Cost Accounting

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Essentials of

Cost Accounting for

HEALTH CARE ORGANIZATIONS Third Edition

STEVEN A. FINKLER, PhD, CPA Program in Health Policy and Management Robert F. Wagner Graduate School of Public Service New York University New York, New York

DAVID M. WARD, PhD College of Health Professions University of New England Biddeford, Maine

JUDITH J. BAKER, PhD, CPA The Resource Group Dallas, Texas

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World Headquarters Jones and Bartlett Publishers 40 Tall Pine Drive Sudbury, MA 01776 978-443-5000 [email protected] www.jbpub.com

Jones and Bartlett Publishers Canada 6339 Ormindale Way Mississauga, Ontario L5V 1J2 CANADA

Jones and Bartlett Publishers International Barb House, Barb Mews London W6 7PA UK

Jones and Bartlett’s books and products are available through most bookstores and online booksellers. To contact Jones and Bartlett Publishers directly, call 800-832-0034, fax 978-443-8000, or visit our website, www.jbpub.com. Substantial discounts on bulk quantities of Jones and Bartlett’s publications are available to corporations, professional associations, and other qualified organizations. For details and specific discount information, contact the special sales department at Jones and Bartlett via the above contact information or send an email to [email protected]. Copyright © 2007 by Jones and Bartlett Publishers, Inc. All rights reserved. No part of the material protected by this copyright may be reproduced or utilized in any form, electronic or mechanical, including photocopying, recording, or by any information storage and retrieval system, without written permission from the copyright owner. This publication is designed to provide accurate and authoritative information in regard to the Subject Matter covered. It is sold with the understanding that the publisher is not engaged in rendering legal, accounting, or other professional service. If legal advice or other expert assistance is required, the service of a competent professional person should be sought. Library of Congress Cataloging-in-Publication Data Finkler, Steven A. Essentials of cost accounting for health care organizations / Steven A. Finkler, David M. Ward, Judith J. Baker. — 3rd ed. p. ; cm. Includes bibliographical references and index. ISBN-13: 978-0-7637-3813-6 ISBN-10: 0-7637-3813-1 1. Health facilities—Costs—Accounting. 2. Hospitals—Cost of operation—Accounting. 3. Cost accounting. I. Ward, David M. (David Marc), 1964- II. Baker, Judith J. III. Title. [DNLM: 1. Costs and Cost Analysis. 2. Health Facilities—economics. 3. Accounting—methods. 4. Economics, Hospital. WX 157 F499e 2007] HF5686.H7F563 2007 657’.8322042—dc22 2006028724 6048 Production Credits Publisher: Michael Brown Production Director: Amy Rose Associate Editor: Katey Birtcher Production Assistant: Amy Browning Marketing Manager: Sophie Fleck Manufacturing Buyer: Therese Connell Composition: Northeast Compositors, Inc. Cover Design: Timothy Dziewit Cover/Title Page Image: © Leah Groisberg/Shutterstock, Inc. Printing and Binding: Malloy, Inc. Cover Printing: Malloy, Inc. Printed in the United States of America 11 10 09 08 07 10 9 8 7 6 5 4 3 2 1

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Dedication

To Lilli, Joanne, and R.W. (the Bear)

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Contents

Preface . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .xiii About the Authors . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .xvii PART I

COST ACCOUNTING FOUNDATIONS . . . . . . . . . . . . . . . . . . .1

CHAPTER 1

Introduction to Cost Accounting . . . . . . . . . . . . . . . . . . . . . . . . . .3 The Purpose of Cost Accounting . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .4 Costs for Reporting vs. Costs for Management Planning and Control . . . . . .7 Good Cost Accounting Systems . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .8 The Human Element in Cost Accounting . . . . . . . . . . . . . . . . . . . . . . . . . . . . .9 Suggested Reading . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .10 Exercises . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .10

CHAPTER 2

Cost Definitions . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .13 Definition and Characteristics of Costs . . . . . . . . . . . . . . . . . . . . . . . . . . . . .15 Cross-Subsidization of Costs . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .19 True Cost, Economic Cost, and Accounting Cost . . . . . . . . . . . . . . . . . . . . .21 The Long Term vs. the Short Term . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .24 Departmental vs. Product-Line Costing . . . . . . . . . . . . . . . . . . . . . . . . . . . . .26 External Costs . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .30 Notes . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .31 Suggested Reading . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .31 Exercises . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .31 Problems . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .31

CHAPTER 3

Product Costing . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .33 The Need for Product Costing . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .34 Job-Order and Process Costing . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .34 Process Costing . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .36 Job-Order Costing . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .37

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Hybrid Approaches to Product Costing . . . . . . . . . . . . . . . . . . . . . . . . . . . . .40 Standard Costing Systems . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .41 Microcosting . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .46 Product Costing and Computers . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .46 Notes . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .47 Suggested Reading . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .47 Exercises . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .47 Problems . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .48

CHAPTER 4

Cost Allocation . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .49 What Is Cost Allocation? . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .51 Determining Overhead Application Rates . . . . . . . . . . . . . . . . . . . . . . . . . . .52 Cost Allocation and Motivation . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .59 Allocating Joint Costs . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .63 Traditional Cost Allocation for Health Care Organizations . . . . . . . . . . . . . .66 Is Good-Enough Cost Finding Good Enough? . . . . . . . . . . . . . . . . . . . . . . . .76 Notes . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .79 Suggested Reading . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .79 Exercises . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .79 Problems . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .80

CHAPTER 5

Costing for Nonroutine Decisions . . . . . . . . . . . . . . . . . . . . . . . .83 Cost Information for Nonroutine Decisions . . . . . . . . . . . . . . . . . . . . . . . . . .84 Sunk Costs Are Irrelevant . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .85 The Role of Volume . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .86 Terminology for Relevant Costing . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .88 Examples of Nonroutine Decisions . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .88 Cost-Benefit and Cost-Effectiveness Analysis . . . . . . . . . . . . . . . . . . . . . . . .92 Notes . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .94 Suggested Reading . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .94 Exercises . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .94 Problems . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .95

CHAPTER 6

Cost-Volume-Profit Analysis . . . . . . . . . . . . . . . . . . . . . . . . . . . .97 The Cost-Volume-Profit Relationship . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .98 Breakeven Analysis . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .100 Caveats . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .107 Mixed Costs and Step-Fixed Costs . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .111 Using Breakeven Analysis for Decision Making . . . . . . . . . . . . . . . . . . . . .112 Suggested Reading . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .113 Exercises . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .113 Problems . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .114

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PART II CHAPTER 7

COST ACCOUNTING INFORMATION FOR PLANNING AND CONTROL . . . . . . . . . . . . . . . . . . . . . . . . . .117 Predicting Future Costs . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .119 Using Groups for Estimating Costs . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .121 Indexing for Inflation . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .122 Cost Estimation Using Linear Regression . . . . . . . . . . . . . . . . . . . . . . . . . .125 Forecasting . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .136 Learning Curves . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .150 Suggested Reading . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .155 Exercises . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .155 Problems . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .156 Case Study—Part 1 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .157

CHAPTER 8

Budgeting . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .159 The Role of Budgeting . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .160 Budgeting Philosophy . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .162 The Master Budget . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .163 The Long-Range Budget . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .164 The Operating Budget . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .165 The Cash Budget . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .167 Program Budgets . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .175 The Capital Budget . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .175 Special-Purpose Budgets . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .187 The Negotiation and Approval Process . . . . . . . . . . . . . . . . . . . . . . . . . . . .187 Flexible Budgets . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .188 Note . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .188 Suggested Reading . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .188 Exercises . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .189 Problems . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .189 Case Study—Part 2 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .191 Appendix 8–A: Present Value and Compound Interest Tables . . . . . . . . . . .193

CHAPTER 9

Flexible Budgeting and Variance Analysis . . . . . . . . . . . . . . . .199 Traditional Variance Analysis . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .201 Flexible Budget Variance Analysis . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .203 Calculation of Variances . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .210 Variance Analysis and Management Control . . . . . . . . . . . . . . . . . . . . . . . .214 Revenue Variances . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .218 Notes . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .225 Suggested Reading . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .225

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Exercises . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .225 Problems . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .226 Case Study—Part 3 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .227

CHAPTER 10 Management Control . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .229 Is Management Control a Science? . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .230 Responsibility Centers for Management Control . . . . . . . . . . . . . . . . . . . . .231 The Management Control Process . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .233 Key Variables . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .235 Internal Control Systems . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .237 Transfer Pricing . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .242 Management Control of Projects . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .242 Notes . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .250 Suggested Reading . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .250 Exercises . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .251 Problem . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .251

PART III

ADDITIONAL COST ACCOUNTING TOOLS TO AID IN DECISION MAKING . . . . . . . . . . . . . . . . . . . . . . . . . .253

CHAPTER 11 Cost Accounting Ratios . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .255 Financial Ratios . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .256 Development of a New Set of Ratios . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .257 Some Cost Accounting Ratios . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .258 Comparisons . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .260 Notes . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .262 Suggested Reading . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .262 Exercises . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .262 Problems . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .263

CHAPTER 12 Measuring Productivity . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .265 Productivity Defined . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .266 The Traditional Approach to Measuring Productivity . . . . . . . . . . . . . . . . .266 The Total Productivity Ratio . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .267 The Partial Productivity Ratio . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .268 Productivity and Indirect Costs . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .270 Managing Discretionary Costs . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .273 Notes . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .280 Suggested Reading . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .280 Exercises . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .281 Problems . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .281

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CHAPTER 13 Inventory . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .283 Inventory Costing . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .284 Minimization of Inventory Costs . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .291 Inventory Issues Related to Health Care Manufacturing . . . . . . . . . . . . . . .303 Notes . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .303 Suggested Reading . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .303 Exercises . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .303 Problems . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .304

CHAPTER 14 Dealing with Uncertainty . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .305 Uncertainty . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .306 The Expected Value Technique . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .306 Simulation Analysis . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .313 Network Cost Budgeting . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .319 Linear Programming . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .326 Notes . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .331 Suggested Reading . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .331 Exercises . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .332 Problems . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .332

CHAPTER 15 Information Systems for Costing . . . . . . . . . . . . . . . . . . . . . . . .335 Considerations in Designing Costing Systems . . . . . . . . . . . . . . . . . . . . . . .336 The Risks of Do-It-Yourself Computing . . . . . . . . . . . . . . . . . . . . . . . . . . .338 Suggested Reading . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .342 Exercises . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .343

CHAPTER 16 Performance Evaluation and Incentive Compensation . . . . .345 Responsibility Centers . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .346 Evaluating Investment Centers and Their Managers . . . . . . . . . . . . . . . . . .349 Creating Compensation Incentives . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .353 Notes . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .358 Suggested Reading . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .358 Exercises . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .358 Problem . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .359

PART IV

COST ACCOUNTING FOR THE FUTURE . . . . . . . . . . . . .361

CHAPTER 17 New Approaches to Cost Accounting . . . . . . . . . . . . . . . . . . . .363 Is There a Problem with Traditional Cost Accounting? . . . . . . . . . . . . . . . .364 Kaplan’s Four-Stage Cost Model . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .365 An Alternative: New Generally Accepted Accounting Principles for One Unified System . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .367

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The Japanese Alternative . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .369 Dashboards . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .370 Balanced Scorecards . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .371 Notes . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .372 Suggested Reading . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .373 Exercises . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .373

CHAPTER 18 Activity-Based Costing . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .375 What is ABC? . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .376 Why Use ABC? . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .378 Two Approaches to ABC . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .378 Tracing vs. Allocating in ABC . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .378 ABC Allocation Principles . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .379 What Should Be Allocated in ABC? . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .380 An ABC Example in the Pharmacy . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .381 Designing and Documenting an ABC Project . . . . . . . . . . . . . . . . . . . . . . .386 Commencing an ABC Project in the Day Surgery . . . . . . . . . . . . . . . . . . . .387 Another Approach to ABC . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .389 The Activity-Based Management Concept . . . . . . . . . . . . . . . . . . . . . . . . . .390 Does ABC Make Sense for Health Care Organizations? . . . . . . . . . . . . . . .391 Notes . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .392 Suggested Reading . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .392 Exercises . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .392 Problems . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .393

Chapter 19

Total Cost Management: Measuring the Costs of Quality . . .395 Cost Accounting and Quality Management . . . . . . . . . . . . . . . . . . . . . . . . .396 An Introduction to TQM . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .397 A Focus on Time . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .399 A Focus on Cost . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .400 Total Cost Management . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .401 The Quality of Cost Data . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .416 A Focus on Customers . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .419 Notes . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .419 Suggested Reading . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .420 Exercises . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .420 Problems . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .421

Chapter 20

Summary and Issues for the Future . . . . . . . . . . . . . . . . . . . . .423 Cost Accounting Foundations . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .424 Cost Accounting Information for Planning and Control . . . . . . . . . . . . . . .427 Additional Cost Accounting Tools to Aid in Decision Making . . . . . . . . . .429 Cost Accounting for the Year 2010 and Beyond . . . . . . . . . . . . . . . . . . . . .431 Additional Future Issues . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .433

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Notes . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .438 Suggested Reading . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .439 Exercises . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .439

Glossary . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .441 Index . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .461

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Cost accounting is an essential part of health care management. As managed care has taken hold, all health care organizations have increased their focus on the measurement and control of costs. All health care managers, not just accountants, are becoming more and more aware of the importance of understanding as much about costs as they possibly can. A number of textbooks are available in the cost accounting field. However, these generic cost accounting texts focus primarily on manufacturing industries and only secondarily on service industries such as health care. Their emphasis is therefore largely on the process of converting raw materials into finished goods. Such books give a great deal of attention to determining the cost of work-in-process and by-products. However, cost accounting texts written expressly for health care are scarce. This book thoroughly covers the essentials of cost accounting from a health care perspective, including all of the basic tools of cost accounting common to all industries, using health care examples. Essentials of Cost Accounting for Health Care Organizations, Third Edition, focuses on costing issues and concepts unique to the health care field. The tools covered are all practical, although not all are commonly used. Some approaches, such as learning curves, are commonly used in other industries but not in health care. It is our hope that readers will see the value of some of these less frequently used techniques and adopt them for use in their organizations. The main theme of the book is the generation of useful cost information to aid managers in making decisions. The contents are therefore oriented toward both current and future accountants who will generate the information, as well as all current and future health care managers who want to know the types of information potentially available. Essentials of Cost Accounting for Health Care Organizations does not rely heavily on debits, credits, journal entries, and other technical accounting terminology. This omission was intentional to make the book accessible to a wide range of readers—students and faculty in university programs for health administration (both undergraduate and graduate), as well as individuals already working in the field of health administration. The need to obtain improved information to facilitate decisions is critical at all levels of management. In keeping with the first and second editions, this book provides a thorough conceptual foundation. In this third edition, we have continued to follow the trend of the health care industry, moving away from a dominant focus on hospitals. The concepts and examples used in the text address not only hospitals but also nursing homes, physician practices, managed care organizations, clinics, surgicenters, and a wide range of other types of health care organizations.

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In the third edition, we also continue to integrate personal computers (PCs) and the internet. Many chapters provide examples designated as “Excel® Problems.” These problems are specifically designed to be solved with a computer-based spreadsheet application like Microsoft Excel®. In addition, we have created ancillaries at www.jbpub.com/catalog/0763738131 that include data sets and Excel® templates that readers can download to solve the Excel® problems. On this site, we also include instructions on specific Excel® tasks related to the chapters and the problems. The text is broken into four parts. Part I provides the foundations of cost accounting. Part II addresses the use of cost accounting for planning and control. Part III provides additional cost accounting tools to aid in decision making, and Part IV discusses the latest trends and techniques in cost accounting. Part I provides the reader with a solid base in the essentials of cost accounting. The chapters in this section introduce costing and cost definitions. Various approaches to product costing and cost allocation are discussed. Breakeven analysis is also covered in the section, as are techniques for making nonroutine decisions. A primary focus of cost accounting is on developing information that managers can use for planning and control. Once the reader is familiar with the foundations of cost accounting provided in Part I, Part II presents a number of specific tools for improved planning and control. The chapters in this section focus on forecasting and predicting future costs, budgeting, flexible budgeting and variance analysis, and management control. Part III addresses a number of additional cost accounting tools that can be helpful in generating management information for decision making. Specifically, there are chapters on cost accounting ratios, productivity measurement, inventory, uncertainty, information systems, and performance evaluation. For the past several decades, literature critical of current cost accounting practices throughout all U.S. industries has been growing. The concern is that costing has evolved primarily into a tool for external reporting of financial results rather than for managing the organization. This concern has led to a movement to revise cost accounting practices drastically to make them more relevant. The criticisms of cost accounting and a number of suggested approaches for improvement are discussed in Part IV. A new chapter about activity-based costing has been added to this third edition. The chapters in this part also examine total quality management and the future of costing. The last chapter summarizes the book. Some instructors may choose to assign this last chapter at the beginning of the course to provide an in-depth overview of the material. It can then be assigned again at the end, for review, and to integrate the great breadth of material covered in the book. Each chapter begins with a set of specific learning objectives listed for the reader. In addition, we present key application questions, which serve as examples of typical questions readers will be able to answer after completing the chapter. The key application questions are followed by a set of key terms used in the chapter. Each of the key terms is shown in boldface italics the first time it appears in the chapter, and all are defined in the glossary at the end of the book. Each chapter has exercises and questions for discussion. An instructor’s manual is available online for instructors who adopt the book for classroom use. The manual includes solutions to all questions and problems at the end of the chapters and an examination test bank with solutions, along with PowerPoint slides arranged by chapter. While the task of updating and revising is certainly easier than creating, putting together the third edition of this book proved to be quite a challenge. We have attempted to create a book that provides

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a thorough, clearly written, comprehensive coverage of cost accounting. However, we recognize that there is always room for improvement. Readers are encouraged to use the resources at www.jbpub.com/catalog/0763738131 to email us to point out errors or unclear passages, or to suggest additional applications or other improvements. All contributions will be acknowledged in the next edition. Any corrections to errors in the text will be posted on the Web page. Our thanks go to the many individuals who helped us in the process of developing this book. Steven A. Finkler David M. Ward Judith J. Baker

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