common basis for every department. A procedure with an RVU
of 2 consumes twice as much labor as a procedure with an RVU of 1.
5.
In designing its costing system, why is it important for Peter Brannan Hospital to separate its
costs into fixed and variable components?
Separating total costs into fixed and variable components will allow management to more
accurately predict total costs at different levels of volume.
Supplement Nine
1.
Explain the meaning of each symbol in the linear regression equation y = a + bx, when linear
regression is used to separate total costs into fixed and variable components.
Y = total cost
a = fixed cost
b = variable cost per unit
x = number of units
2.
Wally Hughes, director of housekeeping for St. Mary’s Hospital has accumulated the following
data on the labor costs of housekeeping for the delivery room:
Month
January
February
March
April
May
June
Deliveries
82
70
98
77
69
75
Labor Costs
4,400
3,820
5,150
4,000
3,700
4,070
Required:
A.
Calculate the estimated fixed and variable costs using
i.
The high-low method.1
The formula for the high-low method is (Yhigh – Ylow)/(Xhigh – Xlow) =($5,150 – $3,700)/(98
– 69) = 1,450/29 = $50 per delivery. This is the b in the equation Y = a + bX; b of
course is variable cost per unit. The fixed cost can be computed by subtracting the total
1
For a review of the high-low and least-squares methods, see any introductory managerial accounting textbook.
Revised 8/25/2010
Page 24
variable costs at any level of production from the total costs at that level. Let’s use high
costs.
High total costs ($5,150) – variable costs at high level of production ($50 x 98 = $4,900)
= $250.
The cost equation, therefore, is Y = a + bx or, Y = 250 + 50x
ii.
The least squares method (use the regression analysis option in Excel or some
other spreadsheet program).
You can solve part A with any multiple regression software package. We used Excel.
From the menu select:
Tools
Data analysis
Regression
OK
Input Y range (block and enter the dollar or Y values, from the third column in the table)
Input X range (block and enter the deliveries from the second column in the table)
OK
The output is shown in the following table. The intercept of is the a in the equation which
of course is the fixed cost. The X variable 1 coefficient is the b, which is the variable cost
per unit. The cost equation using regression analysis, therefore, is:
Y = $335.9877085 + $49.09569789X
SUMMARY OUTPUT
Regression Statistics
Multiple R
0.992621254
R Square
0.985296953
Adjusted R Square 0.981621192
Standard Error
71.56165953
Observations
6
ANOVA
df
Regression
Residual
Total
Intercept
X Variable 1
B.
1
4
5
SS
MS
F
Significance F
1372715.716 1372715.716 268.052461
8.1468E-05
20484.28446 5121.071115
1393200
Coefficients Standard Error
t Stat
P-value
Lower 95% Upper 95%
335.9877085 237.2042143 1.416449153 0.22959199 -322.5981354 994.5735524
49.09569798 2.998703587 16.37230775 8.1468E-05 40.76994484 57.42145112
What does the r2 tell us about the model?
Revised 8/25/2010
Page 25
An R squared of .985296953 tells us we have a good fit. Basically this R squared
indicates that any change in the number of deliveries explains 98.5296953 of the change
that will occur in the costs incurred. The closer R squared is to 1.0, the better the fit.
C.
Using spreadsheet software, demonstrate the closeness of the fit by sorting the data in
ascending order, then graph the data.
We used the graphics package of Excel. Highlight the second and third columns of data.
Select the chart wizard on the menu bar, then select:
XY(Scatter)
Next
Finish
You should get the following graph:
D.
From preadmission information provided by the Admitting Department, Wally estimates
that St. Mary’s Hospital will deliver 86 babies in July. Using the cost equation from your
regression projection, what should the budget for labor be for the month of July?
Y = a + bX = 335.99 + 49.10(86) = $4,558.89
3.
Tracy Hilliam, manager of the Carbon County Clinic, has collected the following data on the
costs of providing black-lung x-rays to coal miners:
Revised 8/25/2010
Page 26
X-rays
5
10
15
20
25
30
35
40
45
50
55
Cost
$50
175
225
260
275
290
300
315
340
375
450
Required
A.
Using spreadsheet software, prepare a scatter graph of the costs shown above.
Cost of Xrays
500
450
400
350
Cost
300
250
Series1
200
150
100
50
0
0
10
20
30
40
50
60
Number of Xrays
C.
What is the Y intercept? What does the graph tell you about the data? Can we use a
linear function to model the data?
The Y intercept is negative, which is impossible—there is no such thing as negative fixed
costs. The reason this occurs is that the data is not linear. If we still wish to use a
Revised 8/25/2010
Page 27
model, we could break the graph into three segments (from 0 to 15, 20 to 40, and 45 to
60), then use regression or the high-low method to calculate three equations.
D.
Use regression methodology to calculate the cost function i n the range from 20 to 40 xrays.
You can solve part C with any multiple regression software package. We used Excel.
From the menu select:
Tools
Data analysis
Regression
Ok
Input Y range (block and enter the dollar values).
Input X range (block and enter the number of x-rays).
OK
SUMMARY OUTPUT
Regression Statistics
Multiple R
0.997948716
R Square
0.995901639
Adjusted R Square 0.994535519
Standard Error
1.58113883
Observations
5
ANOVA
df
Regression
Residual
Total
1
3
4
SS
1822.5
7.5
1830
MS
1822.5
2.5
F
729
Coefficients Standard Error
t Stat
P-value
207 3.082207001 67.15966835 7.27442E-06
2.7
0.1
27 0.000111491
Intercept
X Variable 1
Significance F
0.000111491
Lower 95% Upper 95%
197.1910325 216.8089675
2.381755071 3.018244929
The cost function, therefore, is Y = 207 + 2.70 x. Translated into English, the fixed costs are
$207, the variable costs per unit are $2.70.
4.
John Banaski, director of pharmacy at Huntington Memorial Hospital, has collected the following
information on the labor costs of operating the pharmacy:
Prescriptions
500
1,000
1,500
2,000
2,500
3,000
3,500
4,000
Revised 8/25/2010
Labor costs
$2,000
2,500
3,000
3,500
4,000
6,000
6,500
7,000
Page 28
Required:
A.
Using spreadsheet software, prepare a sactter diagram of the above data.
Labor Costs Pharmacy
8000
7000
Labor Costs
6000
5000
Series1
4000
3000
2000
1000
0
500
0
1000
1500
2000
2500
3000
3500
4000
4500
Prescriptions
B.
Analyze the data shown on the graph. What is the probable reason for the cost pattern
shown?
The graph indicates that the cost function changes at about 3,500 units. The most likely
explanation is that the relevant range for fixed costs if from 0 to 3,500 units. After that
fixed costs increase.
5.
Cullimore Hospital uses RVUs to determine standard labor rates for each of its lab tests. An
RVU has been calculated to be equivalent to $8.50 of direct labor. Determine the standard labor
costs for a test with 6 RVUs of labor.
Standard labor for the test would be 6 x $8.50 = $51.00.
6.
McCormick Memorial Hospital uses industrial engineered studies to calculate standard labor costs.
The laboratory uses a standard costing system. The standard labor to perform a white blood count
(WBC) is four minutes. The standard labor rate for technicians is $15 per hour. What is the
standard labor cost for a WBC?
$15/60 minutes = $0.25 per minute. 4 minutes x $0.25 = $1.00.
Revised 8/25/2010
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Supplement Ten
1.
Differentiate between department overhead and general hospital overhead. How are both
calculated and allocated to individual revenue-producing departments?
Department overhead includes the indirect costs of the department. For example, in the nursing
department, the salary of the nursing director and her assistant nursing director are department
overhead costs. General hospital overhead includes the cost of service departments. Examples
include administration, human resources, the business office, medical records, and housekeeping.
Department overhead is allocated to products by dividing overhead by the total yearly relative
value units in the department. This results in a department overhead rate using RVUs as the
base. This number is then multiplied by the number of relative value units in each procedure.
General hospital overhead is allocated using the double apportionment allocation method.
2.
The laboratory of St. Mary’s Hospital uses a standard costing system. The standard labor to
perform a white blood count (WBC) is seven minutes. The standard labor rate for technicians is
$15 per hour.
A.
What would you propose as the standard labor cost for a WBC?
Part A The standard cost per minute is $15/60 = $0.25 per minutes. The standard cost
per test is 7 x $0.25 = $1.75
B.
During the month of March, the laboratory performed 1,000 WBCs. Laboratory
technicians used 6,850 minutes of labor performing these tests. The average labor rate
paid during the month was $14.85 per hour. Calculate the labor rate and labor efficiency
variances for the month of March.
The actual labor rate per minute was $14.85/60 = $0.2475
Actual quantity x
actual price =
6,850 minutes x
$0.2475 =
$1,695.38
$17.12 favorable
rate variance
Actual quantity x
standard price =
6,850 x $0.25 =
$1,712.50
$37.50 favorable
efficiency variance
Standard quantity x
standard price =
3.
(7 minutes x 1,000
tests) x $.025
$1,750.00
The Radiology Department of Fort Dodge Community Hospital performs three procedures:
Test
A
B
Revised 8/25/2010
Estimated number of
tests performed annually
5,000
2,000
RVUs
4.00
1.00
Page 30
C
3,200
2.50
The department’s direct labor budget for the year was $120,000. Material costs for each test were
Test A = $12.50; Test B = $15.00; Test C = 13.50. Departmental and allocated overhead
(amounting to $30,000) is allocated to procedures on the basis of RVUs, as is department direct
labor. Assuming the hospital wants to earn a profit of 10 percent of the total direct and allocated
cost of each test, what should it charge for each test?
First let’s calculate the total number of RVUs in the department for the year:
Test
Estimated number of RVUs
tests performed annually
A
B
C
Total
5,000
2,000
3,200
Total RVUs
(Column 2 x
Column 3)
20,000
2,000
8,000
30,000
4.00
1.00
2.50
Now we will calculate direct labor per RVU: $120,000/30,000 = $4.00 per RVU
Let’s do the same thing for allocated overhead: $30,000/30,000 = $1.00 per RVU
Now we will multiply the cost per RVU by the number of RVUs in each test, and plug the figures
into the following table.
Direct labor
Direct materials
Department and allocated
overhead
Subtotal
Profit
Total charge
4.
Test A
$16.00
12.50
4.00
Test B
$4.00
15.00
1.00
Test C
$10.00
13.50
2.50
$32.50
3.25
$35.75
$20.00
2.00
$22.00
$26.00
2.60
$28.60
The controller of Rose Hospital has provided you with the following data on service-department
costs to be distributed to revenue-producing departments.
Lab
X-ray
P.T.
O.R.
Costs
$260,000 $400,000 $38,000
Personnel
6
8
6
56
9
6
2
11
Sq feet
1,800
420
2,500
25,000
1,800
2,100
3,000
4,000
Revised 8/25/2010
Hskp*
Nursing
Laundry*
Admin*
Service Department Costs and Hospital Statistics for Double Apportionment
Page 31
Pounds of
Laundry
200
1,500
200
18,000
600
1,000
2,400
4,000
* Designates service department
Administrative costs are to be distributed using the number of hospital employees as the base.
Housekeeping costs are to be distributed using the number of square feet as a base, and Laundry
costs are to be distributed using pounds of laundry used.
Using the double apportionment method, distribute service-department costs to revenueproducing departments.
1st Alloc
Admin
Personnel
Sq ft
Hskp Laundry Nursing
Lab
X-ray
P.T.
O.R.
Base
2nd
Alloc
Base
98
98
6
8
6
56
9
6
2
11
1,800
420
2,500
25,000
1,800
2,100
3,000
4,000
40,200 38,400
200
1,500
200
18,000
600
1,000
2,400
4,000
27,700 26,000
38,000
15,918 148,571 23,877
15,918
5,306 29,183
26,195 261,955 18,860
22,004
31,434 41,912
Pounds of
Laundry
First
Allocation
Costs -- $
260,000 400,000
Allocate
(260,000)
21,224
Admin
Allocate Hskp
18,860 (421,224)
Allocate
578
Laundry
Subtotal
19,439
Second Allocation
Allocate
(19,439)
Admin
Allocate Hskp
4,338
4,338
Revised 8/25/2010
1,735
2,892
462,586 44,473
40,814
1,190
11,108
1,785
1,190
(5,925)
385
3,857
277
324
(1,575)
1,091
36
60
478,643 46,573
42,389
First Allocation Base
Administration 2,653.06
Housekeeping
10.48
Laundry
2.89
Laundry
52,059
1,586
Allocate
Laundry
Total cost allocated
Second Allocation Base
Administration
Housekeeping
(80,113)
198.36
0.15
0.06
0.00
$
6,941 11,568
$
43,682 82,665 698,000
396
2,181
$
462
617
$
145
242
$
44,687 85,706 698,000
260,000 / 98
421,224 / 40,200
80,113 / 27,700
19,439 / 98
5,925 / 38,400
1,575 / 26,000
Page 32
5.
A statement of direct and indirect costs for Methodist Rural Hospital is shown below. Use the
step-down (sequential) allocation method to allocate service department costs to revenueproducing centers. Allocate departments in the following order: (1) Administration, (2)
Housekeeping, and (3) Dietary. Allocate administration costs on the basis of number of employees, housekeeping on the basis of square feet, and dietary on the basis of number of meals served.
Admin
5
1,000
1,000
$126,000
# Empl
Sq Ft
# Meals
OH Cst
Hskpng
18
900
7,000
$350,000
Dietary
19
2,300
8,000
$970,000
Nursing
64
22,500
99,000
$3,950,000
Lab
12
7,000
6,200
$93,000
Total
Answer
Admin
5
1,000
1,000
Hskp
18
900
7,000
Dietary
19
2,300
8,000
Nursing
64
22,500
99,000
Lab
12
7,000
6,200
$ 126,000.00
$ (126,000.00)
$ 350,000.00
$ 20,070.80
$ (370,070.80)
$ 970,000.00
$
21,185.84
$
26,766.13
$(1,017,951.97)
$3,950,000.00
$
71,362.83
$
261,842.54
$
957,958.60
$ 5,241,163.98
$93,000.00
$ 13,380.53
$ 81,462.13
$ 59,993.37
$ 247,836.02
Admin
$1,115.0442478
Hskp
$ 11.6374464
# employees
Sq ft
# meals
Allocation
Base
113
31,800
105,200
Total
OH cost
Alloc Admin
Alloc Hskp
Alloc Dietary
Total
Rates:
$
$
$
$
Dietary
9.6763495
Supplement Eleven
1.
The laboratory of Memorial Hospital has decided to use RCC for calculating standard costs.
Last year, the laboratory had $1,200,000 in revenue, $600,000 in direct department costs, and
$300,000 in department overhead and allocated overhead. The current charge for a urinalysis is
$15. What would be the RCC standard cost?
Total costs = $600,000 + $300,000 = $900,000.
The ratio of costs to charges is 900,000/1,200,000 = .75
Revised 8/25/2010
Page 33
-
The standard cost for a urinalysis using the RCC methodology would be
.75 x $15 = $11.25.
Supplement Twelve
1.
Data on two competing hospitals is given below. Calculate (1) each hospital’s case-mix index,
(2) each hospital’s average charge, and (3) each hospital’s adjusted average charge. Which
hospital appears to have the lowest charges? Which has the lowest average charge? Which is
most cost efficient?
ST. JOSEPH’S HOSPITAL
DRG
Case Mix Index Number of Cases
1
1.5
1,000
2
2.9
2,000
3
3.0
500
4
4.0
2,500
Hospital Charge
$3,100
$6,350
$5,100
$7,850
ST. LUKE’S HOSPITAL
DRG Case Mix Index
1
1.5
2
2.9
3
3.0
4
4.0
Hospital Charge
$3,600
$6,100
$4,800
$8,050
Revised 8/25/2010
Number of Cases
3,000
1,000
1,100
2,000
Page 34
St. Joseph's Hospital
A
B
C
Case Mix Number of
DRG
Index
Cases
1
2
3
4
1.50
2.90
3.00
4.00
1,000
2,000
500
2,500
6,000
D
E
Hospital Case Mix
Charge
Units
(B x C)
$ 3,100
1,500
$ 6,350
5,800
$ 5,100
1,500
$ 7,850
10,000
18,800
F
$
$
$
$
$
Total
Revenue
(C x D)
3,100,000
12,700,000
2,550,000
19,625,000
37,975,000
18,800/6,000 = 3.13 case mix index
$37,975,000/6,000 cases = $6,329.17 average charge per case
$6,329.17/3.13 = $2,022.10
St. Luke's Hospital
A
B
C
Case Mix Number of
DRG
Index
Cases
1
2
3
4
1.50
2.90
3.00
4.00
3,000
1,000
1,100
2,000
7,100
D
E
Hospital Case Mix
Charge
Units
(B x C)
$ 3,600
4,500
$ 6,100
2,900
$ 4,800
3,300
$ 8,050
8,000
18,700
F
$
$
$
$
$
Total
Revenue
(C x D)
10,800,000
6,100,000
5,280,000
16,100,000
38,280,000
18,700/7,100 = 2.63 case mix index
$38,280,000/7,100 cases = $5,391.55 average charge per case
$5,391.55/2.63 = $2,050.02
2.
The reimbursement at St. Anthony’s hospital for DRG 152 is $4,100. At a volume of 1,200 DRG
152 procedures, St. Anthony’s fixed costs are $2,000,000. Variable costs per procedure are
$2,183. At a production volume of 1,200, how much will the hospital make or lose in total on
DRG 152?
The cost equation is Y = a + bX where Y is total cost, a is fixed cost, b is variable cost per unit
and X is the number of units. Plugging the data given into this equation:
Y = 2,000,000 + $2,183(1200) = $$4,619,600
Revenue at his volume will be $4,100 x 1,200 = 4,920,000
The hospital will make 4,920,000 – $4,619,600 =$300,300
Revised 8/25/2010
Page 35
Supplement Thirteen
1.
The following standard costs have been provided to you by the controller. An internal study
indicates that the resource profile for DRG 7 is:
3 acuity 1 patient days
1 acuity 2 patient day
1 radiology procedure 1
3 radiology procedure 4
2 lab test 1
1 lab test 2
1 lab test 3
3 lab test 5
Operating room minutes = 35
The standard costs for each of the above procedures are:
Standard
Cost
Department--Nursing
Workunit--Patient Day
Acuity Level 1
Acuity Level 2
Acuity Level 3
Acuity Level 4
Acuity Level 5
$
$
$
$
$
250.00
275.00
350.00
470.00
610.00
Department-Radiology
Workunit--Procedure
Procedure 1
Procedure 2
Procedure 3
Procedure 4
Procedure 5
Procedure 6
Procedure 7
$ 25.00
$ 50.00
$ 100.00
$ 230.00
$ 75.00
$ 35.00
$ 650.00
Department--Laboratory
Workunit--Test
Test 1
Test 2
Test 3
Test 4
Test 5
Test 6
Test 7
Revised 8/25/2010
$ 145.00
$ 28.00
$ 55.00
$ 32.00
$ 250.00
$ 58.00
$ 22.00
Page 36
Department--Operating Room
Workunit--OR Minute
Basic Minute
Total Standard Cost
$
45.00
Required:
A. Calculate the standard cost for DRG 7.
Standard
Cost
Number
Total
Cost
Acuity Level 1
$ 250.00
3
$750.00
Acuity Level 2
Acuity Level 3
Acuity Level 4
Acuity Level 5
$
$
$
$
275.00
350.00
470.00
610.00
1
$ 275.00
$ 25.00
$ 50.00
$ 100.00
$ 230.00
$ 75.00
$ 35.00
$ 650.00
1
$
3
$690.00
$ 145.00
$ 28.00
$ 55.00
$ 32.00
$ 250.00
$ 58.00
$ 22.00
2
1
1
$ 290.00
$ 28.00
$ 55.00
3
$ 750.00
35
$1,575.00
$4,438.00
Department--Nursing
Workunit--Patient Day
Department-Radiology
Workunit--Procedure
Procedure 1
Procedure 2
Procedure 3
Procedure 4
Procedure 5
Procedure 6
Procedure 7
25.00
Department--Laboratory
Workunit--Test
Test 1
Test 2
Test 3
Test 4
Test 5
Test 6
Test 7
Department--Operating Room
Workunit--OR Minute
Basic Minute
Total Standard Cost
Revised 8/25/2010
$
45.00
Page 37
B. The reimbursement for DRG 7 is $4,250. How much does the hospital make or lose on each
DRG 7?
$4,250 - $4,438 = loss of $188
Revised 8/25/2010
Page 38