Code Blue
Chapters 15 through 18
Includes Supplements 1, 2 and 3
Chapter 18
• Wes Douglas eventually needs a system that
provides costs by product
– Products will have to be defined in some level of detail
• Until he gets that he will probably define his
product as a patient day
• Today we will talk about two systems, the interim
(temporary) and final costing system
Costing Information
• Currently Available
– Total costs per
department
– Total costs per patient
day
• Not Not Available
– Individual procedure
costs
– Average cost per DRG
– Cost per DRG per
physician
– Costs by product line
– Costs by employer
The final costing system will need to
provide information for many types
of fixed price contracts
• DRG reimbursement
• Capitation payment
• Other contracts
He needs a system that is flexible, that will allow him to
capture costs on some elementary level, then roll those
costs up to more complex cost objectives.
We are not there yet, however
• It takes time to design and implement a
complete costing system
• We need something we can use to make
decisions today—an interim system
Interim Cost Objective
• Since Wes Douglas needs data now
• He is willing to sacrifice level of detail for
timeliness
• He decides that his interim cost objective
will be patient day since the hospital
association has data on nursing labor
costs per patient day
He can now calculate . . .
• Direct labor variances
• Direct materials variances
• Overhead variances
Per
patient
day
Formula for labor rate variances
AH x AR = X1
X1 - X2 = Labor rate variance
AH x SR = X2
SH x SR = X3
X2 - X3 = Labor efficiency
variance
AH = Actual Hours
SH = Standard Hours
AR = Actual Labor Rate
SR = Standard Labor Rate
How will he determine?
• Standard labor rate (SR)
– He will take the rates established by Alma
Cowdrey
• Standard labor hours (SH)
– Industrial engineer study
– Borrow standards from other hospitals
– Adopt current actual figures as standard,
tighten standards with time
We have reviewed the interim
costing system that Wes can use
until he gets something better. Now
let’s talk about the final (ultimate)
costing system.
Should the final system be . . .
• A job costing system?
• A process costing system?
• A combination of job costing and process
costing
Should the final system be . . .
• An actual cost accounting system?
– Debit WIP for actual direct labor, actual direct
materials, and actual overhead
• A normal cost accounting system?
– Debit WIP for actual direct labor, actual direct
materials, but use overhead rate
• A standard cost accounting system?
– Debit WIP for standard direct labor, standard direct
materials, and standard overhead
Possible advantages of standard
costing system
• More accurate
information on why
the hospital is losing
money
• Easier methodology
for assigning costs to
patients
• Mechanism for
involving employees
in cost savings
through bonuses
• Better methodology
for implementation of
responsibility
accounting
What is the difference between
data and information?
• Data are numbers processed by the
accounting system
• Information is data that is useful for
decision making
The information needed is
different to manage each of
these contracts
• Prospective payment contracts
– DRG Reimbursement
– Capitation Payment
• Retrospective payment contracts
– Billed Charges
– Cost Reimbursement
Questions to ask in designing
management reports
• How does the hospital make or lose money
on this particular type of contract?
• What variables, therefore, should the
manager monitor?
• What information must be sent on these
variables?
Questions to ask in designing
management reports
• How will we gather the data to prepare the
reports?
• What format should the information take?
• How timely must the information be?
The information needed is
different to manage each of
these contracts
• Prospective payment contracts
– DRG Reimbursement
– Capitation Payment
• Retrospective payment contracts
– Billed Charges
– Cost Reimbursement
Supplement Two
• Calculating accurate labor rate variances
– Labor rate variances tell how much a company
or made (or lost) because the labor rate was
lower (or higher) than budgeted
– Labor efficiency variances tell how much a
company made (or lost) because they used
fewer (or greater) hours than budgeted
The Compensation Study
• Designed to establish standard labor rates
that are:
– Internally consistent--this means that pay is
fair, that pay is based upon the characteristics
of the work done
– Externally valid--pay is consistent with market
The Compensation Study
• Based on job tasks and job characteristics
– Job tasks: Activities performed by the job
incumbent (balancing a ledger, administering
a medication)
– Job characteristics: An attribute the employee
must have to perform the job (i.e. a college
education, ability with math, manual dexterity,
ability to supervise people).
History of Job Analysis
Quantitative job analysis is approximately 55
years old. The first companies to use it were
defense companies during World War II. Their
objective was to determine what the pay should
be for jobs that had no equivalent in the
civilian workforce (i.e. what do you pay a bomb
loader?).
History of Job Analysis
• The objective was to quantify jobs by
assigning them job points that could be
directly correlated with pay
– Initially they tried to quantify job tasks. This
was impossible as there is are and unlimited
number of tasks in the world of work.
– The next attempt was to quantify job
characteristics.
History of Job Analysis
Using multiple regression, researchers
identified 13 to 16 job basic job
characteristics that were correlated with
pay.
Job Characteristics that
Correlate with Pay
•
•
•
•
•
•
•
Level of decision making
Amount of planning and scheduling
Job related experience and training
Job required personal contact
Supervision of other personnel
Supervision received
Amount of frustration/stress created by the
job
Job Characteristics that
Correlate with Pay
•
•
•
•
•
•
Attention to detail
Updating job knowledge
Responsibility for material assets
General responsibility
Job structure
Criticality of position
Formula Used:
Y = a + b1X1 + b2X2 + . . . bnXn
where:
Y = total job points
a = constant
b = weight applied by the market to the
particular job characteristic
X = the amount of that characteristic that must
be evidenced by the job incumbent
Example
• For the purpose of simplification assume
that there are only 3 job characteristics in
the world of work that correlate with pay
– Level of education required
– Level of decision making required
– Level of supervision over other employees
Example
• Let’s assume a study was conducted, and
the b values assigned to these job
characteristics by the market are:
– Education (b1) = 1
– Decision making (b2) = 3
– Supervision (B3) = 2
• Lets also assume that the constant was
found to be 5.
The formula therefore is:
Y = 5 + (1)X1 + (3)X2 + (2)X3
Example
• Now assume that the analyst, armed with
the formula and methodology interviews
each job incumbent to determine how
much of each job characteristic is required
by the particular job.
Example
• The results are:
– Education (X1) = 5
– Decision making (X2) = 3
– Supervision (X3) = 4
How do they come up with these values? Through scales
developed by the industry.
Substituting these values into
the formula we get:
Y = 5 + (1)(5) + (3)(3) + (2)(3) = 25 job points
How do we interpret this? A job with 25 job
points should be paid twice that as a job with
12.5 points.
Graph of Salary Line
Hourly Wage
Secretary
In this example, the
secretary is currently
paid too much if we
are to achieve internal
consistency
Present Wage
Correct Wage as
Determined by Model
Salary line dictated by the
model of the market
Job Points for
Secretary
Job Characteristic Points
Supplement Three
• Calculating Labor Variances
In a service industry what is the
product?
• We need to have a cost objective or
product to:
– Establish standard costs for
– Calculate variances for
• The product is sometimes more difficult to
define in service industries than it is in
manufacturing
Three levels products (review)
• Primary Products
• Intermediate Products
• Final products
Primary Products
• These are the most basic services
rendered
• Component costs include direct labor,
direct materials, and overhead
• Examples of primary products:
– Changing a dressing
– Suturing a wound
– Giving an injection
Calculating the cost of a primary
product
Direct Labor
Direct Materials
Primary
Product
(i.e changing
a dressing)
Overhead
Intermediate Products
Primary Product
Primary Product
Primary Product
Intermediate Product
(i.e. major surgical
procedure)
Intermediate Products
• Consist of services that have as
components two or more primary products
• An example might be a major surgical
procedure such as an appendectomy
Primary and intermediate
products are cost objectives
A cost objective is a function, organizational
subdivision, contract, or other work unit for
which cost data are desired and for which
provision is made to accumulate costs.
Purpose of cost objectives
• Decision making
• Control
Final Products
Intermediate
Product
Final Product
(i.e. DRG, Capitation
Day, Patient Day)
Intermediate
Product
Final Products
• Are made up of two or more intermediate
products
• Final products are final cost objectives
Examples of Final Products
• A Diagnostic Related Group
• A capitation day for a specific employee
group
• A patient day
–
–
–
–
Medical
Surgical
Obstetric
Etc.
Interim Cost Objective
• Wes Douglas needs data now
• He is willing to sacrifice level of detail for
timeliness
• He decides that his interim cost objective
will be patient day since the hospital
association has data on nursing labor
costs per patient day
He can now calculate . . .
• Direct labor variances
• Direct materials variances
• Overhead variances
Labor Variances
• Labor rate variance
– Formula: (AH x AR) - (AH x SR)
• Labor efficiency variance
– Formula: (AH x SR) - (SH x SR)
The End!