This report doesn’t describe where our costs are generated. We’re applying one standard to all patients, regardless of their level of care. What incentive is there to identify and account for the costs of each diagnosis?
Ann Julian, M.D., Chief of the Department of Medicine (DOM) at Carroll University Hospital (CUH), was reviewing her most recent cost report. Disappointed with its contents, she was meeting with Jonathan Haskell, the department’s administrator, who had worked with the hospital’s finance office to generate the report. She continued:
Unless I have better cost information, all our attempts to control costs will focus on decreasing the number of inpatient days. This limits our options. In fact, it’s not even an appropriate response to the hospital’s reimbursement constraints.
With the advent of DRGs and the growth of managed care, CUH had felt the pinch of third parties’ attempts to control hospital costs by putting hospitals at increased risk. Carroll, like many other tertiary care institutions, had extended cost control responsibility to its middle managers, requiring each department head to become involved in the hospital’s budgeting process, and to be accountable for the costs associated with his or her department’s activities.
After some discussion with the board, the Vice President for Medical Affairs had agreed that each clinical department chief should assume responsibility for the costs associated with caring for patients in his or her department. By enlisting the participation of chiefs in the cost control efforts, Carroll’s senior management hoped to improve the hospital’s overall financial performance. In the Department of Medicine, Dr. Julian had decentralized this responsibility to the directors of the various divisions, such as general medicine, cardiology, oncology, and gastroenterology.
THE PRESENT SYSTEM
The hospital’s present cost accounting system was based on an average standard costing unit applied to each department. For inpatient costs, the system used a cost-per-bed-per-day, known as a bed/day. For operating rooms (both inpatient and emergency), the standard unit was a cost per-operation or procedure.
To calculate unit costs, the finance office began with a department’s direct costs (shown in Exhibit 1). It then allocated indirect costs, such as maintenance and depreciation, according to a method that it had developed to report costs to third parties, such as Medicare. The method used allocation bases such as square feet, salary dollars, and beds. For a given cost, the basis of allocation was designed to distribute indirect costs fairly across departments.
Once all direct costs had been assigned to departments, and indirect costs had been allocated, the finance staff would calculate the average cost per unit by dividing the department’s total costs by the number of activity units for that department. Exhibit 2 shows the average cost . . .
- What is the cost of treating a patient with pancreatitis under each of the cost accounting systems? A patient with cardiac dysrythmia? A patient with liver cancer? What accounts for the changes from one system to the next?
- Which of the three systems is the best? Why?
- From a managerial perspective, of what use is the information in the second and third systems? That is, how, if at all, would this additional information improve Dr. Julian’s ability to control costs?
- What should Dr. Julian do?