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Course: Healthcare Financial Accounting at Univ. of Phoenix
Complete
Part I by computing contractual allowances.
Complete Part II by indicating the cost center and the correct revenue source.
Complete Part III by indicating the cost center for the expense.
Post
your assignment as a Microsoft® Excel® spreadsheet.
SPREADSHEET in the ATTACHMENTS BELOW
Note.. When you open spreadsheet parts I & II are at the bottom lefthand corner. Click on tabs.
Resource University
Material:
Chapters are attached (if needed).
No Plagiarism
P A R T
Record
Financial
Operations
II
25
Assets, Liabilities,
and Net Wo r t h 3
C H A P T E R
OVERVIEW
Assets, liabilities, and net worth are part of the language
of finance. As such, it is important to understand both
their composition and how they fit together. Short defi-
nitions appear below, followed by examples.
Assets
Assets are economic resources that have expected future
benefits to the business. In other words, assets are what
the organization owns and/or controls.
Liabilities
Liabilities are “outsider claims” consisting of economic
obligations, or debts, payable to outsiders. Thus, liabili-
ties are what the organization owes, and the outsiders to
whom the debts are due are creditors of the business.
Net Worth
“Insider claims” are called owner’s equity, or net worth.
These are claims held by the owners of the business. An
owner has a claim to the entity’s assets because he or she
has invested in the business. No matter what term is used,
the sum of these claims reflects what the business is
worth, net of liabilities—thus “net worth.”
The Three-Part Equation
An accounting equation reflects a relationship among
assets, liabilities, and net worth as follows: assets equal
After completing this chapter,
you should be able to
1. Recognize typical assets.
2. Recognize typical liabilities.
3. Understand net worth
terminology.
4. See how assets, liabilities, and
net worth fit together.
P r o g r e s s N o t e s
liabilities plus net worth. The three pieces must always balance among themselves because
this is how they fit together. The equation is as follows:
Assets � Liabilities � Net Worth.
WHAT ARE EXAMPLES OF ASSETS?
All of the following are typical business assets.
Examples of Assets
Cash, accounts receivable, notes receivable, and inventory are all assets. If the Great Lakes
Home Health Agency (HHA) has cash in its bank account, that is an economic resource—
an asset. The HHA is owed money for services rendered; these accounts receivable are also
an economic resource—an asset. If certain patients have signed a formal agreement to pay
the HHA, then these notes receivable are likewise economic resources—assets. All types of
business receivables are assets. The Great Lakes HHA also has an inventory of medical sup-
plies (dressings, syringes, IV tubing, etc.) that are used in its day-to-day operations. This in-
ventory on hand is an economic resource—an asset. Land, buildings, and equipment are
also assets. Exhibit 3-1 summarizes asset examples.
Short-Term versus Long-Term Assets
Assets are often labeled either “current” or “long-term” assets. Current is another word
for “short-term.” If an asset can be turned into cash within a 12-month period, it is current,
or short term. If, on the other hand, an asset cannot be converted into cash within a 12-
month period, it is considered long term. In our Great Lakes HHA example, accounts re-
ceivable should be collected within one year and thus should be current assets. Likewise,
the inventory should be converted to business use within one year; thus, it too is considered
short term.
Classification of the note receivable depends on the length of time that payment is prom-
ised. If the entire note receivable will be paid within one year, it is a short-term asset. Con-
sider, however, what would happen if the
note is to be paid over three years. A portion
of the note—that amount to be paid in the
coming 12 months—will be classified as
short-term or current, and the rest of the
note—that amount to be paid further in the
future—will be classified as long-term.
The land, building, and equipment will
generally be classified as long-term because
these assets will not be converted into cash
in the coming 12 months. Buildings and
equipment are also generally stated at a net
26 CHAPTER 3 Assets, Liabilities, and Net Worth
Exhibit 3–1 Asset Examples
Cash
Accounts receivable
Notes receivable
Inventory
Land
Buildings
Equipment
What Are the Different Forms of Net Worth? 27
figure called book value, which reduces their historical cost by any accumulated deprecia-
tion. (The concept of depreciation is discussed in Chapter 8.)
WHAT ARE EXAMPLES OF LIABILITIES?
All of the following are typical business liabilities.
Examples of Liabilities
Accounts payable, payroll taxes due, notes payable, and mortgages payable are all liabilities.
The Great Lakes HHA owes vendors for medical supplies it has purchased. The amount
owed to the vendors is recognized as accounts payable. When the HHA paid its employees,
it withheld payroll taxes, as required by the government. The payroll taxes withheld are due
to be paid to the government and thus are also a liability. The HHA has borrowed money
and signed a formal agreement and thus the amount due is a liability. The HHA also has a
mortgage on its building. This mortgage is likewise a liability. In other words, debts are lia-
bilities. Exhibit 3-2 summarizes liability examples.
Short-Term versus Long-Term Liabilities
Liabilities are also usually labeled as either “current” (short-term) or “long-term” liabilities.
In this case, if a liability is expected to be paid within a 12-month period, it is current, or
short-term. If, however, the liability cannot reasonably be expected to be paid within a 12-
month period, it is considered long-term. In our Great Lakes HHA example, accounts
payable and payroll taxes due should be paid within one year and thus should be labeled as
current liabilities.
Classification of the note payable depends on the length of time that payment is prom-
ised. If the HHA is going to pay the entire note payable within one year, it is a short-term li-
ability. But consider what would happen if the note is to be paid over three years. A portion
of the note—that amount to be paid in the coming 12 months—will be classified as short-
term or current, and the rest of the note—that amount to be paid further in the future—
will be classified as long-term. The mortgage will be treated slightly differently. That portion
to be paid within the coming 12 months will be classified as a short-term liability, while the
remaining mortgage balance will be labeled as long-term.
WHAT ARE THE DIFFERENT FORMS
OF NET WORTH?
Net worth—the third part of the accounting
equation—is labeled differently, depending
on the type of organization. For-profit or-
ganizations will have equity accounts with
which to report their net worth. (Equity is
the ownership right in property or the
Exhibit 3–2 Liability Examples
Accounts payable
Payroll taxes due
Notes payable
Mortgage payable
Bonds payable
28 CHAPTER 3 Assets, Liabilities, and Net Worth
money value of property.) For example, a sole proprietorship or a partnership’s net worth
may simply be labeled as “Owners’ Equity.” A corporation, on the other hand, will generally
report two types of equity accounts: “Capital Stock” and “Retained Earnings.” Capital stock
represents the owners’ investment in the company, indicated by their purchase of stock. Re-
tained earnings, as the name implies, represents undistributed company income that has
been left in the business.
Not-for-profit organizations will generally
use a different term such as “Fund Balance”
to report the difference between assets and
liabilities in their report. This is presumably
because nonprofits should not, by defini-
tion, have equity. Exhibit 3-3 summarizes
terminology examples for net worth as just
discussed.
INFORMATION CHECKPOINT
What Is Needed? A report that shows the balance sheet for your organiza-
tion.
Where Is It Found? Probably with your supervisor.
How Is It Used? Study the balance sheet to find the assets and liabilities.
Check the equity section to see whether equity is listed
as net worth or as fund balance.
KEY TERMS
Assets
Equity
Fund Balance
Liabilities
Net Worth
DISCUSSION QUESTIONS
1. Do you ever work with balance sheets in your current position?
2. If so, is the balance sheet you receive for your department only or for the entire or-
ganization? Do you know why this reporting method (departmental versus entire or-
ganization) was chosen by management?
Exhibit 3–3 Net Worth Terminology Examples
For-profit sole proprietors or partnerships:
Owners’ Equity
For-profit corporations:
Capital Stock
Retained Earnings
Not-for-profit (nonprofit) companies:
Fund Balance
3. If you receive a copy of the balance sheet, is one distributed to you once a month,
once a year, or on some other more irregular basis? What are you supposed to do with
it upon receipt?
4. Do you think the balance sheet report you receive gives you useful information? How
do you think it could be improved?
Discussion Questions 29
31
Revenues (Inflow) 4
C H A P T E R
OVERVIEW
Revenue represents amounts earned by an organization:
that is, actual or expected cash inflows due to the organi-
zation’s major business. In the case of health care, rev-
enue is mostly earned by rendering services to patients.
Revenue flows into the organization and is sometimes re-
ferred to as the revenue stream.
Revenue is generally defined as the value of services
rendered, expressed at the facility’s full established rates.
For example, hospital A’s full established rate for a cer-
tain procedure is $100, but Giant Health Plan has nego-
tiated a managed care contract whereby the plan pays
only $90 for that procedure. The revenue figure—the
full established rate—is $100. Revenues can be received
in the form of cash or credit. Most, but not all, healthcare
revenues are received in the form of credit.
RECEIVING REVENUE FOR SERVICES
One way that revenue is classified is by whether payment
is received before or after the service is delivered. The
amount of revenue received for services is often influ-
enced by this classification.
Payment after Service Is Delivered
The traditional payment method in health care is that of
payment after service is delivered. Two basic types of pay-
ment after service is delivered are discussed in this sec-
tion: fee for service and discounted fee for service. One
evolved from the other.
After completing this chapter,
you should be able to
1. Understand how receiving
revenue for services is a
revenue stream.
2. Recognize contractual
allowances and discounts and
their impact on revenue.
3. Understand the differences in
sources of healthcare revenue.
4. See how to group revenue for
planning and control.
P r o g r e s s N o t e s
1. Fee for service. The truly traditional U.S. method of receiving revenue for services is
fee for service. The provider of services is paid according to the service performed.
Before the 1970s, with a very few exceptions, fee for service was the dominant
method of payment for health services in the United States.1
2. Discounted fee for service. In this variation on the original fee for service, a con-
tracted discount is agreed upon. The organization providing the services then re-
ceives a payment that is discounted in accordance with the contract. Sometimes the
contract contains fee schedules. A large provider of services can have many different
contracts, all with different discounted contractual arrangements. Many variations
are therefore possible.
Payment before Service Is Delivered
Traditional payment methods in the United States have begun to give way to payment be-
fore service is delivered. There are multiple names and definitions for such payment. We
have chosen to use a general descriptive term for payment received before service is deliv-
ered: predetermined per-person payment. The payment method itself and its rate-setting
variations are discussed in this section.
1. Predetermined per-person payment. Payment received before service is delivered is
generally at an agreed-upon predetermined rate. Payment, therefore, consists of the
predetermined rate for each person covered under the agreement. Thus, the
amount received is a per-head or per-person count at a particular point in time.
2. Rate-setting differences. Different agreements can use varying assumptions about the
group to be served, and these variations will affect the rate-setting process. Numerous
variations are therefore possible.
Contractual Allowances and Other Deductions from Revenue
Revenues are recorded at the organization’s full established rates, as previously discussed.
Those amounts estimated to be uncollectible are considered to be deductions from rev-
enues and are recorded as such on the books of the organization. (For purposes of the ex-
ternal financial statements released for third-party use, reported revenue must represent
the amounts that payers [or patients] are obligated to pay. Therefore, the terms gross rev-
enue and deductions from revenue will not be seen on external statements. The discussion
that follows, however, pertains to the books and records that are used for internal manage-
ment, where these classifications will be used.)
Contractual allowances are the difference between the full established rate and the
agreed-upon contractual rate that will be paid. Contractual allowances are often for com-
posite services. Take the case of hospital A as an example. As discussed in the overview to
this chapter, hospital A’s full established rate for a certain procedure is $100, but Giant
Health Plan has negotiated a managed care contract whereby the plan pays only $90 for
that procedure. The $10 difference between the revenue figure ($100) and the contracted
amount that the plan pays ($90) represents the contractual allowance.
32 CHAPTER 4 Revenues (Inflow)
Sources of Healthcare Revenue 33
It is not uncommon for different plans to
pay different contractual rates for the same
service. This practice is illustrated in Table
4-1, which shows contractual rates to be paid
for visit codes 99213 and 99214 for 10 dif-
ferent health plans. Note the variations in
rates.
The second major deduction from rev-
enue classification is an allowance for bad
debts, also known as a provision for doubt-
ful accounts. (Again, for purposes of the ex-
ternal financial statements released for
third-party use, the provision for doubtful
reports must be reported separately as an
expense item. The discussion that follows,
however, still pertains to the books and
records that are used for internal manage-
ment, where the classification of deductions
from revenue will be used.) The allowance
for bad debts is charged with the amount of
services received on credit (recorded as accounts receivable) that are estimated to result in
credit losses.
Beyond contractual allowances and a provision for bad debts, the third major deduction
from revenue classification is charity service. Charity service is generally defined as services
provided to financially indigent patients.
SOURCES OF HEALTHCARE REVENUE
Healthcare revenue in the United States comes from a variety of public programs (govern-
mental sources) and private payers. The sources of healthcare revenue are generally
termed payers. Payer mix—the proportion of revenues realized from the different types of
payers—is a measure that is often included in the profile of a healthcare organization. For
example, “Hospital A has a payer mix that includes 40 percent Medicare and 33 percent
Medicaid” might be part of the profile.
Governmental Sources
The Medicare Program
Title XVIII of the Social Security Act is commonly known as Medicare. Actually entitled
“Health Insurance for the Aged and Disabled,” Medicare legislation established a health in-
surance program for the aged in 1965. The program was intended to complement other
benefits (such as retirement, survivors’, and disability insurance benefits) under other titles
within the Social Security Act.
Table 4–1 Variations in Physician Office Revenue
for Two
Visit Codes
Visit Codes
Payer 99213 99214
FHP $25.35 $35.70
HPHP 42.45 58.85
MC 39.05 54.90
UND 39.90 60.40
CCN 44.00 70.20
MAYO 45.75 70.75
CGN 10.00 10.00
PRU 39.05 54.90
PHCS 45.00 50.00
ANA 38.25 45.00
Rates for illustration only.
34 CHAPTER 4 Revenues (Inflow)
The Medicare program currently has four parts. The first part, known as Part A, is hos-
pital insurance (HI) and is funded primarily by a mandatory payroll tax. The second part,
known as Part B, is called supplementary medical insurance (SMI). SMI is voluntary and is
funded primarily by insurance premiums (usually deducted from monthly Social Security
benefit checks of those enrolled) supplemented by federal general revenue funds. Guide-
lines determine both the services to be covered and the eligibility of the individual to re-
ceive the services under the Medicare program. Medicare claims (billings) are processed
by fiscal agents who act on behalf of the federal government. These fiscal agents include in-
termediaries who process the claims for Part A (HI) institutional services and outpatient
claims for Part B (SMI), carriers who process the claims for Part B (SMI) physician and med-
ical supplier services and Medicare Administrative Contractors (MACs) who process both A
and B claims.
Medicare’s third part, Part C, is known as “Medicare Advantage.” Medicare Advantage
consists of managed care plans, private fee-for-service plans, preferred provider organiza-
tion plans, and specialty plans. Although Medicare Advantage is offered as an alternative to
traditional Medicare, coverage must never be less than what Part A and Part B (traditional
Medicare) would offer the beneficiary.
Medicare’s fourth part, Part D, is the prescription drug benefit, effective as of January 1,
2006. The prescription drug benefit represents expanded coverage. It is a voluntary pro-
gram that requires payment of a separate premium and contains cost-sharing provisions.
The Medicare program covers approximately 95 percent of the U.S. aged population
along with certain eligible individuals receiving Social Security disability benefits.2
Medicare is an important source of healthcare revenue to most healthcare organizations.
The Medicaid Program
Title XIX of the Social Security Act is commonly known as Medicaid. Medicaid legislation
established a federal and state matching entitlement program in 1965. The program was in-
tended to provide medical assistance to eligible needy individuals and families.
The Medicaid program is state specific. The federal government has established broad
national guidelines. Each state has the power to set eligibility, service restrictions, and pay-
ment rates for services within that state. In doing so, each state is bound only by the broad
national guidelines. Medicaid policies are complex, and considerable variation exists
among states. The federal government is responsible for a certain percentage of each
state’s Medicaid expenditures; the specific amount due is calculated by an annual formula.
The state pays the providers of Medicaid services directly. Thus, the source of Medicaid rev-
enue to a healthcare organization is considered to be the state government’s Medicaid pro-
gram representative.
The Medicaid program is the largest U.S. government program providing funds for med-
ical and health-related services for the poor.3 Therefore, although the proportion of Med-
icaid services within the payer mix may vary, Medicaid is a source of healthcare revenue in
almost every healthcare organization.
Other Pro g r a m s
There are numerous other sources of federal, state, and local revenues for healthcare or-
ganizations. Generally speaking, for most organizations, none of the other revenue sources
will exceed the Title XVIII and Title XIX programs just discussed. Other programs include
the Department of Veterans’ Affairs health programs, workers’ compensation programs,
and state-only general assistance programs (versus the federal-and-state jointly funded Med-
icaid program). Still other public programs are school health programs, public health clin-
ics, maternal and child health services, migrant healthcare services, certain mental health
and drug and alcohol services, and special programs such as Indian healthcare services.
Managed Care Sources
In the 1970s, managed care began to appear in healthcare models in the United States. An
all-purpose definition of managed care is: managed care is a means of providing healthcare
services within a network of healthcare providers. The responsibility to manage and pro-
vide high-quality and cost-effective health care is delegated to this defined network of
providers.4 A central concept of managed care is the coordination of all healthcare services
for an individual. In general, managed care plans receive a predetermined amount per
member in premiums.
Types of Plans
The most prevalent type of managed care plan today is the health maintenance organiza-
tion (HMO). Members enroll in the HMO. They prepay a fixed monthly amount; in return,
they receive comprehensive health services. The members must use the providers who are
designated by the HMO; if they go outside the designated providers, they must pay all or a
large part of the cost themselves. The designated providers of services in turn contract with
the HMO to provide services at agreed-upon rates. Several different forms of HMOs have
evolved over time.
The preferred provider organization (PPO) is a type of plan found across the United
States. It consists of a group of providers called a panel. The panel members are an ap-
proved group of various types of providers, including hospitals and physicians. The panel
is limited in size and generally has utilization review powers. If the patients in a PPO use
health providers who are not within the PPO itself, they must pay a higher amount in de-
ductibles and coinsurance.
Types of Contracts
In the case of an HMO, the designated providers of health services contract with the HMO
to provide services at agreed-upon rates. The different types of HMOs—including the staff
model, the group model, the network model, the point-of-service model, and the individual
practice association (IPA) model—have various methods of arriving at these rates. A PPO
contracts with its selected group, who are all participating payers, to buy services for its eli-
gible beneficiaries on the basis of discounted fee for service. A large healthcare facility will
have one or more individuals responsible for managed care contracting.5
Other Revenue Sources
A considerable amount of healthcare revenue is still realized from sources other than Title
XVIII, Title XIX, and managed care:
Sources of Healthcare Revenue 35
36 CHAPTER 4 Revenues (Inflow)
• Commercial insurers. Generally speak-
ing, conventional indemnity insurers,
or commercial insurers, simply pay for
the eligible health services used by
those individuals who pay premiums
for healthcare insurance. They do not
tend to have a say in how those health
services are administered.
• Private pay. This is payment by patients
themselves or by the families of pa-
tients. Private pay is more prevalent in
nursing facilities and in assisted-living
facilities than in hospital settings. Phy-
sicians’ offices also receive a certain
amount of private pay revenue.
• Other. Additional sources of revenue for healthcare facilities include donations re-
ceived by voluntary nonprofit organizations and tax revenues levied by governmental
nonprofit organizations.
Healthcare revenue is often reported to managers by source of the revenue. Table 4-2
presents such a revenue summary. This example covers all types of sources discussed in this
section. Both dollar totals and proportionate percentages by source are reported.
GROUPING REVENUE FOR PLANNING AND CONTROL
Grouping revenue by different classifications is an effective method for managers to use the
information to plan and to control. In the preceding paragraph, we have just seen revenue
reported by source. Other classification examples are now discussed.
Revenue Centers
A revenue center classification is one form of a responsibility center. In a responsibility cen-
ter, the manager is responsible, as the name implies, for a particular set of activities. In the
case of a revenue center, a particular unit of the organization is given responsibility for gen-
erating revenues to meet a certain target. Actually, the responsibility in the healthcare set-
ting is more for generating volume than for generating a specific revenue dollar amount.
(The implication is that the volume will, in turn, generate the dollars.) Revenue centers tend
to occur most often in special programs where volume is critical to survival of the program.
Care Settings
Grouping revenue by care setting recognizes the different sites at which services are deliv-
ered. The most basic grouping by care settings is inpatient versus ambulatory services.
Exhibit 4-1, however, illustrates a six-way classification of care setting revenues within a
health system. In this case, hospital inpatient, hospital outpatient, off-site clinic, skilled
Table 4–2 Sample Monthly Statement of Revenue
by Source
Summary Year to Date %
Private revenue $100,000 2.9
HMO revenue 560,000 16.7
Medicare revenue 1,420,000 42.4
Medicaid revenue 820,000 24.5
Commercial revenue 400,000 12.0
Other revenue 50,000 1.5
Total $3,350,000 100.0%
Grouping Revenue for Planning and Control 37
nursing facility, home health agency, and hospice are all accounted for. A percentage is
shown for each. This type of classification is useful for a brochure or a report that profiles
the different types of healthcare services offered by the organization.
Service Lines
In traditional cost accounting circles, a product line is a grouping of similar products.6 In
the healthcare field, many organizations opt instead for “service line” terminology. A ser-
vice line is a grouping of similar services. Strategic planning sometimes sets out service lines.
Hospitals
A number of hospitals have adopted the major diagnostic categories (MDCs) as service
lines. One advantage of MDCs is that they are a universal designation in the United States.
MDCs also have the advantage of possessing
a standard definition. In another approach
to service line classification, a hospital re-
cently updated its strategic plan and settled
on five service lines: (1) medical, (2) surgi-
cal, (3) women and children, (4) mental
health, and (5) rehabilitation (neuro ortho
rehab) (see Figure 4-1).7
L o n g – Term Care
A continuing care retirement community
(CCRC) can use its various levels of care as a
starting point. Thus, the CCRC usually has
four service lines, listed in the descending
order of resident acuity: (1) skilled nursing
facility, (2) nursing facility, (3) assisted liv-
ing, and (4) independent living. The skilled
nursing facility provides services for the
highest level of resident acuity, and the in-
dependent living provides services for the
Exhibit 4–1 Revenues by Care Setting
42% 38% 4%
Hospital Hospital Off-Site
Inpatient Outpatient Clinic
8% 6% 2%
Skilled Home Hospice
Nursing Health
Facility Agency
Women
&
Children
Mental Health
Medical
Surgical
Rehabilitation
Figure 4–1 Hospital Service Lines.
Source: Courtesy of Resource Group, Ltd., Dallas, Texas.
38 CHAPTER 4 Revenues (Inflow)
lowest level of resident acuity. One adjustment to this approach includes isolating subacute
services from the remainder of skilled nursing facility services. Another adjustment involves
splitting independent living into two categories, one for Housing and Urban Development
(HUD)–subsidized independent housing and the other for private-pay independent hous-
ing. Figure 4-2 illustrates CCRC service lines by acuity level.
Home Care
Numerous categories of service delivery can be considered as “home care.” A practical ap-
proach was taken by one home care entity—part of a health system—that defined its “key
functions.” Key functions can in turn be converted to service lines (Figure 4-3).
Skilled
Nursing
Facility
Nursing
Facility
Assisted
Living
Independent
Living
Nonsubsidized
Subsidized
Balance of SNF
Subacute
Figure 4–2 Long-Term Care Service Lines.
Source: Courtesy of Resource Group, Ltd., Dallas, Texas.
Infusion Therapy
Mental Health
Pulmonary
Maternity Services
Wound Care
Diabetes Education
Special Services Home CareStandard Home Care
Figure 4–3 Home Care Service Lines.
Source: Courtesy of Resource Group, Ltd., Dallas, Texas.
Physician Gro u p s
Service delivery for physician groups will
vary, of course, with the nature of the group
itself. A generic set of service lines is pre-
sented in Figure 4-4.
Other Designations
Other classifications may meet the needs of
particular organizations. Columbia/HCA is
now reported to classify its services in a dis-
ease management approach. The classifica-
tion consists of eight disease management
areas: (1) cancer, (2) cardiology, (3) dia-
betes, (4) behavioral health, (5) workers’
compensation, (6) women’s services, (7) se-
nior care, and (8) emergency services.8 Whatever classification is chosen, it must be consis-
tent with the current structure of the organization.
INFORMATION CHECKPOINT
What Is Needed? A report that shows revenue in your organization.
Where Is It Found? With your supervisor.
How Is It Used? Examine the report to find various revenue sources; look
for how the contractual allowances and discounts are
handled on the report.
What Is Needed? A report that groups revenue by some type of classification.
Where Is It Found? With your supervisor, or in the information services divi-
sion.
How Is It Used? Examine the report to discover the methods that are used
for grouping. You will probably find that these group-
ings are used for performance measures. They can also
be used for control and planning.
KEY TERMS
Discounted Fee for Service
Fee for Service
Managed Care
Medicaid Program
Medicare Program
Payer Mix
Revenue
Key Terms 39
Office Visits
Surgical
Procedures
Emergency
Medicine
Laboratory
Radiology
Figure 4–4 Physicians Group Service Lines.
Source: Courtesy of Resource Group, Ltd., Dallas, Texas.
40 CHAPTER 4 Revenues (Inflow)
DISCUSSION QUESTIONS
1. Does your organization receive revenue mainly in the form of payment after service
is delivered or payment before service is delivered?
2. Why do you think this is so?
3. What do you believe the proportion of revenues from different sources is for your or-
ganization?
4. Do you believe that this proportion (payer mix) will change in the future? Why?
5. What grouping of revenue do you believe your organization uses (revenue centers,
care settings, service lines, other)?
6. From your perspective, would there be a better grouping possible? If so, why do you
think it is not used?
41
Expenses
(Outflow) 5
C H A P T E R
OVERVIEW
Expenses are the costs that relate to the earning of rev-
enue. Another way to think of expenses is as the costs of
doing business. Just as revenues represent the inflow into
the organization, so do expenses represent the outflow—
a stream of expenditures flowing out of the organization.
Examples of expenses include salary expense for labor
performed, payroll tax expense for taxes paid on the
salary, utility expense for electricity, and interest expense
for the use of money.
In actual fact, expenses are expired costs—costs that
have been used up, or consumed, while carrying on
business. Revenues and expenses affect the equity of the
business. The inflow of revenues increases equity,
whereas the outflow of expenses decreases equity. In
nonprofit organizations, the term is fund balance rather
than equity. This is because a nonprofit organization, by
its nature, is not in business to make a profit. Thus, it
should not have equity. However, the principle of inflow
and outflow remains the same. In the case of nonprofits,
the inflow of revenues increases fund balance, and the
outflow of expenses decreases fund balance.
Many managers use the terms expense and cost inter-
changeably. Expense in its broadest sense includes every
expired (used up) cost that is deductible from revenue.
A narrower interpretation groups expenses into cate-
gories such as operating expenses, administrative ex-
penses, and so on. Cost is the amount of cash expended
(or property transferred, services performed, or liability
incurred) in consideration of goods or services received
or to be received. As we have already said, costs can be
After completing this chapter,
you should be able to
1. Understand the distinction
between expense and cost.
2. Understand how
disbursements for services
represent an expense stream
(an outflow).
3. Follow how expenses are
grouped in different ways for
planning and control.
4. Recognize why cost reports
have influenced expense
formats.
P r o g r e s s N o t e s
either expired or unexpired. Expired costs are used up in the current period and are thus
matched against current revenues. Unexpired costs are not yet used up and will be matched
against future revenues.1
For example, an electric bill for $500 is recorded in the books of the clinic as an expense.
The administrator sees the $500 as the cost of electricity for that month in the clinic. And
the administrator is actually correct in seeing the $500 as a cost because it has been used up
(expired) within the month.
Confusion also exists in healthcare reporting over the term cost versus charges. Charges
are revenue, or inflow. Costs are expenses, or outflow. Charges add; costs take away. Because
the two are inherently different, they should never be intermingled.
DISBURSEMENTS FOR SERVICES
There are two types of disbursements for services:
1. Payment when expense is incurred. If an expense is paid for at the point where it is in-
curred, it does not enter the accounts payable account. In large organizations, it is
relatively rare to see payments when expenses are incurred. The only place where this
usually occurs is the petty cash fund.
2. Payment after expense is incurred. In most healthcare organizations, expenses are
paid at a later time and not at the point when the expense is incurred. If this is the
case, the expense is recorded in the accounts payable account. It is cleared from ac-
counts payable when payment is made. One measurement of operations is “days in
accounts payable,” whereby the operating expenses for the organization are reduced
to a rate per day and compared with the amount in accounts payable.
GROUPING EXPENSES FOR PLANNING AND CONTROL
Cost Centers
A cost center is one form of a responsibility center. In a responsibility center, the manager
is responsible, as the name implies, for a particular set of activities. In the case of a cost cen-
ter, a particular unit of the organization is given responsibility for controlling costs of the
operations over which it holds authority. The medical records division is an example of a
cost center. The billing and collection office might be another example. A cost center
might be a division, an office, or an entire department, depending on how the organization
is structured.
In healthcare organizations, it is common to find departments as cost centers. This is
often a logical way to designate a cost center because the lines of authority are generally or-
ganized by department. Cost centers can then be grouped into larger groups that have
something in common. Within this method of grouping, the manager of a cost center may
receive his or her own reports and figures, but not those of the entire group. The director
or officer that is in charge of all of those particular departments receives the larger report
that contains multiple cost centers. The chief executive officer receives a total report be-
cause he or she is ultimately responsible for overseeing the operations of all of the cost cen-
42 CHAPTER 5 Expenses (Outflow)
Grouping Expenses for Planning and Control 43
ters involved in that segment of the organi-
zation.
Exhibit 5-1 illustrates this concept. It con-
tains 20 different cost centers, all of which
are revenue producing. The 20 cost centers
are divided into two groups: nursing ser-
vices and other professional services. There
are five cost centers in the nursing services
group, ranging from operating room to
obstetrics–nursery. There are 15 cost centers
in the other professional services group. In
the hospital that uses the grouping shown
in Exhibit 5-1, however, not all of the 20 cost
centers are departments. Some are divisions
within departments. For example, EKG and
EEG operate out of the same department
but are two separate cost centers.
Exhibit 5-2 shows 11 different cost cen-
ters that are not directly revenue producing.
(The dietary department yields some cafe-
teria revenue, but that revenue is not
central to the major business of the organi-
zation, which is to provide healthcare ser-
vices.) The 11 cost centers are divided into
two groups: general services and support
services. The six cost centers in the general
services group happen to all be depart-
ments in this hospital. (Other hospitals
might not have security as a separate de-
partment. The other cost centers—dietary,
maintenance, laundry, housekeeping, and
medical records—would be separate de-
partments.) The five cost centers in the sup-
port services group include one “general” cost center that contains administrative costs; the
remaining four are related to employee salaries and wages. These four are insurance, So-
cial Security taxes, employee welfare, and pension cost centers, all of which will probably be
in the same department. It is the prerogative of management to set up cost centers specific
to the organization’s own needs and preferences. It is the responsibility of management to
make the cost centers match the proper lines of authority.
Exhibit 5-2 illustrates two categories of healthcare expense: general services and support. A
third related category is operations expense. An operations expense provides service directly
related to patient care. Examples are radiology expense and drug expense. A general services
expense provides services necessary to maintain the patient, but the service is not directly re-
lated to patient care. Examples are laundry and dietary. Support services expenses, on the other
hand, provide support to both general services expenses and operations expenses. A support
Exhibit 5–1 Nursing Services and Other Pro-
fessional Services Cost Centers
Nursing Services Cost Center
Nursing Services
Routine Medical-Surgical $390,000
Operating Room 30,000
Intensive Care Units 40,000
OB-Nursery 15,000
Other 35,000
Total $510,000
Other Professional Services
Cost Center
Other Professional Services
Laboratory $220,000
Radiology 139,000
CT Scanner 18,000
Pharmacy 128,000
Emergency Service 89,000
Medical and Surgical Supply 168,000
Operating Rooms and
Anesthesia 142,000
Respiratory Therapy 48,000
Physical Therapy 64,000
EKG 16,000
EEG 1,000
Ambulance Service 7,000
Substance Abuse 43,000
Home Health and Hospice 120,000
Other 12,000
Total $1,215,000
44 CHAPTER 5 Expenses (Outflow)
service expense is necessary for support, but it
is neither directly related to patient care nor is
it a service necessary to maintain the patient.
Examples of support services are insurance
and payroll taxes.
Diagnoses and Procedures
It is common to group expenses by diagnoses
and procedures for purposes of planning
and control. This grouping is beneficial be-
cause it matches costs against common classi-
fications of revenues. Much of the revenue in
many healthcare organizations is designated
by either diagnoses or procedures. One
prevalent method groups costs into cost cen-
ters by major diagnostic categories (MDCs).
The 23 MDCs serve as the basic classification
system for diagnosis-related groups (DRGs).
(Each DRG represents a category of patients.
This category contains patients whose re-
source consumption, on statistical average, is
equivalent. DRGs are part of the prospective
payment reimbursement methodology.) Exhibit 5-3 provides a listing of the 23 MDCs.2
How does the hospital use the MDC grouping? Exhibit 5-4 shows a departmental and
cost center grouping in actual use. This hospital uses 27 cost center codes: the 23 MDCs
plus four other codes (“Special Drugs,” “HIV,” “Unassigned,” and “Outpatient”). The spe-
cial drugs and HIV cost centers represent high-cost elements that management wants to
track separately. Unassigned is a default category and should have little assigned to it. Out-
patient is a separate cost center at the preference of management.
Exhibit 5-5 illustrates the grouping of costs for MDC 18 (Infectious Diseases). The hos-
pital’s departmental code is 18, per Exhibit 5-4. The DRG classification, ranging from 415
to 423, appears in the next column. The description of the particular DRG appears in the
third column, and the related cost appears in the fourth and final column. These costs can
now be readily matched to equivalent revenues.
Outpatient services in particular are generally designated by procedure codes. Procedure
codes, known as Current Procedural Terminology (CPT) codes, are commonly used to group
cost centers for outpatient services. (CPT codes represent a listing of descriptive terms and
identifying codes for identifying medical services and procedures performed.) However, pro-
cedures can—and are—also used for purposes of grouping inpatient costs, generally within a
certain cost center. A hospital example of reporting radiology department costs by procedure
code appears in Table 5-1. In this example, the procedure code is in the left column, the de-
scription of the procedure is in the middle column, and the departmental cost for the partic-
ular procedure appears in the right column. These costs can now be readily matched to
equivalent revenue.
Exhibit 5–2 General Ser vices and Support
Services Cost Centers
General Services Cost Center
General Services
Dietary $97,000
Maintenance 92,000
Laundry 27,000
Housekeeping 43,000
Security 5,000
Medical Records 30,000
Total $294,000
Support Services Cost Center
Support Services
General $455,000
Insurance 24,000
Social Security Taxes 112,000
Employee Welfare 188,000
Pension 43,000
Total $822,000
Care Settings and Service Lines
Expenses can be grouped by care setting,
which recognizes the different sites at which
services are delivered. “Inpatient” versus “out-
patient” is a basic type of care setting group-
ing. Or expenses can be classified by service
lines, a method that groups similar services.3
If revenues are grouped by care setting or
by service line, as discussed in the previous
chapter, then expenses should also be
grouped by these categories. In that way,
Grouping Expenses for Planning and Control 45
Exhibit 5–3 Major Diagnostic Categories
MDC1 Diseases and Disorders of the
Nervous System
MDC 2 Eye
MDC 3 Ear, Nose, Mouth, and Throat
MDC 4 Respiratory System
MDC 5 Circulatory System
MDC 6 Digestive System
MDC 7 Hepatobiliary System and
Pancreas
MDC 8 Musculoskeletal System and
Connective Tissue
MDC 9 Skin, Subcutaneous Tissue,
and Breast
MDC 10 Endocrine, Nutritional, and
Metabolic
MDC 11 Kidney and Urinary Tract
MDC 12 Male Reproductive System
MDC 13 Female Reproductive System
MDC 14 Pregnancy, Childbirth, and
the Puerperium
MDC 15 Newborns and Other
Neonates with Conditions
Originating in the
Perinatal Period
MDC 16 Blood and Blood-Forming
Organs and
Immunological Disorders
MDC 17 Myeloproliferative and Poorly
and Differentiated
Neoplasms
MDC 18 Infections and Parasitic
Diseases (Systemic or
Unspecified Sites)
MDC 19 Mental Diseases and Disorders
MDC 20 Alcohol/Drug Use and
Alcohol/Drug-Induced
Organic Mental Disorders
MDC 21 Injuries, Poisoning, and Toxic
Effect of Drugs
MDC 22 Burns
MDC 23 Factors Influencing Health
Status and Other Contacts
with Health Services
Exhibit 5–4 Hospital Departmental Code List
Based on Major Diagnostic Categories
1 Nervous System
2 Eye
3 Ear, Nose, Mouth, and Throat
4 Respiratory System
5 Circulatory System
6 Digestive System
7 Hepatobiliary System
8 Musculoskeletal System and
Connective Tissue
9 Skin, Subcutaneous Tissue, and Breast
10 Endocrine, Nutritional, and
Metabolic
11 Kidney and Urinary Tract
12 Male Reproductive System
13 Female Reproductive System
14 Obstetrics
15 Newborns
16 Immunology
17 Oncology
18 Infectious Diseases
19 Mental Diseases
20 Substance Use
21 Injury, Poison, and Toxin
22 Burns
23 Other Health Services
24 Special Drugs
25 HIV
26 Unassigned
59 Outpatient
46 CHAPTER 5 Expenses (Outflow)
matching of revenues and expenses can
readily occur. A more detailed discussion of
care settings and service lines, with examples,
was presented in the preceding chapter.
Programs
A program can be defined as a project that
has its own objectives and its own program in-
dicators. Within management’s functions of
planning, controlling, and decision making,
the program must stand on its own. A pro-
gram is often funded separately and for finite
periods of time. For example, funds from a
grant might fund a specific project for—as an
example—three years. Often programs—especially those funded separately from the revenue
stream of the main organization—have to arrange their expenses in a special format that is
specified by the entity that provides the grant funds.
Program expenses should be grouped in such a way that they are distinguishable. Also, if
such programs have been specially funded, the reporting of their expenses should not be
commingled. An example of a program cost center is given in Exhibit 5-6. This cost center
example has received special funds and must be reported separately, as shown.
COST REPORTS AS INFLUENCERS OF EXPENSE FORMATS
Cost reports are required by both the Medicare program (Title XVIII) and the Medicaid
program (Title XIX). Ever y provider participating in the program is required to file
an annual cost report. An array of providers who must file cost reports is illustrated in
Table 5-2. The arrangement of expense headings on the cost reports has been consistent
since the advent of such reports in 1966. Therefore, this standard and traditional
arrangement has strongly influenced the arrangement of expenses in many healthcare
information systems.
Exhibit 5–5 Example of Hospital Departmental Costs Classified by Diagnoses, MDC, and DRG
Hospital Departmental Code DRG Description Cost
18 INFECTIOUS DISEASES 415 O/R—INFECT/PARASITIC DIS $4,000
18 INFECTIOUS DISEASES 416 SEPTICEMIA)17 10,000
18 INFECTIOUS DISEASES 417 SEPTICEMIA 0–17 20,000
18 INFECTIOUS DISEASES 418 POSTOP/POSTTRAUMA INFECT 2,000
18 INFECTIOUS DISEASES 419 FEVER—UKN ORIG) 17W/C 3,000
18 INFECTIOUS DISEASES 420 FEVER—UKN ORIG) 17W/OC 6,000
18 INFECTIOUS DISEASES 421 VIRAL ILLNESS)17 4,000
18 INFECTIOUS DISEASES 422 VIR ILL/FEVER UNK 0–17 1,000
18 INFECTIOUS DISEASES 423 OT/INFECT/PARASITIC DX 3,000
Table 5–1 Example of Radiology Department
Costs Classified by Procedure Code
Procedure Procedure Department
Code Description Cost
557210 Ribs, Unilateral $ 60,000
557230 Spine Cervical Routine 125,000
557280 Pelvis 33,000
557320 Limb—Shoulder 55,000
557360 Limb—Wrist 69,000
557400 Limb—Hip, Unilateral 42,000
557410 Limb—Hip, Bilateral 14,000
557430 Limb—Knee Only 62,000
Total $460,000
Cost Reports as Influencers of Expense Formats 47
The cost report uses a method of cost
finding. Its focus is what is called a cost
center. The concept is not the same as the
type of responsibility center “cost center”
that has been discussed earlier in this chap-
ter. Instead, the cost-finding “cost center”
is, broadly speaking, a type of cost pool
used in the cost-finding process. The pri-
mar y purpose of the cost pool/cost center
in cost finding is to assist in allocating
overhead.
The central worksheets for cost finding
are Worksheet A, Worksheet B, and Work-
sheet B-1. Worksheet A contains the basic
trial balance of all expenses for the facility.
(Trial balances are discussed in a preceding
chapter.) The beginning trial balance is re-
flected in the first three columns:
[Column 1] [Column 2] [Column 3]
“Salaries” � “Other” � “Total”
(all other expenses)
The trial balance is grouped at the outset into cost center categories. The placement of
these categories and their respective line items on the page stay constant throughout the
flow of Worksheets A, B, and B-1. The cost centers are grouped into seven categories:
1. General service
2. Inpatient routine service
3. Ancillary service
4. Outpatient service
5. Other reimbursable
6. Special purpose
7. Nonreimbursable
Exhibit 5–6 Program Cost Center: Southside
Homeless Intake Center
Program: Southside Homeless
Intake Center
Department: Feeding Ministry
For the Month of: January 2000
Raw Food $14,050
Dietary Supplies 200
Paper Supplies 300
Minor Equipment 50
Consultant Dietician 50
Utilities 300
Telephone 50
Program Total $15,000
Table 5–2 Selected Cost Report Forms
Type Form
Hospital complex HCFA 2552
(includes all hospital-based facilities)
Skilled nursing facility HCFA 2540
Home health agencies HCFA 1728
Comprehensive outpatient rehabilitation facilities HCFA 2088
48 CHAPTER 5 Expenses (Outflow)
The line items within these seven categories represent the long-lived traditional arrange-
ment that has strongly influenced the arrangement of expenses in so many healthcare in-
formation systems.
INFORMATION CHECKPOINT
What Is Needed? A report that shows expense in your organization.
Where Is It Found? With your supervisor.
How Is It Used? Examine the report to find various types of expenses; look
for how the expense flow is handled on the report.
What Is Needed? A report that groups expenses by some type of classification.
Where Is It Found? With your supervisor or in the information services division.
How Is It Used? Examine the report to discover the methods that are used
for grouping. You will probably find that these group-
ings are used for performance measures. They can also
be used for control and planning.
KEY TERMS
Cost
Diagnoses
Expenses
Expired Costs
General Services Expenses
Support Services Expenses
Operations Expenses
Procedures
Unexpired Costs
DISCUSSION QUESTIONS
1. Have you worked with cost centers in your duties? If so, how have you been exposed
to them?
2. Have you had to manage from a cost center type of report? If so, how was it
categorized?
3. Do you believe that grouping expenses by diagnoses and procedures (based on type
of services provided) is better to use for control and planning than grouping ex-
penses by care setting (based on location of service provided)?
4. If so, why?
5. What grouping of expenses do you believe your organization uses (traditional cost
centers, diagnoses/procedures, care settings, other)?
6. From your perspective, would there be a better grouping possible? If so, why do you
think it is not used?
>PART I
0 Health Care Finance
92 is $ 4. The physician bills the insurance company $72 for the patient visit. The physician has a contract where it was agreed that the health plan would pay $4 for a patient visit. Therefore, the contractual allowance is the difference between the established rate of $84 and the agreed-upon amount of $45.
new patient physicals, one for each payer, and will bill each of the health plans the established rate of $174 for procedure code 982 5. The contracted rate is listed in . You must find the contractural allowance for each health plan and place the result in .
Column B Column C Contractual Allowance 0.00
2.95
0.45
5.90
2.00
.00
Medicare Medicaid s by Cost Center
12
HCA/2
7
PART I –
Contractual Allowance
Background: Each health plan negotiates specific contracts with the physician or hospital. Each procedure code has an established rate and a contracted rate. Let’s say that the established rate for the code
9
1
4
8
5
Directions: Contractual allowances represent the difference between the full established procedure rate and the rate that will be paid to the physician practice based upon the agreed-upon contractural rate. For Part I of this assignment, assume that each payer listed below have negotiated a Managed Care contract with the physician. The physician has performed
10
3
Column B
Column C
New Patient Physical Exam Code is 99385 . Established rate of $174.
Column A
Health Plan Payer
Contracted Rate
There are three parts to this assignment. Each part is located under a different tab in this document. To move onto Part II, click on the Part II tab at the bottom left of the screen. If you do not see the Part II and Part III tabs, open the spreadsheet fully by clicking the double squares in the upper right corner.
HAP
$
11
Tricare
$98.00
HPM
$
14
Medicaid
$
6
Medicare
$70.20
BCN PPO
$
13
BCBS
$
15
Humana
$1
12
CCN
$74.35
Priority Health
$128.25
PART II
HCA270 Health Care Finance
PART II – Grouping Revenue by Payer Source
Background: The Metropolis Health System (MHS) has revenue sources from operations, donations, and interest income. The revenue from operations is primarily received for services. MHS groups its revenue first by cost center. Within each cost center, the service revenue is then grouped by payer.
Directions: For each situation, enter an X in the column that represents the correct revenue sources for the item. The ten situations are as follows: (1) Insured patient had in vitro fertilization performed. Services not covered under patient’s insurance.
(2) Patient admitted to emergency room via the county jail. The emergency room visit was billed to the jail.
(3) Pathology tests performed and billed to employee’s insurance program.
(4) Emergency room visits and subsquent admission billed to member’s preferred plan organization plan.
(5) An intensive care unit stay was billed to a county health plan.
(6) Series of allergy tests run for eligible Medicaid beneficiary.
(7) Outpatient surgery performed and billed to Tricare Prime.
(8) Infant labor and delivery billed to Blue Cross Blue Shield.
(9) Mammogram performed and billed to Medicare beneficiary.
(10) Emergency visit for patient without insurance.
#
Other Public Programs
Patients
Commercial Insurance
Managed Care Contracts
1
2
3
4
5
6
7
8
9
10
PART III
Appendix C – HCA/270 Health Care Finance
PART III – Grouping
Expense
Background: Cost centers are used in an organization to group expenses. For example, the patient registration department would be a cost center. All costs associated with operating the patient registration department would be grouped into this cost center. Items such as paper, copier rental, education and training for new employees, and computers used by the registration employees would be allocated to this cost center.
Directions: The Ascension Health System’s rehabilitation center offers outpatient physical therapy, occupational health services, plus cardiac and pulmonary rehabilitation to get people back to a normal way of living. Place an X for each expense in the box that corresponds with the appropriate cost center. The rehabilitation center expenses include the following:
(1) Physical therapist salaries
(2) Customer service call center
(3) Electrocardiography machine for evaluating cardiac patients
(4) Nurse manager salary
(5) New exercise mats used for physical therapy
(6) TV commercials and billboards
(7) Walkers, canes, transfer bars, barbells, and Weights
(8) Office supplies
(9) Employee attended health care seminars
(10) Pulmonary function test machine
(11) Patient education pamphlets and videos
(12) Pots and pans, large utensils, reachers, and other help aids
(13) New employee orientation
(14) Occupational therapists’ salaries
(15) Copier maintenance Expense
Cost Centers
Professional Services: RN, therapy
Cardiac/ Pulmonary Rehab
Therapy Rehab
Marketing
Administrative
Training
2
3
4
5
6
7
8
9
10 11
12
13
14
15
