"Cost Control" Please respond to the following: • Use the Internet or Strayer Databases to research “cost escalation” within the health care segment. Next, determine one (1) key driver of health care cost escalation. Indicate one (1) strategy health car
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HSA525 Week 3, Chapter 6, Lecture 1 Script: Cost Classifications
Professor Quan reviews last lecture and introduces this lecture’s topics.
HSA525_2_1_1_ProfQuan-1: Hello everyone….welcome back! During our previous lecture, we discussed Revenues and Expenses. Today, we will focus our attention on Cost Classifications and Cost Behavior. We will also have an opportunity to apply the concept of Breakeven Analysis.
HSA525_2_1_1_ProfQuan-2: Cost classification enables financial managers to track annual budget expenditures. Because cost classification breaks costs down into groups of similar categories, managers can effectively track -the largest expenditures. Healthcare costs can be classified under various methods so it is helpful for managers to become familiar with each type. Common methods of classifying healthcare costs are by function, traceability, behavior, and relevance to decision making. We will take a look at each separately.
HSA525_2_1_1_Sophia-1: Professor, when I hear cost classification, I automatically think about direct and indirect costs….how does direct and indirect costs relate to the methods that you have discussed?
Discussion of Financial accounting costs and managerial accounting costs.
HSA525_2_1_2_ProfQuan-1: As we discussed in our previous lecture, there are two basic accounting functions that are used in healthcare organizations, financial accounting and managerial accounting.
HSA525_2_1_2_ProfQuan-2: Can anyone recall the difference between the two types of accounting functions?
HSA525_2_1_2_Lauren-1: Financial accounting provides information for external stakeholders, such as investors and creditors. While, managerial accounting provides information for internal stakeholders, such as employees, managers, and executives of the organization.
HSA525_2_1_2_ProfQuan-3: Precisely….both provide key information that serve as integral components of the decision making process. Financial accounting costs are a measurement in monetary terms of the amount of resources used for specified purposes.
HSA525_2_1_2_ProfQuan-4: Basically, cost is a value placed on goods or services…when the value expires or is consumed, the cost becomes an expense. Managerial accounting costs are present and future costs that enable managers to make informed financial decisions.
HSA525_2_1_2_ProfQuan-5: Generating a hospital cost report for Medicare, for example, is part of financial accounting since the end-user of the information is the Centers for Medicare and Medicaid Services, the CMS, which is an external entity.
HSA525_2_1_2_ProfQuan-6: A cost report for the Chief Financial Officer (CFO) of the organization would be considered managerial accounting because the end user is an internal stakeholder. Another important distinction involves regulatory compliance.
HSA525_2_1_2_Sophia-1: So, professor…is it safe then to assume that the use of financial accounting cost reports are valuable to the internal manager as well, even though the reports are prepared for the external stakeholder?
HSA525_2_1_2_Lauren-2: I would like to share my thoughts on Sophia’s question if you do not mind, professor.
HSA525_2_1_2_ProfQuan-7: Sure, let’s hear your thoughts…
HSA525_2_1_2_Lauren-3: In my organization, we generate cost reports for the CMS and one of the things that we are told is to be careful because the information may be useful in some respect, but not in every aspect given that the information relates to past performance. Managers are often concerned with the current and future performance so changes may have been implemented subsequent to the compilation of the financial data.
HSA525_2_1_2_ProfQuan-8: Great point! Those are valid points related to the relevancy of financial and managerial data. Lauren’s comments were on target. The information in financial reporting is reflective of what has taken place financially and provides aggregated or summarized data. Managers need more detailed information in the planning and decision making process. It is important for managers be acutely aware of changes that are occurring within the industry in order to implement adaptive strategies. The historical nature of financial statements is not always conducive to real-time adaptability.
HSA525_2_1_2_Lauren-4: Well, I think that it has to do with the regulatory compliance of financial information that is used for external stakeholders.
For instance, all costs must be reported according to generally accepted accounting principles, GAAP.
HSA525_2_1_2_Tyler-1: I am not sure that I fully understand. It seems as though the information would be perfect for the manager because it has to follow GAAP guidelines.
HSA525_2_1_2_ProfQuan-9: While you both make very good points…It is important to keep in mind that planning is a critical element of the healthcare manager’s job, and managerial accounting has a strong short and long term orientation.
HSA525_2_1_2_ProfQuan-10: On the other hand, financial accounting essentially summarizes past financial transactions. While the summary may be a good tool to use in the planning process, its usefulness can be limited due to the historic orientation of the data.
HSA525_2_1_2_ProfQuan-11: While the past often predicts the future, changes may influence the performance in the future. Changes in economic conditions, customer needs, and changes to the competitive environment, are factors that must considered in financial planning.
HSA525_2_1_2_ProfQuan-12: As such, the manger’s planning must be based in large part on estimates of what will happen rather than on summaries of what has already taken place.
Discussion of operating costs and Nonoperating costs.
HSA525_2_1_3_ProfQuan-1: Another way that costs are classified is based on management function, operating costs and non-operating costs.
HSA525_2_1_3_ProfQuan-2: Operating costs are associated with producing the product or delivering the service. For example, supply costs associated with a patient’s emergency room visit would be considered an operating cost.
HSA525_2_1_3_ProfQuan-3: Whereas, non-operating costs are support costs for the production of a product or delivery of service. An example of a non-operating cost is the interest paid on borrowed money for equipment used in the emergency room.
HSA525_2_1_3_ProfQuan-4: Can you think of other examples of operating and non-operating costs incurred by healthcare organizations?
HSA525_2_1_3_Tyler-1: I would think that administrative expenses and rent are two types of operating costs. In terms of non-operating costs, I would say expenses related to obsolescence of equipment.
HSA525_2_1_3_ProfQuan-5: Great examples…. Healthcare managers today face a significant challenge in terms of doing more with fewer resources. Oftentimes, the manager must be creative in terms of reducing overall costs. When cuts from the budget become necessary, managers tend to cut from non-operating costs first…
HSA525_2_1_3_Sophia-1: I imagine that doesn’t make employees happy….
HSA525_2_1_3_ProfQuan-6: Well, let’s just say that it is not the ideal situation, but as managers, there are difficult decisions that must be made and healthcare, just as any other type of organizations has seen its share of challenges with respect to reductions in its non-operating expenses.
Discussion of direct, indirect, full, and average costs.
HSA525_2_1_4_ProfQuan-1: Traceability allows for the manager to classify costs based on cause and effect relationship. Costs categorized for traceability include direct, indirect, full, and average costs.
HSA525_2_1_4_ProfQuan-2: Direct costs can be traced directly to a department, product, or service. For example, the salary of the unit technology specialist in a hospital radiology department is directly traceable to that department.
HSA525_2_1_4_ProfQuan-3: Indirect costs cannot be traced directly to a department, product, or service.
Indirect costs do not show a causal relationship, but the manager must assume a linkage.
HSA525_2_1_4_ProfQuan-4: Full costs include both direct and indirect costs.
HSA525_2_1_4_ProfQuan-5: Average costs are full costs divided by the number of products and services. Incorrect cost classification is a common problem in cost accounting given that cost relationships are not always well understood.
HSA525_2_1_4_Tyler-1: Professor, is it appropriate to state that indirect costs should never be included in the determination of controllable costs?
HSA525_2_1_4_ProfQuan-6: It is not invariably true that indirect costs should never be included in the determination of controllable costs. There are some costs that may be classified as indirect, but could be controlled by the manager. For instance, housekeeping costs may be classified as indirect cost to the physical therapy department. However, the actual amount of housekeeping services required by the physical therapy department may be affected by, and thereby controlled by the actions of the physical therapy department manager.
HSA525_2_1_4_ProfQuan-7: Let’s now take a look at cost classification according to cost behavior.
Check Your Understanding:
Each of the following is classified as direct costs except:
A. Managed Care Marketing Expense
B. Real Estate Taxes
C. Clinic telephone expense
D. Emergency room medical supplies
• Managed care marketing expense is considered a direct cost as it can be attributed to a specific a particular area.
• Real estate taxes cannot be attributed to a particular unit; therefore, this is the correct answer.
• Clinic telephone expense is considered a direct cost as it can be attributed to a specific a particular area
• Emergency room medical supplies is considered a direct cost as it can be attributed to a specific a particular area
Discussion of Cost behavior
HSA525_2_1_5_ProfQuan-1: Cost behaviors refer to classification based on the degree of variability in relation to output.
HSA525_2_1_5_ProfQuan-2: Variable costs change as output or volume changes. For example if output increases by 15%, costs also increase by 15% reflecting a constant cost increment per unit of output.
HSA525_2_1_5_Sophia-1: Professor, wouldn’t supply costs be considered variable?
HSA525_2_1_5_ProfQuan-3: Yes, absolutely….supply costs are directly proportional to volume; therefore, supply costs are considered variable costs.
HSA525_2_1_5_Lauren-1: Can you provide an example of a semi-variable cost?
HSA525_2_1_5_ProfQuan-3: Semi-variable costs vary incrementally to changes in volume. For example, a hospital may not hire a new housekeeper if patient volume increases 1% because the current housekeeping staff can probably handle the extra cleaning required due to the small increase in volume.
HSA525_2_1_5_ProfQuan-4: But, if the volume increases 10%, the hospital is more likely to hire an additional housekeeper. The point is….the costs will only go up if the volume increases by a certain increment, which is based on management projections of what would be considered the appropriate increase in volume.
HSA525_2_1_5_Tyler-1: Professor, so am I correct in assuming that direct costs can be considered variable?
HSA525_2_1_5_ProfQuan-5: Yes, direct costs can be considered variable. It is so important, however, to remember that only direct costs can be variable, but not all direct costs are variable. Direct costs contain both variable and fixed elements, whereas, indirect costs only contains fixed elements.
HSA525_2_1_5_ProfQuan-6: Fixed costs, as you might imagine, are costs that remain constant in relation to volume. This would include rent, property taxes, or salary expense (not hourly wage expense) for example.
HSA525_2_1_5_ProfQuan-7: Fixed costs are a function of the passage of time as opposed to output. Rent and salaries remain constant for a period of time, irrespective of the volume of patients. Managerial costs are the cost associated with producing one more unit.
HSA525_2_1_5_Lauren-2: I have always found the concept of marginal costs to be challenging. Can you provide an example?
HSA525_2_1_5_ProfQuan-7: Let’s say that a medical lab may determine that if it performs one-hundred urinalysis tests per day, the cost per unit the fixed costs plus the variable costs, divided by one-hundred equals $10 per test. If the lab performs 101 tests, the marginal cost of that one additional test would be less than $10.
HSA525_2_1_5_ProfQuan-8: Remember, the fixed costs will likely remain unchanged, so the marginal cost would consist solely of the variable costs associated with an additional test, in this case, the supplies.
Check Your Understanding:
Horizon Health has fixed costs totaling $297,000. Its variable costs are $10 per visit. What is the total costs to support 4,500 visits during the period?
A. The correct answer is $342, 000. Using the formula Total costs = fixed cost + variable costs
Total costs = $297,000 + ($10 x 4,500 visits)
Total costs = $297,000 + $45,000
$342,000 = total costs
B. Incorrect response, the total costs = fixed + variable costs
C. Incorrect response, the total costs = fixed + variable costs
HSA525_2_1_6_ProfQuan-1: Let’s review some of the concepts from today’s lecture.
HSA525_2_1_6_ProfQuan-2: We discussed the importance of cost classification. We also described the relationship between changes in volume and how those changes affect costs.
HSA525_2_1_6_ProfQuan-3: During our next meeting, we will discuss breakeven analysis. Before we adjourn, are there any questions about today’s lecture?
HSA525_2_1_6_Sophia-1: No questions, we really covered a lot today…
HSA525_2_1_6_ProfQuan-4: This concludes today’s lecture.
HSA525 Week 3, Lecture 2: Cost Behavior and Break-Even Analysis
Scene 1: Professor Quan introduces the lecture topics and then begins to lecture on profit and loss.
HSA525_3_2_1_ProfQuan-1: Hello, during this lecture, we will cover the concept of breakeven analysis. Certain techniques can be applied when analyzing the relationships among cost, volume, and profit. The techniques rely on categorizing costs as fixed and variable.
HSA525_3_2_1_ProfQuan-2: We discussed during the previous lecture that fixed costs are those that remain constant irrespective of changes in volume, while variable costs fluctuate with changes in output or volume.
HSA525_3_2_1_ProfQuan-3: Profits within a healthcare organization are influenced by several factors including rates, volume, costs, payer mix, and bad debt.
HSA525_3_2_1_ProfQuan-4: Managers must understand how these factors support the organization’s financial goals. A Breakeven analysis is used to estimate the volume at which a business, department, or service becomes financially self-sufficient or cost and revenue are equal.
HSA525_3_2_1_Lauren-1: Professor, what is the relationship between breakeven and cost volume profit analysis?
HSA525_3_2_1_ProfQuan-5: The breakeven analysis is often referred to as the cost volume profit analysis. To calculate the breakeven point, let’s look at the following example.
HSA525_3_2_1_ProfQuan-6: Let’s assume that Horizon Health has variable cost per case of one-thousand dollars. Horizon’s fixed cost per period equals one-hundred-thousand dollars and its price per case is two-thousand-four-hundred dollars.
HSA525_3_2_1_ProfQuan-7: To determine its breakeven point, we must divide its fixed costs by the contribution margin, which is calculated as price minus variable costs. In this example, the break even volume in units would equal -seventy-one-point-four cases.
HSA525_3_2_1_ProfQuan-8: If the volume exceeds the number of cases at breakeven, the organization would show a profit…likewise, if the number of cases goes below seventy-one, there would be a loss.
HSA525_3_2_1_Sophia-1: Professor, so the contribution margin is used in the breakeven analysis?
HSA525_3_2_1_ProfQuan-9:Yes, just remember that the contribution margin is the difference between price and variable costs. The contribution margin is the amount that remains to cover fixed costs. Once the breakeven point has been reached and the fixed costs have been covered, each subsequent unit contributes to profit.
HSA525_3_2_1_ProfQuan-10: Let’s take a closer look….
Scene 2: Professor Quan demonstrates a real life example.
HSA525_3_2_2_ProfQuan-1: Let’s consider the following example…
Assume the following for Horizon Medical Supply:
Fixed Costs, twenty-thousand dollars;
Selling Price, one-thousand dollars; and
Variable Cost, six-hundred dollars.
What is the breakeven point in units?
HSA525_3_2_2_Lauren-1: I think that we will first need to consider the fixed costs to the contribution margin….to arrive at fifty units. My calculations are twenty-thousand dollars divided by four-hundred dollars. That will equal fifty units…
HSA525_3_2_2_ProfQuan-2: Tyler, what did your calculations show?
HSA525_3_2_2_Tyler-1: I arrived at the same conclusion as Lauren.
HSA525_3_2_2_Sophia-1: So did I….
HSA525_3_2_2_ProfQuan-3: That’s great…now, can you compute the breakeven point in dollars using the same information?
HSA525_3_2_2_Sofia-2: I believe that the breakeven point in dollars will equal fifty-thousand dollars. I came to that conclusion based on the breakeven units of fifty times the price, which is one-thousand dollars.
HSA525_3_2_2_ProfQuan-4: Very nicely done….now, Tyler would you care to calculate the contribution margin as a percent for us?
HSA525_3_2_2_Tyler-2: Sure…(pause)…If my calculations are correct, the percentage would equal forty-percent, or price minus volume divided by costs.
Scene 3: Classroom discussion between professor Quan and the students.
HSA525_3_2_3_ProfQuan-1: Great job! Now, what inference can the manager make as a result of the information?
HSA525_3_2_3_Tyler-1: The contribution margin tells the manager how much money will be available to cover fixed costs and subsequently profit once the breakeven point is met.
HSA525_3_2_3_Sophia-1: The contribution margin also shows how costs behave and it helps the manager with planning.
HSA525_3_2_3_Lauren-1: I would like to add to Sophia’s comments that it is important to understand how volume changes influence revenues, costs, and even profit.
HSA525_3_2_3_ProfQuan-2: What are some of the limitations of the Cost Volume Profit, CVP, or breakeven, analysis?
HSA525_3_2_3_Lauren-2: I think that a significant limitation involves the assumption that price of a service or good will remain the same. This could be a potential problem as prices will need to be adjusted based on several factors and in healthcare, there are so many fee schedules to consider.
HSA525_3_2_3_ProfQuan-3: Excellent….any other comments?
HSA525_3_2_3_Tyler-2: I think that another limitation would involve the length of time used…I think that breakeven analysis is a great tool, but should not be used over the long term.
HSA525_3_2_3_ProfQuan-4: That is interesting…can you share more of your thoughts? Why should a breakeven analysis be used only in the short term? From your perspective, what constitutes short term?
HSA525_3_2_3_Tyler-3: Professor, I would say that because of the changes in price, for example, the use of breakeven should be limited to one year.
HSA525_3_2_3_Lauren-3: I agree with Tyler because of the constant changes in the environment in which the healthcare organizations operate, one period or year would be best.
Check Your Understanding:
Calculate the breakeven point in units for the following….
Assume fixed costs of $10,000
Selling price $100
Variable cost $20
What is the breakeven point in dollars?
A. Is incorrect …. Breakeven points in units to be calculated first at Total Fixed Costs/ (price - variable costs) = 125 units; Then, calculate b/e in dollars 125 x $100 = 12,500
B. Is incorrect: Breakeven points in units to be calculated first at Total Fixed Costs/ (price - variable costs) = 125 units; Then, calculate b/e in dollars 125 x $100 = 12,500
C. Correct….Breakeven points in units to be calculated first at Total Fixed Costs/ (price - variable costs) = 125 units
Then, calculate b/e in dollars 125 x $100 = 12,500swer feedback:
Scene 4: Summary
HSA525_3_2_4_Prof.Quan-1: Well, we have concluded another lecture…do you have any questions about any of the material that we have covered?
HSA525_3_2_4_Lauren-1: No, I think that I have a good understanding of how the concepts are applied.
HSA525_3_2_4_Sophia-1: No questions, I think that putting the information into the context of how it will be used is helpful
HSA525_3_2_4_Tyler-1: None at this time….thanks
HSA525_3_2_4_Prof.Quan-2: If there are no questions, we will adjourn. During our next lecture, we will cover the concepts of Inventory and Depreciation.
these are the lectures that go with the discussion
HSA525 Week 3, Chapter 6, Lecture 1 Script: Cost Classifications
Professor Quan …