I’m very concerned about your department’s financial performance. We’d been planning on a surplus of about $74,000 from you, and you’ve run a deficit of over $125,000. Unless something is done to turn this trend around, the hospital will have to begin a series of layoffs that will affect all departments.
Maria Delgado, Chief of Medicine of Los Reyes Hospital, stared at the memorandum from the hospital’s Vice President for Medical Affairs. A similar memorandum had been sent to all chiefs of service, expressing concern that the results of the most recent quarter’s operations were considerably worse than budgeted.
Dr. Delgado knew she had some explaining to do. In fact, she, along with several other chiefs, had been asked to make a presentation at the next Executive Committee meeting of the hospital concerning the role that their departments had played in the hospital’s poor performance, and their plans for corrective action.
In reviewing the budgeted and actual results, Dr. Delgado discovered that almost all of her department’s variation could be attributed to four case types and four hospital services. For reasons of simplicity, she decided to base her presentation on these only.
Exhibit 1 shows the original quarterly budget for these four case types: DRG089 (Simple pneumonia & pleurisy, age over 17), DRG014 (Specific cerebral vascular disorders except transient ischemic attack), DRG096 (Bronchitis & asthma, age over 17), and DRG140 (Angina pectoris). It also shows the budgeted variable expenses per case for the four hospital services: routine care (i.e. the hospital stay), radiology films, laboratory tests, and pharmacy units (such as prescriptions).
Since the hospital negotiated all of its managed care contracts on the basis of diagnosis, it was paid on a per-case basis. Its anticipated revenue for each DRG is shown in Exhibit 1, as is the anticipated utilization of services and the variable expense per unit for each service for each DRG.
Using these estimates, the hospital’s fiscal affairs department had calculated total variable expense per case for each DRG. The revenue and total variable expense per case then had been multiplied by the anticipated number of cases to give total revenue and total variable expenses by DRG. The latter was deducted from total revenue to give the contribution to fixed expenses from each DRG. The department’s fixed expenses (including its allocated overhead) were then deducted from the total contribution to give a total budgeted surplus of $73,650 for the quarter.
Exhibit 2 is similar to Exhibit 1, except that it shows actual results. As it indicates, instead of a surplus, the department incurred a deficit of $125,475. It was this that led to the concern expressed in the memorandum from the hospital’s Vice President for Medical Affairs. . . .
- Be sure you understand how Exhibit 3 was prepared. Do you agree with Mr. Hawkins’ analyses so far?
- Besides changes in the number of cases and the payment rate per case, what are the other reasons why actual results might have diverged from budget?
- Calculate the variance associated with each of the reasons you gave in Question 2. How, if at all, might this information be used by Dr. Delgado in managing the department? How might it be used by the hospital’s administration? What other information concerning cases, costs, and revenues would you suggest Dr. Delgado see on a regular basis? How might your answer be affected by the hospital’s decision about the types of responsibility centers in its management control system?