300 words due today

150 words

Consult Ch. 1, 2, and the glossary of
Health Care Finance for concepts, definitions, and real world examples. List at least five concepts, their definitions, and real-world examples as explained or provided in the text.

150 words

Polynomials – Explain three rules for exponents listed in your text. Create an expression for your classmates to solve that uses scientific notation and/or at least one of the rules for exponents you have described.

P A R T

Healthcar

Finan

O v e r v i e w

Introduction to
Healthcare Finance 1

C H A P T E R

THE HISTORY

Financial management has a long and distinguished his-
tory

Consider, for example, that Socrates wrote abou

the universal function of management in human en-
deavors in 400 B.C. and that Plato developed the concept
of specialization for efficiency in 350 B.C. Evidence of so-
phisticated financial management exists for much earlier
times: the Chinese produced a planning and control sys-
tem in 1100 B.C., a minimum-wage system was developed
by Hammurabi in 1800 B.C., and the Egyptians and
Sumerians developed planning and record-keeping sys-
tems in 4000 B.C.1

Many managers in early history discovered and redis-
covered managerial principles while attempting to rea

their goals. Because the idea of management thought a

a discipline had not yet evolved, they formulated princi-
ples of management because certain goals had to be ac-
complished. As management thought became codified
over time, however, the building of techniques for man-
agement became more organized. Management as a dis-
cipline for educational purposes began in the United
States in 1881. In that year, Joseph Wharton created the
Wharton School, offering college courses in business
management at the University of Pennsylvania. It was the
only such school until 1898, when the Universities of
Chicago and California established their business
schools. Thirteen years later, in 1911, 30 such schools
were in operation in the United States.2

Over the long span of history, managers have al

sought how to make organizations work more effectively.
Financial management is a vital part of organizational

After completing this chapter,
you should be able to

1. Discuss the three viewpoints of
managers in organizations.

2. Identify the four elements of
financial management.

3. Understand the differences
between the two types of
accounting.

4. Identify the types of
organizations.

5. Understand the compositio

and purpose of an organization
chart.

P r o g r e s s N o t e s

effectiveness. This book’s goal is to provide the keys to unlock the secrets of financial man-
agement for nonfinancial managers.

THE CONCEPT

A Method of Getting Money in and out of the Business

One of our colleagues, a nurse, talks about the area of healthcare finance as “a method of
getting money in and out of the business.” It is not a bad description. As we shall see, rev-
enues represent inflow and expenses represent outflow. Thus, “getting money in” repre-
sents the inflow (revenues), whereas “getting money out” (expenses) represents the
outflow. The successful manager, through planning, organizing, controlling, and decision
making, is able to adjust the inflow and outflow to achieve the most beneficial outcome for
the organization.

HOW DOES FINANCE WORK IN THE HEALTHCARE BUSINESS?

The purpose of this book is to show how the various elements of finance fit together: in
other words, how finance works in the healthcare business. The real key to understanding
finance is understanding the various pieces and their relationship to each other. If you, the
manager, truly see how the elements work, then they are yours. They become your tools to
achieve management success.

The healthcare industry is a service industry. It is not in the business of manufacturing,
say, widgets. Instead, its essential business is the delivery of healthcare services. It may have
inventories of medical supplies and drugs, but those inventories are necessary to service de-
livery, not to manufacturing functions. Because the business of health care is service, the
explanations and illustrations within this book focus on the practice of financial manage-
ment in the service industries.

VIEWPOINTS

The managers within a healthcare organization will generally have one of three views: (1) fi-
nancial, (2) process, or (3) clinical. The way they manage will be influenced by which view
they hold.

1. The financial view. These managers generally work with finance on a daily basis. The
reporting function is part of their responsibility. They usually perform much of the
strategic planning for the organization.

2. The process view. These managers generally work with the system of the organization.
They may be responsible for data accumulation. They are often affiliated with the in-
formation system hierarchy in the organization.

3. The clinical view. These managers generally are responsible for service delivery. They
have direct interaction with the patients and are responsible for clinical outcomes of
the organization.

4 CHAPTER 1 Introduction to Healthcare Finance

The Elements of Financial Management 5

Managers must, of necessity, interact with
one another. Thus, managers holding differ-
ent views will be required to work together.
Their concerns will intersect to some degree,
as illustrated by Figure 1-1. The nonfinancial
manager who understands healthcare fi-
nance will be able to interpret and negotiate
successfully such interactions between and
among viewpoints.

In summary, financial management is a
discipline with a long and respected history.
Healthcare service delivery is a business,
and the concept of financial management
assists in balancing the inflows and outflows
that are a part of the business.

WHY MANAGE?

Business does not run itself. It requires a variety of management activities in order to oper-
ate properly.

THE ELEMENTS OF FINANCIAL MANAGEMENT

There are four recognized elements of financial management: (1) planning, (2) control-
ling, (3) organizing and directing, and (4) decision making. The four divisions are based
on the purpose of each task. Some authorities stress only three elements (planning, con-
trolling, and decision making) and consider organizing and directing as a part of the con-
trolling element. This text recognizes organizing and directing as a separate element of
financial management, primarily because such a large proportion of a manager’s time is
taken up with performing these duties.

1. Planning. The financial manager identifies the steps that must be taken to accom-
plish the organization’s objectives. Thus, the purpose is to identify objectives and
then to identify the steps required for accomplishing these objectives.

2. Controlling. The financial manager makes sure that each area of the organization is
following the plans that have been established. One way to do this is to study current
reports and compare them with reports from earlier periods. This comparison often
shows where the organization may need attention because that area is not effective.
The reports that the manager uses for this purpose are often called feedback. The
purpose of controlling is to ensure that plans are being followed.

3. Organizing and directing. When organizing, the financial manager decides how to
use the resources of the organization to most effectively carry out the plans that have
been established. When directing, the manager works on a day-to-day basis to keep
the results of the organizing running efficiently. The purpose is to ensure effective re-
source use and provide daily supervision.

Financial

Clinical

Process

Figure 1–1 3 Views of Mgmt within an Organization.

6 CHAPTER 1 Introduction to Healthcare Finance

4. Decision making. The financial manager makes choices among available alternatives.
Decision making actually occurs parallel to planning, organizing, and controlling. All
types of decision making rely on information, and the primary tasks are analysis and
evaluation. Thus, the purpose is to make informed choices.

THE ORGANIZATION’S STRUCTURE

The structure of an organization is an important factor in management.

Organization Types

Organizations fall into one of two basic types: profit oriented or nonprofit oriented. In the
United States, these designations follow the taxable status of the organizations. The profit-
oriented entities, also known as proprietary organizations, are responsible for paying in-
come taxes. Proprietary subgroups include individuals, partnerships, and corporations.
The nonprofit organizations do not pay income taxes.

There are two subgroups of nonprofit entities: voluntary and government. Voluntary
nonprofits have sought tax-exempt status. In general, voluntary nonprofits are associated
with churches, private schools, or foundations. Government nonprofits, on the other hand,
do not pay taxes because they are government entities. Government nonprofits can be
(1) federal, (2) state, (3) county, (4) city, (5) a combination of city and county, (6) a hos-

pital taxing district (with the power to raise
revenues through taxes), or (7) a state uni-
versity (perhaps with a teaching hospital
affiliated with the university). The organiza-
tion’s type may affect its structure. Exhibit
1-1 summarizes the subgroups of both pro-
prietary and nonprofit organizations.

Organization Charts

In a small organization, top management
will be able to see what is happening. Exten-
sive measures and indicators are not neces-
sary because management can view overall
operations. But in a large organization, top
management must use the management
control system to understand what is going
on. In other words, to view operations, man-
agement must use measures and indicators
because he or she cannot get a firsthand
overall picture of the total organization.

As a rule of thumb, an informal manage-
ment control system is acceptable only if the

Exhibit 1–1 Types of Organizations

Profit Oriented—Proprietary
Individual
Partnership
Corporation
Other

Nonprofit—Voluntary
Church Associated
Private School Associated
Foundation Associated
Other

Nonprofit—Government
Federal
State
County
City
City-County
Hospital District
State University
Other

manager can stay in close contact with all aspects of the operation. Otherwise, a formal sys-
tem is required. In the context of health care, therefore, a one-physician practice (Figure
1-2) could use an informal method, but a hospital system (Figure 1-3) must use a formal
method of management control.

The structure of the organization will affect its financial management. Organization
charts are often used to illustrate the structure of the organization. Each box on an orga-
nization chart represents a particular area of management responsibility. The lines between
the boxes are lines of authority.

In the health system organization chart illustrated in Figure 1-3, the president/chief ex-
ecutive officer oversees seven senior vice presidents. Each senior vice president has vice
presidents reporting to him or her in each particular area of responsibility designated on
the chart. These vice presidents, in turn, have an array of other managers reporting to them
at varying levels of managerial responsibility.

The organization chart also shows the degree of decentralization within the organiza-
tion. Decentralization indicates the delegating of authority for decision making. The chart
thus illustrates the pattern of how managers are allowed—or required—to make key deci-
sions within the particular organization.

The purpose of an organization chart, then, is to indicate how responsibility is assigned
to managers and to indicate the formal lines of communication and reporting.

TWO TYPES OF ACCOUNTING

Financial

Financial accounting is generally for outside, or third party, use. Thus, financial accounting
emphasizes external reporting. External reporting to third parties in health care includes,
for example, government entities (Medicare, Medicaid, and other government programs)
and health plan payers. In addition, proprietary organizations may have to report to stock-
holders, taxing district hospitals have to report to taxpayers, and so on.

Two Types of Accounting 7

Reception
Scheduling

Billing
Accounting

Front
Office

Physician’s
Assistant

Registered
Nurse

Clinical
Services

Physician

Figure 1–2 Physicians Office Organization Chart.
Source: Courtesy of Resource Group, Ltd., Dallas, Texas.

8 CHAPTER 1 Introduction to Healthcare Finance
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Key Terms 9

Financial reporting for external purposes must be in accordance with generally accepted
accounting principles. Financial reporting is usually concerned with transactions that have
already occurred: that is, it is retrospective.

Managerial

Managerial accounting is generally for inside, or internal, use. Managerial accounting, as
its title implies, is used by managers. The planning and control of operations and related
performance measures are common day-by-day uses of managerial accounting. Likewise,
the reporting of profitability of services and the pricing of services are other common on-
going uses of managerial accounting. Strategic planning and other intermediate and long-
term decision making represent an additional use of managerial accounting.3

Managerial accounting intended for internal use is not bound by generally accepted ac-
counting principles. Managerial accounting deals with transactions that have already oc-
curred, but it is also concerned with the future, in the form of projecting outcomes and
preparing budgets. Thus, managerial accounting is prospective as well as retrospective.

INFORMATION CHECKPOINT

What Is Needed? Reports for management purposes.
Where Is It Found? With your supervisor.
How Is It Used? To manage better.
What Is Needed? Organization chart.
Where Is It Found? With your supervisor or in the administrative offices.
How Is It Used? To better understand the structure and lines of authority in

your organization.

KEY TERMS

Controlling
Decision Making
Financial Accounting
Managerial Accounting
Nonprofit Organization (also see Voluntary Organization)
Organization Chart
Organizing
Planning
Proprietary Organization (also see Profit-Oriented Organization)

10 CHAPTER 1 Introduction to Healthcare Finance

DISCUSSION QUESTIONS

1. What element of financial management do you perform most often in your job?
2. Do you perform all four elements? If not, why not?
3. Of the organization types described in this chapter, what type is the one you work

for?
4. Have you ever seen your company’s organization chart? If so, how decentralized is

it?
5. If you receive reports in the course of your work, do you believe that they are pre-

pared for outside (third party) use or for internal (management) use? What leads
you to believe this?

What Does the
Healthcare

Manager Need to
K n o w ?

2
C H A P T E R

HOW THE SYSTEM WORKS IN HEALTH CARE

The information that you, as a manager, work with is only
one part of an overall system. To understand financial
management, it is essential to recognize the overall sys-
tem in which your organization operates. An order exists
within the system, and it is generally up to you to find
that order. Watch for how the information fits together.
The four segments that make a healthcare financial sys-
tem work are (1) the original records, (2) the informa-
tion system, (3) the accounting system, (4) and the
reporting system. Generally speaking, the original
records provide evidence that some event has occurred;
the information system gathers this evidence; the ac-
counting system records the evidence, and the reporting
system produces reports of the effect. The healthcare
manager needs to know that these separate elements
exist and that they work together for an end result.

THE INFORMATION FLOW

Structure of the Information System

Information systems can be simplistic or highly com-
plex. They can be fully automated or semiautomated.
Occasionally—even today—they can still be generated
by hand and not by computer. (This last instance is be-
coming rare and can happen today only in certain small
and relatively isolated healthcare organizations that are
not yet required to electronically submit their billings.)

We will examine a particular information system
and point out the basics that a manager should be able to

After completing this chapter,
you should be able to

1. Understand that four segments
make a financial management
system work.

2. Follow an information flow.
3. Recognize the basic system

elements.
4. Follow the annual management

cycle.

P r o g r e s s N o t e s

recognize. Figure 2-1 shows information system components for an ambulatory care setting.
This complex system uses a clinical and financial data repository; in other words, both clin-
ical and financial data are fed into the same system. An automated medical record is also
linked to the system. These are basic facts that a manager should recognize about this am-
bulatory information system.

In addition, the financial information, both outpatient and any relevant inpatient, is fed
into the data repository. Scheduling-system data also enter the data repository, along with
any relevant inpatient care plan and nursing information. Again, all of these are basic facts
that a manager should recognize about this ambulatory care information system.

These items have all been inputs. One output from the clinical and financial data repos-
itory (also shown in Figure 2-1) is insurance verification for patients through an electronic
data information (EDI) link to insurance company databases. Insurance verification is daily
operating information. Another output is decision-making information for managed care
strategic planning, including support for demand, utilization, enrollment, and eligibility,
plus some statistical support. The manager does not have to understand the specifics of all
the inputs and outputs of this complex system, but he or she should recognize that these
outputs occur when this ambulatory system is activated.

Function of Flowsheets

Flowsheets illustrate, as in this case, the flow of activities that capture information.1 Flow-
sheets are useful because they portray who is responsible for what piece of information as it

12 CHAPTER 2 What Does the Healthcare Manager Need to Know?

Managed Care Systems
–Enrollment/eligibility
–Utilization management
–Demand management
–Algorithmic scheduling
support

Insurance

Verification

EDI
Link

Enterprise-Wide
Master Patient Index

Interface Engine

Clinical and Financial
Data Repository

Practice Management
System Scheduling

Ancillary Scheduling

Patient Accounting System
Financial (OP and IP)

OR Scheduling

Other Provider
Inpatient System

–Clinical order entry
–IP care plans
–IP nursing

Chart
Tracking

(IP and OP)

A
u
t
o
m
a
t
e
d

M
e
d
i
c
a
l

R
e
c
o
r
d

Figure 2–1 Information System Components for an Ambulatory Care Setting; OP, Outpatient; IP, Inpa-
tient; OR, Operating Room.

The Information Flow 13

enters the system. The manager needs to realize the significance of such information. We
give, as an example, obtaining confirmation of a patient’s correct address. The manager
should know that a correct address for a patient is vital to the smooth operation of the sys-
tem. An incorrect address will, for example, cause the billing to be rejected. Understand-
ing this connection between deficient data (e.g., a bad address) and the consequences (the
bill will be rejected by the payer and thus not be paid) illustrates the essence of good fi-
nancial management knowledge.

We can examine two examples of patient information flows. The first, shown in Figure
2-2, is a physician’s office flowsheet for address confirmation. Four different personnel are
involved, in addition to the patient. This physician has computed the cost of a bad address
as $12.30 to track down each address correction. He pays close attention to the handling of
this information because he knows there is a direct financial management consequence in
his operation.

The second example, shown in Figure 2-3, is a health system flowsheet for verification of
patient information. This flowsheet illustrates the process for a home care system. In this
case, the flow begins not with a receptionist, as in the physician office example, but with a
central database. This central database downloads the information and generates a sum-
mary report to be reviewed the next day. Appropriate verification is then made in a series of
steps, and any necessary corrections are made before the form goes to the billing depart-
ment. The object of the flow is the same in both examples: that is, the billing must have a

Initiates
Call

Mark
Superbill
if Change

Patient

Enter
Corrected
Address in
Computer

Copy
Insurance

Card

Instruct
Patient

to
Correct

Financial
Data

Check
Address

Insurance

Review
Patient

Records

Record
Message

Receive
Call

Phone Intake
Entry/Exit

Receptionist

Ask
Address
Change

Medical
Assistant

Ask
Address
Change

Doctor

Type
Chart
Label

Coder

Ask
Insurance
Change

Figure 2–2 Physician’s Office Flowsheet for Address Confirmation.

14 CHAPTER 2 What Does the Healthcare Manager Need to Know?

correct address to receive payment. But the flow is different within two different systems. A
manager must understand how the system works to understand the consequences—then
good financial management can prevail.

BASIC SYSTEM ELEMENTS

To understand financial management, it is essential to decipher the reports provided to the
manager. To comprehend these reports, it is helpful to understand certain basic system el-
ements that are used to create the information contained in the reports.

Chart of Accounts—The Map

The chart of accounts is a map. It outlines the elements of your company in an organized
manner. The chart of accounts maps out account titles with a method of numeric coding. It
is designed to compile financial data in a uniform manner that the user can decode.

The groupings of accounts in the chart of accounts should match the groupings of the
organization. In other words, the classification on the organization chart (as discussed in
the previous chapter) should be compatible with the groupings on the chart of accounts.
Thus, if there is a human resources department on your facility’s organization chart, and if

Central intake enters
demographics at time

referral received

Patient Accounts
Clerk generates

Patient Information
Summary next day

Data downloads to
CDB overnight

Information on Patient
Information Summary

verified by
care manager at next

visit

Correct information
written in by staff

Information
Correct?

Form is placed in
appropriate

care manager’s
mailbox

Form turned in to
Patient Accounts
Representative

Data in CDB’s central
intake updated

by Patient Accounts
Representative

Form placed in
billing folder

New labels generated
if necessary

YesNo

Figure 2–3 Health System Flowsheet for Verification of Patient Information.

expenses are grouped by department in your facility, then we would expect to find a human
resources grouping in the chart of accounts.

The manager who is working with financial data needs to be able to read and compre-
hend how the dollars are laid out and how they are gathered together, or assembled. This
assembly happens through the guidance of the chart of accounts. That is why we compare
it to a map.

Basic guidance for healthcare charts of accounts is set out in publications such as that of
Seawell’s Chart of Accounts for Hospitals.2 However, generic guides are just that—generic.
Every organization exhibits differences in its own chart of accounts that express the unique
aspects of its structure. We examine three examples to illustrate these differences. Remem-
ber, we are spending time on the chart of accounts because your comprehension of de-
tailed financial data may well depend on whether you can decipher your facility’s own chart
of accounts mapping in the information forwarded for your use.

The first format, shown in Exhibit 2-1, is a basic use, probably for a smaller organization.
The exhibit is in two horizontal segments, “Structure” and “Example.” There are three
parts to the account number. The first part is one digit and indicates the financial statement
element. Thus, our example shows “1,” which is for “Asset.” The second part is two digits
and is the primary subclassification. Our example shows “10,” which stands for “Current
Asset” in this case. The third and final part is also two digits and is the secondary subclassi-
fication. Our example shows “11,” which stands for “Petty Cash—Front Office” in this case.
On a report, this account number would probably appear as 1-10-11.

The second format, shown in Exhibit 2-2, is full use and would be for a large organiza-
tion. The exhibit is again in two horizontal segments, “Structure” and “Example,” and there

Basic System Elements 15

Exhibit 2–1 Chart of Accounts, Format 1

Structure
X XX XX
Financial Primary Secondary
Statement Subclassification Subclassification

Element

Example
1 10 11
Asset Current Petty Cash—

Asset Front Office
(Financial (Primary (Secondary
Statement Subclassification) Subclassification)

Element)

16 CHAPTER 2 What Does the Healthcare Manager Need to Know?

are now two line items appearing in the Example section. This full-use example has five
parts to the account number. The first part is two digits and indicates the entity designator
number. Thus, we conclude that there is more than one entity within this system. Our ex-
ample shows “10,” which stands for “Hospital A.” The second part is two digits and indicates
the fund designator number. Thus, we conclude that there is more than one fund within
this system. Our example shows “10,” which stands for “General Fund.”

The third part of Exhibit 2-2 is one digit and indicates the financial statement element.
Thus, the first line of our example shows “4,” which is for “Revenue,” and the second line of
our example shows “6,” which is for “Expense.” (The third part of this example is the first
part of the simpler example shown in Exhibit 2-1.) The fourth part is four digits and is the
primary subclassification. Our example shows 3125, which stands for “Lab—Microbiology.”
The number 3125 appears on both lines of this example, indicating that both the revenue
and the expense belong to Lab—Microbiology. (The fourth part of this example is the sec-
ond part of the simpler example shown in Exhibit 2-1. The simpler example used only two
digits for this part, but this full-use example uses four digits.) The fifth and final part is two
digits and is the secondary subclassification. Our example shows “03” on the first line, the
revenue line, which stands for “Payer: XYZ HMO” and indicates the source of the revenue.
On the second line, the expense line, our example shows “10,” which stands for “Clerical
Salaries.” Therefore, we understand that these are the clerical salaries belonging to Lab—

Exhibit 2–2 Chart of Accounts, Format 2

Structure
XX XX X XXXX XX
Entity Fund Financial Primary Secondary
Designator Designator Statement Subclassification Subclassification

Element

Example
10 10 4 3125 03
Hospital General Revenue Lab—Microbiology Payer: XYZ HMO
A Fund

10 10 6 3125 10
Hospital General Expense Lab—Microbiology Clerical Salaries
A Fund

(Entity (Fund (Financial (Primary (Secondary
Designator) Designator) Statement Subclassification) Subclassification)

Element)

Basic System Elements 17

Microbiology in Hospital A. (The fifth part of this example is the third and final part of the
simpler example shown in Exhibit 2-1.) On a report, these account numbers might appear
as 10-10-4-3125-03 and 10-10-6-3125-10. Another optional use that is easier to read at a
glance is 10104-3125-03 and 10106-3125-10.

Because every organization is unique and because the chart of accounts reflects that
uniqueness, the third format, shown in Exhibit 2-3, illustrates a customized use of the chart
of accounts. This example is adapted from a large hospital system. There are four parts to
its chart of accounts number. The first part is an entity designator and designates a com-
pany within the hospital system. The fund designator two-digit part, as traditionally used
(see Exhibit 2-2), is missing here. The financial statement element one-digit part, as tradi-
tionally used (see Exhibit 2-2), is also missing here. Instead, the second part of Exhibit 2-3
represents the primary classification, which is shown as an expense category (“Payroll”) in
the example line. The third part of Exhibit 2-3 is the secondary subclassification, repre-
senting a labor subaccount expense designation (“Regular per-Visit RN”). The fourth and
final part of Exhibit 2-3 is another subclassification that indicates the department within the
company (“Home Health”). On a report for this organization, therefore, the account num-
ber 21-7000-2200-7151 would indicate the home care services company’s payroll for regu-
lar per-visit registered nurses (RNs) in the home health department. Finally, remember that
time spent understanding your own facility’s chart of accounts will be time well spent.

Exhibit 2–3 Chart of Accounts, Format 3

Structure
XX XXXX XXXX XXXX
Company Expense Subaccount Department

Category

(Entity (Primary (Secondary (Additional
Designator) Classification) Subclassification) Subclassification)

Example
21 7000 2200 7151
Home Payroll Regular Home Health
Care per-Visit RN
Services

(Company) (Expense (Subaccount) (Department)
Category)

18 CHAPTER 2 What Does the Healthcare Manager Need to Know?

Books and Records—Capture Transactions

The books and records of the financial information system for the organization ser ve to
capture transactions. Figure 2-4 illustrates the relationship of the books and records to
each other. As a single transaction occurs, the process begins. The individual transaction is
recorded in the appropriate subsidiar y journal. Similar such transactions are then
grouped and balanced within the subsidiary journal. At periodic intervals, the groups of
transactions are gathered, summarized, and entered in the general ledger. Within the gen-
eral ledger, the transaction groups are reviewed and adjusted. After such review and ad-
justment, the transactions for the period within the general ledger are balanced. A
document known as the trial balance is used for this purpose. The final step in the process
is to create statements that reflect the transactions for the period. The trial balance is used
to produce the statements.

All transactions for the period reside in the general ledger. The subsidiary journals are so
named because they are “subsidiary” to the general ledger: in other words, they serve to
support the general ledger. Figure 2-5 illustrates this concept. Another way to think of the
subsidiary journals is to picture them as feeding the general ledger. The important point
here is to understand the source and the flow of information as it is recorded.

Individual Transaction
[begins process]

Individual Transaction
Is Recorded

Similar Transactions
Are Grouped and Balanced

Groups of Transactions
Are Gathered and Summarized

Summarized Groups of Transactions
Are Reviewed and Adjusted

Adjusted and Reviewed Transactions
for Period Are Balanced

Statements Reflecting Transactions Are Created
[ends process]

Creates
Original Record

Into
Subsidiary Journals

Within the
Subsidiary Journals

Into the
General Ledger

Within the
General Ledger

Trial Balance Is Produced
from the General Ledger
for This Purpose

Statements Are Produced
from the Trial Balance

Figure 2–4 The Progress of a Transaction.
Source: Courtesy of Resource Group, Ltd., Dallas, Texas.

Reports—The Product

Reports are more fully treated in a subsequent chapter of this text (see Chapter 10). It is
sufficient at this point to recognize that reports are the final product of a process that com-
mences with an original transaction.

THE ANNUAL MANAGEMENT CYCLE

The annual management cycle affects the type and status of information that the manager
is expected to use. Some operating information is “raw”—that is, unadjusted. When the
same information has passed further through the system and has been verified, adjusted,
and balanced, it will usually vary from the initial raw data. These differences are a part of
the process just described.

Daily and Weekly Operating Reports

The daily and weekly operating reports generally contain raw data, as discussed in the pre-
ceding paragraph. The purpose of such daily and weekly reports is to provide immediate
operating information to use for day-by-day management purposes.

Quarterly Reports and Statistics

The quarterly reports and statistics generally have been verified, adjusted, and balanced.
They are called interim reports because they have been generated some time during the
reporting period of the organization and not at the end of that period. Managers often use
quarterly reports as milestones. A common milestone is the quarterly budget review.

The Annual Management Cycle 19

Payroll

Journal

Accounts
Receivable

Journal

Cash
Receipts
Journal

Cash
Disbursements

Journal

Accounts
Payable
Journal

GENERAL LEDGER

SUBSIDIARY JOURNALS

THE BOOKS

Figure 2–5 Recording Information: Relationship of Subsidiary Journals to the General Ledger.
Source: Courtesy of Resource Group, Ltd., Dallas, Texas.

20 CHAPTER 2 What Does the Healthcare Manager Need to Know?

Annual Year-End Reports

Most organizations have a 12-month reporting period known as a fiscal year. A fiscal year,
therefore, covers a period from the first day of a particular month (e.g., January 1) through
the last day of a month that is one year, or 12 months, in the future (e.g., December 31). If
we see a heading that reads, “For the year ended June 30,” we know that the fiscal year
began on July 1 of the previous year. Anything less than a full 12-month year is called a “stub
period” and is fully spelled out in the heading. If, therefore, a company is reporting for a
three-month stub period ending on December 31, the heading on the report will read, “For
the three-month period ended December 31.” An alternative treatment uses a heading that
reads, “For the period October 1 to December 31.”

Annual year-end reports cover the full 12-month reporting period or the fiscal year. Such
annual year-end reports are not primarily intended for managers’ use. Their primary pur-
pose is for reporting the operations of the organization for the period to outsiders, or third
parties.

Annual year-end reports represent the closing out of the information system for a spe-
cific reporting period. The recording and reporting of operations will now begin a new
cycle with a new year.

COMMUNICATING FINANCIAL INFORMATION TO OTHERS

The ability to communicate financial information effectively to others is a valuable skill. It
is important to

• Create a report as your method of communication.
• Use accepted terminology.
• Use standard formats that are accepted in the accounting profession.
• Begin with an executive summary.
• Organize the body of the report in a logical flow.
• Place extensive detail into an appendix.

The rest of this book will help you learn how to create such a report. Our book will also
sharpen your communication skills by helping you better understand how heathcare fi-
nance works.

INFORMATION CHECKPOINT

What Is Needed? An explanation of how the information flow works in your
unit.

Where Is It Found? Probably with the information system staff; perhaps in the
administrative offices.

How Is It Used? Study the flow and relate it to the paperwork that you
handle.

KEY TERMS

Accounting System
Chart of Accounts
General Ledger
Information System
Original Records
Reporting System
Subsidiary Journals
Trial Balance

DISCUSSION QUESTIONS

1. Have you ever been informed of the information flow in your unit or division?
2. If so, did you receive the information in a formal seminar or in an informal manner,

one-on-one with another individual? Do you think this was the best way? Why?
3. Do you know about the chart of accounts in your organization as it pertains to infor-

mation you receive?
4. If so, is it similar to one of the three formats illustrated in this chapter? If not, how is

it different?
5. Do you work with daily or weekly operating reports? With quarterly reports and sta-

tistics?
6. If so, do these reports give you useful information? How do you think they could be

improved?

Discussion Questions 21

C h e c k l i s t s A
A P P E N D I X

1. Is this budget static (not adjusted for volume) or flexible (adjusted for volume dur-
ing the year)?

2. Are the figures designated as fixed or variable?

3. Is the budget for a defined unit of authority?

4. Are the line items within the budget all expenses (and revenues, if applicable) that
are controllable by the manager?

5. Is the format of the budget comparable with that of previous periods so that sev-
eral reports over time can be compared if so desired?

6. Are actual and budget for the same period?

7. Are the figures annualized?

8. Test one line-item calculation. Is the math for the dollar difference computed cor-
rectly? Is the percentage properly computed based on a percentage of the budget
figure?

Checklist A-1 Reviewing a Budget

334 APPENDIX A Checklists

1. What is the proposed volume for the new budget period?

2. What is the appropriate inflow (revenues) and outflow (cost of services delivered)
relationship?

3. What will the appropriate dollar cost be?

(Note: this question requires a series of assumptions about the nature of the oper-
ation for the new budget period.)

3a. Forecast service-related workload.

3b. Forecast non–service-related workload.

3c. Forecast special project workload if applicable.

3d. Coordinate assumptions for proportionate share of interdepartmental proj-
ects.

4. Will additional resources be available?

5. Will this budget accomplish the appropriate managerial objectives for the organi-
zation?

Checklist A-2 Building a Budget

1. What is the date on the balance sheet?

2. Are there large discrepancies in balances between the prior year and the current
year?

3. Did total assets increase over the prior year?

4. Did current assets increase, decrease, or stay about the same?

5. Did current liabilities increase, decrease, or stay about the same?

6. Did land, plant, and equipment increase or decrease significantly over the prior
year?

7. Did long-term debt increase or decrease significantly over the prior year?

Courtesy of Baker and Baker, Dallas, Texas.

Checklist A-3 Balance Sheet Review

Checklists 335

1. What is the period reported on the statement of revenue and expense?

2. Is it one year or a shorter period? If it is a shorter period, why is that?

3. Are there large discrepancies in balances between the prior year operations and
the current year operations?

4. Did total operating revenue increase over the prior year?

5. Did total operating expenses increase, decrease, or stay about the same? Is any par-
ticular line item unusually large or small?

6. Did income from operations increase, decrease, or stay about the same?

7. Are there unusual nonoperating gains or losses?

8. Did the current year result in an excess of revenue over expense? Is it as much as
that of the prior year?

9. Did long-term debt increase or decrease significantly over the prior year?

Checklist A-4 Review of the Statement of Revenue and Expense

• Only one location?

• Equipment—single purpose or multi-purpose?

• Technology—new, middle-aged, old (obsolete vs. untested)

• Equipment compatibility

• Medical supply cost

• High or low capital investment?

• Buy new or used (refurbished)?

• Buy or lease?

• Lease for a number of years or lease on a pay-per-procedure deal?

• How much staff training is required?

• Certification required?

• Square footage required for equipment

• Is the required square footage available?

• Cleaning methods and equipment (and staff level required)

• Repairs and maintenance expense (high, medium, low?)

Checklist A-5 Considerations for Forecasting Equipment Acquisition

W eb-Based
and Software

Learning To o l s B
A P P E N D I X

HOMEPAGE FOR HEALTHCARE FINANCE

Health Care Finance: Basic Tools for Nonfinancial Managers, 3rd edition, has its own page on
Jones and Bartlett Publishers’ Web site. The homepage contains resources for both in-
structors and students. The site can be accessed using the following URL:
http://www.jbpub.com/catalog/0763726605/.

SOFTWARE TOOLS

Microsoft software and its web-based applications are universally available across the United
States, and Microsoft Office Excel offers an array of computation tools. Relevant informa-
tion is available at www.microsoft.com/office.

For example, click on “function reference/financial” for a listing of Excel’s financial com-
putations. And of course the formulas within Excel spreadsheets provide calculator capa-
bility for every-day addition, subtraction, multiplication, and division. The Web site also
offers supporting resources such as online tutorials and a “help and how-to” feature, along
with tips about using the various Excel features.

OTHER WEB-BASED TOOLS

A user who prefers to use a business analyst calculator (as opposed to computer spread-
sheets) can search the Web for a calculator distributor who posts an operating guidebook.

337

N o t e s

Chapter 1

1. C. S. George, Jr., The Histor y of Management Thought, 2nd ed. (Englewood Cliffs, NJ: Prentice Hall,
1972), 1–27.

2. Ibid., 87.
3. S. Williamson et al., Fundamentals of Strategic Planning for Healthcare Organizations (New York: The Ha-

worth Press, 1997).

Chapter 2

1. J. J. Baker, Activity-Based Costing and Activity-Based Management for Health Care (Gaithersburg, MD: Aspen
Publishers, Inc., 1998).

2. L. V. Seawell, Chart of Accounts for Hospitals (Chicago: Probus Publishing Company, 1994).

Chapter 4

1. Texas Medical Association, American Medical Association, Texas Medical Foundation, and Texas Os-
teopathic Medical Association, A Guide to Forming Physician-Directed Managed Care Networks (Austin, TX:
Texas Medical Association, 1994), 3.

2. Health Care Financing Administration, Health Care Financing Review: Medicare and Medicaid Statistical
Supplement (Baltimore, MD: U.S. Department of Health and Human Services, 1997), 8.

3. Ibid., 9.
4. D. I. Samuels, Capitation: New Opportunities in Healthcare Delivery (Chicago: Irwin Professional Publish-

ing, 1996), 20–21.
5. D. E. Goldstein, Alliances: Strategies for Building Integrated Delivery Systems (Gaithersburg, MD: Aspen Pub-

lishers, Inc., 1995), 283; and Texas Medical Association, American Medical Association, Texas Medical
Foundation, and Texas Osteopathic Medical Association, A Guide to Forming Physician-Directed Managed
Care Networks (Austin, TX: Texas Medical Association, 1994), 4–6.

6. C. Horngren et al., Cost Accounting: A Managerial Emphasis, 9th ed. (Englewood Cliffs, NJ: Prentice Hall,
1998), 116.

7. When ICD-10 is fully implemented, it is possible that the term “major diagnostic categories” (MDCs)
may have to be replaced with some other universal designation. Whether these hospitals will change
the names of their service line designations to match the new titles is unknown at this point. We do
know it will take time to decide upon such a change and then additional time to implement the
change.

8. A. Sharpe and G. Jaffe, “Columbia/HCA Plans for More Big Changes in Health-Care World,” Wall Street
Journal, 28 May, 1997, A8.

339

340 NOTES

Chapter 5

1. S. A. Finkler, Essentials of Cost Accounting for Health Care Organizations, 2nd ed. (Gaithersburg, MD: Aspen
Publishers, Inc., 1999).

2. At the time of this writing, 23 major diagnostic categories (MDCs) serve as the basic classification sys-
tem for diagnosis-related groups (DRGs). When ICD-10 is fully implemented, it is probable that the
number of MDCs will be increased. It is also possible that the terminology itself (MDCs) may be
changed to some other designation.

3. G. F. Longshore, “Service-line Mmanagement/Bottom-line Management for Health Care,” Journal of
Health Care Finance, 24, no. 4 (1998): 72–79.

Chapter 6

1. C. Horngren et al., Cost Accounting: A Managerial Emphasis, 9th ed. (Englewood Cliffs, NJ: Prentice Hall,
1998), 70.

2. J. J. Baker, Activity-Based Costing and Activity-Based Management for Health Care (Gaithersburg, MD: Aspen
Publishers, Inc., 1998).

3. D. A. West, T. D. West, and P. J. Malone, “Managing Capital and Administrative (indirect) Costs to
Achieve Strategic Objectives: The Dialysis Clinic versus the Outpatient Clinic,” Journal of Health Care Fi-
nance, 25, no. 2 (1998): 20–24.

Chapter 7

1. C. Horngren et al., Cost Accounting: A Managerial Emphasis, 9th ed. (Englewood Cliffs, NJ: Prentice Hall,
1998).

2. J. J. Baker, Activity-Based Costing and Activity-Based Management for Health Care (Gaithersburg, MD: Aspen
Publishers, Inc., 1998).

3. It is possible that the term “diagnosis-related groups” (DRGs) may be changed to some new terminol-
ogy as a consequence of ICD-10 implementation.

Chapter 8

1. Department of the Treasury, Internal Revenue Service. How to Depreciate Property. Publication 946
(Washington, D.C.: U.S. Government, 2007): 31–32.

2. Ibid., Table 4-1, 38.
3. Ibid., “Required Use of ADS,” 31.
4. Ibid., “Election of ADS,” 38.

Chapter 9

1. J. J. Baker, Prospective Payment for Long-Term Care: An Annual Guide (Gaithersburg, MD: Aspen Publish-
ers, Inc., 1999).

Chapter 10

1. S. A. Finkler, Essentials of Cost Accounting for Health Care Organizations, 2nd ed. (Gaithersburg, MD: Aspen
Publishers, Inc., 1999).

Chapter 12

1. S. Williamson et al., Fundamentals of Strategic Planning for Healthcare Organizations (New York: The Ha-
worth Press, 1997).

Chapter 13

1. Merriam Webster’s Collegiate Dictionary, 10th ed., s.v. “Forecast.”
2. B. A. Brotman, M. Bumgarner, and P. Prime, “Client Flow through the Women, Infants, and Children

Public Health Program,” Journal of Health Care Finance, 25, no. 1 (1998): 72–77.

Chapter 14

1. Merriam Webster’s Collegiate Dictionary, 10th ed., s.v. “Inflation.”

Chapter 15

1. W. O. Cleverly, Essentials of Health Care Finance, 4th ed. (Gaithersburg, MD: Aspen Publishers, Inc.,
1997).

2. C. Horngren et al., Cost Accounting: A Managerial Emphasis, 9th ed. (Englewood Cliffs, NJ: Prentice Hall,
1998), 227.

3. Ibid., 228.
4. J. R. Pearson et al., “The Flexible Budget Process—A Tool for Cost Containment,” A. J. C. P., 84, no. 2

(1985): 202–208.

Chapter 17

1. S. A. Finkler, “Flexible Budget Variance Analysis Extended to Patient Acuity and DRGs,” Health Care
Management Review, 10, no. 4 (1985): 21–34.

Chapter 18

1. Merriam Webster’s Collegiate Dictionary, 10th ed., s.v. “Estimate.”

Chapter 19

1. American Recovery and Reinvestment Act of 2009 (ARRA) Division A Title XIII Sec. 3000.
2. Ibid.
3. A. K. Jha et. al., “Use of Electronic Health Records in U.S. Hospitals,” New England Journal of Medicine

360, no. 16 (2009). http://content.nejm.org/full/3601/16/1628.
4. Ibid.
5. ARRA Division B. Title IV Sec. 4101.
6. 74 Federal Register (FR) 3328 (January 16, 2009).
7. 73 FR 69847 (November 19, 2008).
8. ARRA Division A. Title XIII “Health Information Technology” (HITECH) and Division B. Title IV

“Medicare and Medicaid Health Information Technology.”
9. ARRA Division A. Title XIII Sec. 3001. The Office of the National Coordinator for Health Informa-

tion Coordinator is located within the Department of Health and Human Services.
10. ARRA Division B. Title IV Sec. 4102.
11. Ibid.
12. ARRA Division B. Title IV Sec. 4101.
13. Ibid.
14. Ibid.
15. ARRA Division B. Title IV Sec. 4102.
16. National Center for Health Statistics, International Classification of Diseases, Tenth Revision (ICD-10).

www.cdc.gov/nchs/about/major/dvs/icd10des.htm.
17. World Health Organization, Classifications. www.who.int/classifications/icd/en/.

Notes 341

342 NOTES

18. CMS: ICD-10 Clinical Modification/Procedure Coding System Fact Sheet. www.cms.hhs.gov/MLN
Products/downloads/ICD-10factsheet2008 .

19. National Center for Health Statistics (NCHS), About the International Classification of Diseases,
Tenth Revision, Clinical Modification (ICD-10-CM). www.cdc.gov/nchs/about/otheract/icd9/abticd10
.htm.

20. CMS: ICD-10-CM-PCS Fact Sheet.
21. Ibid.
22. 73 FR 49743 (August 22, 2008).
23. Ibid.
24. 74 FR 3328 (January 16, 2009).
25. 73 FR 49745 (August 22, 2008).
26. 74 FR 3357 (January 16, 2009).
27. 73 FR 49821 (August 22, 2008).
28. Ibid., 49769.
29. Ibid., 49811.
30. Ibid., 49813.
31. Ibid., 49818.
32. Ibid., 49829.
33. Ibid., 49769.
34. CMS: ICD-10-CM-PCS Fact Sheet.
35. Ibid.
36. Ibid.
37. Ibid.

Chapter 20

1. 74 FR 3348-9 (January 16, 2009).
2. CMS: ICD-10-CM-PCS Fact Sheet.
3. J. Zhang, “Why We Need 1,170 Angioplasty Codes,” Wall Street Journal, November 11, 2008.
4. 73 FR 49814-5 (August 22, 2008).
5. Ibid., 49815-6.
6. Ibid., 49815.
7. Ibid., 49816.
8. Ibid., 49815.
9. Ibid., 49816 and 74 FR 3346-7 (January 16, 2009).

10. Ibid., 49816.
11. M. Libicki and I. Brahmakulam, The Costs and Benefits of Moving to the ICD-10 Code Sets (Santa Monica,

CA: RAND Corporation, 2004), 10. http://www.rand.org/pubs/technical_reports/2004/RAND_
TR132 .

12. 73 FR 49816 (August 22, 2008) and 74 FR 3346-7 (January 16, 2009).
13. 73 FR 49817 (August 22, 2008).
14. Ibid., 49816-7.
15. 70 FR 6265 (February 4, 2005).
16. Ibid.
17. 70 FR 67572 (November 7, 2005).
18. D. S. Bell and M. A. Friedman, “E-Prescribing and the Medicare Modernization Act of 2008,” Health

Affairs 24 (2005): 1159–1169.
19. 70 FR 67588 (November 7, 2005).
20. Ibid., 67569.
21. Ibid., 67592.
22. Ibid., 67588.
23. A. Zimmerman, “Sam’s Club to Provide Digital Medical Tools,” Wall Street Journal, March 12, 2009. The

name of the closely held software maker is eClinicalWorks.

24. Ibid.
25. Adapted from 70 FR 67569 (November 7, 2005).
26. 70 FR 6270 (February 4, 2005).
27. 70 FR 67589 (November 7, 2005).
28. CMS, Transmittal 459, CR 6394 (2009): C.
29. Medicare Learning Network, MLN Matters MM6394 (2009): 9.
30. Ibid., 3.
31. Ibid., 4.
32. CMS, Transmittal 459: C.1.
33. Medicare Learning Network, “2009 Electronic Prescribing (E-Prescribing) Incentive Program Made

Simple.” www.cms.hhs.gov/ERxIncentive.
34. Medicare Learning Network: 11.
35. Ibid., 10.
36. 73 FR 69847-8 (November 19, 2008).
37. CMS, Transmittal 459: C.4.
38. 73 FR 69847-8 (November 19, 2008).
39. Medicare Learning Network: 9.
40. Medicare Learning Network: adapted from Step 2, p. 4.
41. Ibid.

Chapter 21

1. Federal Deposit Insurance Corporation, “Who Is the FDIC?” Federal Deposit Insurance Corporation.
www.fdic.gov/about/learn.

2. Ibid.
3. U.S. Securities and Exchange Commission, “The Investor’s Advocate: How the SEC Protects Investors,

Maintains Market Integrity, and Facilitates Capital Formation.” www.sec.gov/about/whatwedo.shtml.
4. Ibid.
5. Merriam Webster’s Collegiate Dictionary, 10th ed., s.v. “Inflation.”
6. Ibid., 303.
7. U.S. Department of Commerce, Bureau of Economic Analysis (BEA). News Release: Gross Domestic

Product: Fourth Quarter 2008 (Final). www.bea.gov/newsreleases/national/gdp.
8. Ibid.

Notes 343

345

G l o s s a r y

Accounting Rate of Return: See Unadjusted Rate of Return.

Accounting System: Records the evidence that some event has occurred in the healthcare
financial system.

Accrual Basis Accounting: Revenue is recorded when it is earned, not when payment is re-
ceived. Expenses are recorded when they are incurred, not when they are paid. The
opposite of accrual basis is cash basis accounting.

Annualize: To convert data to an annual (12-month) period.

Assets: The net value of what an organization owns.

Balance Sheet: One of the four basic financial statements. Generally speaking, the balance
sheet records what an organization owns, what it owes, and what it is worth at a partic-
ular point in time.

Benchmarking: The continuous process of measuring products, services, and activities
against the best levels of performance. Best levels may be found inside or outside of
the organization.

Book Value: The book value (also known as net book value) of a fixed asset is a balance
sheet figure that represents the remaining undepreciated portion of the fixed asset
cost.

Break-Even Point: The point when the contribution margin (i.e., net revenues less variable
costs) equals the fixed costs.

Budget: The organization-wide instrument through which activities are quantified in fi-
nancial terms.

Business Plan: A document that is typically prepared in order to obtain funding and/or
financing.

Capital: Represents the financial resources of the organization. Generally considered to be
a combination of debt and equity.

346 GLOSSARY

Capital Expenditure Budget: A budget usually intended to plan, monitor, and control
long-term financial issues.

Capital Structure: Means the proportion of debt versus equity within the organization. The
phrase “capital structure” actually refers to the debt–equity relationship.

Case Mix Adjusted: A performance measure that has been adjusted for the acuity level of
the patient and, presumably, the resource level required to provide care.

Cash Basis Accounting: A transaction does not enter the books until cash is either received
or paid out. The opposite of cash basis is accrual basis accounting.

Cash Flow Analysis: This type of analysis illustrates how the project’s cash is expected to
move over a period of time.

Chart of Accounts: Maps out account titles in a uniform manner through a method of nu-
meric coding.

Code Users: Any individual who needs to have some level of understanding of the coding
system, but does not actually assign codes.

Common Sizing: A process of converting dollar amounts to percentages to put information
on the same relative basis. Also known as vertical analysis.

Common Stock: Stocks represent equity, or net worth, in a company. Common stock typi-
cally pays a proportionate share of net income out as a dividend to its investors.

Contribution Income Statement: Specifically identifies the contribution margin within the
income statement format.

Contribution Margin: Called this because it contributes to fixed costs and to profits. Com-
puted as net revenues less variable costs.

Controllable Expenses: Subject to a manager’s own decision making and thus “controllable.”

Controlling: Making sure that each area of the organization is following the plans that have
been established.

Cost: The amount of cash expended (or property transferred, services performed, or lia-
bility incurred) in consideration of goods or services received or to be received.

Cost-Profit-Volume: A method of illustrating the break-even point, whereby the three
elements of cost, profit, and volume are accounted for within the computation.

Cost Object: Any unit for which a separate cost measurement is desired.

Cumulative Cash Flow: The accumulated effect of cash inflows and cash outflows are
added and/or subtracted to show the overall net accumulated result.

Current Ratio: A liquidity ratio considered to be a measure of short-term debt-paying abil-
ity. Computed by dividing current assets by current liabilities.

Days Cash on Hand Ratio: A liquidity ratio that indicates the number of days of operating
expenses represented in the amount of unrestricted cash on hand. Computed by di-

viding unrestricted cash and cash equivalents by the cash operating expenses divided
by number of days in the period.

Days Receivables Ratio: A liquidity ratio that represents the number of days in receivables.
Computed by dividing net receivables by net credit revenues divided by number of
days in the period.

Debentures: Bonds that are unsecured. Debentures are backed by revenues that the issu-
ing organization can earn.

Debt Service Coverage Ratio: A solvency ratio universally used in credit analysis to measure
ability to pay debt service. Computed by dividing change in unrestricted net assets
(net income) plus interest, depreciation, and amortization by maximum annual debt
service.

Decision Making: Making choices among available alternatives.

Deflation: A contraction in the volume of available money and credit that results in a gen-
eral decline in prices.

Depreciation: Depreciation expense spreads, or allocates, the cost of a fixed asset over the
useful life of that asset.

Diagnoses: A common method of grouping healthcare expenses for purposes of planning
and control. Such a grouping may be by major diagnostic categories or by diagnosis-
related groups.

Direct Costs: These costs are incurred for the sole benefit of a particular operating unit.
They can therefore be specifically associated with a particular unit or department or
patient. Laboratory tests are an example of a direct cost.

Discounted Fee-for-Service: The provider of services is paid according to an agreed-upon
contracted discount and after the service is delivered.

Dispenser: Either a person or other legal entity who provides drug products for human use
on prescription in the course of professional practice, and who is licensed, registered,
or otherwise permitted by the jurisdiction in which the person practices, or the entity
is located, to do so.

Electronic Health Record (EHR): A health-related electronic record of an individual
that includes patient demographic and clinical information and that has the ca-
pacity to provide clinical decision support, support physician order entr y, capture
and quer y quality information, and exchange and integrate electronic health
information.

Electronic Prescribing (E-Prescribing): Transmitting a prescription or prescription-related
information, using electronic media, between a prescriber, dispenser, PBM, or health
plan. The transmission may be either direct or through an intermediary, including an
e-prescribing network.

Eligible Professional: In this context, physicians, practitioners, and therapists who are eli-
gible for payment in the e-prescribing incentives program.

Glossary 347

348 GLOSSARY

Equity: Claims held by the owners of the business because they have invested in the busi-
ness; what the business is worth on paper, net of liabilities.

Estimates: A judgment that takes the place of actual measurement.

Expenses: Actual or expected cash outflows incurred in the course of doing business. Ex-
penses are the costs that relate to the earning of revenue. An example is salary ex-
pense for labor performed.

Expired Costs: Costs that are used up in the current period and are matched against cur-
rent revenues.

Fee-for-Service: The provider of services is paid according to the service performed and
after the service is delivered.

FIFO: The First-In, First-Out (FIFO) inventory costing method recognizes the first costs
placed into inventory as the first costs moved out into cost of goods sold when a sale
occurs.

Financial Accounting: Is generally for outside, or third-party, use and thus emphasizes ex-
ternal reporting.

Financial Lease: A formal agreement that may be called a lease but is actually a contract to
purchase. This type of lease must meet certain criteria.

Fixed Costs: Those costs that do not vary in total when activity levels or volume of opera-
tions change. Rent expense is an example of fixed cost.

Flexible Budget: A budget based on a range of activity or volume. The flexible budget is ad-
justed, or flexed (thus “flexible”) to the actual level of output achieved or expected to
be achieved during the budget period.

Forecasts: Information used for purposes of planning for the future. Forecasts can be
short, intermediate, or long range.

For-Profit Organization: A proprietary organization that is generally subject to income tax.

Full-Time Equivalent: A measure to express the equivalent of an employee (annualized) or
a position (staffed) for the full time required (thus, “full-time equivalent” or FTE).

Fund Balance: The difference between net assets and net liabilities; a term generally used
by not-for-profit organizations.

General Ledger: A document in which all transactions for the period reside.

General Services Expenses: This type of expense provides services necessary to maintain
the patient, but the service is not directly related to patient care. Examples of general
services expenses are laundry and dietary.

Gross Domestic Product (GDP): A measure of the output of goods and services produced
by labor and property located in the United States. The Bureau of Economic Analysis
(BEA) is responsible for releasing quarterly estimates of the GDP.

Health Information Technology (HIT): Technology that is designed for, or support use by,
healthcare entities or patients. Includes hardware, software, integrated technologies
or related licenses, intellectual property, upgrades, or packaged solutions.

Horizontal Analysis: The process of comparing and analyzing figures over several time pe-
riods. Also known as trend analysis.

Indirect Cost: These costs are incurred on behalf of the overall operation and therefore
cannot be associated with the provision of specific health services. The finance office
is an example of an indirect cost. Also known as joint costs.

Inflation: An increase in the volume of money and credit relative to available goods and
services resulting in a continuing rise in the general price level.

Information System: Gathers the evidence that some event has occurred in the healthcare
financial system.

Internal Rate of Return: A return on investment method, defined as the rate of interest that dis-
counts future net inflows (from the proposed investment) down to the amount invested.

Inventory: All the items (“goods”) that an organization has for sale in the normal course
of its business.

Inventory Turnover: A ratio that shows how fast inventory is sold, or “turns over.”

Joint Costs: These costs are incurred on behalf of the overall operation and therefore can-
not be associated with the provision of specific health services. The finance office is a
typical example of a joint cost. Also known as indirect cost.

Liabilities: What the organization owes.

Liabilities to Fund Balance Ratio: A solvency ratio used as a quick indicator of debt load.
Computed by dividing total liabilities by unrestricted net assets. Also known as Debt to
Net Worth Ratio.

LIFO: The Last-In, First-Out or LIFO inventory costing method recognizes the latest, or
last, costs placed into inventory as the first costs moved out into cost of goods sold
when a sale occurs.

Liquidity Ratios: Ratios that reflect the ability of the organization to meet its current obli-
gations. Liquidity ratios are measures of short-term sufficiency.

Loan Costs: Those costs necessary to close a loan.

Managed Care: A means of providing healthcare services within a network of healthcare
providers. The central concept is coordination of all healthcare services for an individual.

Managerial Accounting: Is generally for inside, or internal, use and thus emphasizes infor-
mation useful for managerial employees.

Medicaid Program: A federal and state matching entitlement program intended to provide
medical assistance to eligible needy individuals and families. The program was estab-
lished under Title XIX of the Social Security Act.

Glossary 349

350 GLOSSARY

Medicare Program: A federal health insurance program for the aged (and, in certain in-
stances, for the disabled) intended to complement other federal benefits. The pro-
gram was established under Title XVIII of the Social Security Act.

Mixed Cost: Those costs that contain an element of variable cost and an element of fixed
cost.

Monetary Unit: A measure of units of currency, such as the dollar. Monetary units should
be comparable when reporting financial results.

Mortgage Bonds: Bonds that are backed, or secured, by certain real property.

Municipal Bonds: Long-term obligations that are typically used to finance capital projects.

Net Worth: See Equity.

Noncontrollable Expenses: Outside the manager’s power to make decisions, and thus
“noncontrollable.”

Nonproductive Time: Paid-for time when the employee is not on duty—that is, not pro-
ducing. Paid-for vacation days and holidays are examples of nonproductive time.

Nonprofit Organization: Indicates the taxable status of the organization. A nonprofit (or
voluntary) organization is exempt from paying income taxes.

Not-for-Profit Organization: See Nonprofit Organization.

Operating Budget: A budget that generally deals with actual short-term revenues and ex-
penses necessary to operate the facility.

Operating Lease: A lease that is considered an operating expense and thus is treated as an
expense of current operations. This type of lease does not meet the criteria to be
treated as a financial lease.

Operating Margin: A profitability ratio generally expressed as a percentage, the operating
margin is a multipurpose measure. It is used for a number of managerial purposes
and also sometimes enters into credit analysis. Computed by dividing operating in-
come (loss) by total operating revenues.

Operations Expenses: This type of expense provides service directly related to patient care.
Examples of operations expenses are radiology expense and drug expense.

Organization Chart: Indicates the formal lines of communication and reporting and how
responsibility is assigned to managers.

Organizing: Deciding how to use the resources of the organization to most effectively carry
out the plans that have been established.

Original Records: Provide evidence that some event has occurred in the healthcare finan-
cial system.

Overhead: Refers to the remaining expenses of operation that are necessary to produce
the service but that are not directly attributable to that service.

Pareto Analysis: An analytical tool employing the Pareto principle, also known as the
80/20 rule. For example, the Pareto principle states that 80% of an organization’s
problems are caused by 20% of the possible causes.

Patient Mix: A term indicating the mix of payers; thus, whether the individual is a
Medicare patient, a Medicaid patient, a patient covered by private insurance, or a pri-
vate pay patient varies the patient mix proportions. Patient mix information allows es-
timated payment levels to be associated with the service utilization assumptions.

Payback Period: The length of time required for the cash coming in from an investment
to equal the amount of cash originally spent when the investment was acquired.

Payer Mix: The proportion of revenues realized from different types of payers. A measure
often included in the profile of a healthcare organization.

Performance Measures: Measures that compare and quantify performance. Performance
measures may be financial, non-financial, or a combination of both types.

Period Cost: For purposes of healthcare businesses, period cost is necessary to support the
existence of the organization itself, rather than actual delivery of a service. Period
costs are matched with revenue on the basis of the period during which the cost is in-
curred. The term originated with the manufacturing industry.

Planning: Identifying objectives of the organization and identifying the steps required to
accomplish the objectives.

Preferred Stock: Stock that has preference over common stock in certain issues such as
payment of dividends.

Prescriber: A physician, dentist, or other person who issues prescriptions for drugs for
human use, and who is licensed, registered, or otherwise permitted by the United
States or the jurisdiction in which he or she practices to do so.

Present Value Analysis: A concept based on the time value of money. The value of a dollar
today is more than the value of a dollar in the future.

Procedures: A common method of grouping healthcare expenses for purposes of plan-
ning and control. Such a grouping will generally be by Current Procedural Terminol-
ogy (or CPT) codes, which list descriptive terms and identifying codes for medical
services and procedures performed.

Product Cost: For the purposes of healthcare businesses, product cost is necessary to actu-
ally deliver the service. The term originated with the manufacturing industry.

Productive Time: Equates to the employee’s net hours on duty when performing the func-
tions in his or her job description.

Profit Center: Makes a manager responsible for both the revenue/volume (inflow) side
and the expense (outflow) side of a department, division, unit, or program. Also
known as a responsibility center.

Glossary 351

352 GLOSSARY

Profitability Ratios: Ratios that reflect the ability of the organization to operate with an ex-
cess of operating revenue over operating expense.

Profit-Oriented Organization: Indicates the taxable status of the organization. A profit-
oriented (or proprietary) organization is responsible for paying income taxes.

Profit-Volume (PV) Ratio: The contribution margin (i.e., net revenues less variable costs)
expressed as a percentage of net revenue.

Proprietary Organization: Indicates the taxable status of the organization. A proprietary
(or profit-oriented) organization is responsible for paying income taxes.

Quartiles: A distribution into four classes, each of which contains one quarter of the whole;
any one of the four classes is a quartile.

Quick Ratio: A liquidity ratio considered the most severe test of short-term debt-paying
ability (even more severe than the current ratio). Computed by dividing cash and cash
equivalents plus net receivables by current liabilities. Also known as the acid-test ratio.

Reporting System: Produces reports of an event’s effect in the healthcare financial system.

Responsibility Centers: Makes a manager responsible for both the revenue/volume (in-
flow) side and the expense (outflow) side of a department, division, unit, or program.
Also known as a profit center.

Return on Total Assets: A profitability ratio generally expressed as a percentage, this is a
broad measure of profitability in common use. Computed by dividing earnings before
interest and taxes, or EBIT, by total assets. This ratio is known by its acronym, EBIT, in
credit analysis circles.

Revenue: Actual or expected cash inflows due to the organization’s major business. Rev-
enues are amounts earned in the course of doing business. In the case of health care,
revenues are mostly earned by rendering services to patients.

Revenue Amount: Refers to how much each payer is expected to pay for the service and/or
drug or device.

Revenue Sources: Refers to how many payers will pay for the service and/or drug and de-
vice, and in what proportion.

Revenue Type: A designation as to whether, for example, revenue is derived entirely from
services or whether part of the revenue is derived from drugs and devices.

Salvage Value: Salvage value, also known as residual value or scrap value, represents any ex-
pected cash value of the asset at the end of its useful life.

Semifixed Costs: Those costs that stay fixed for a time when activity levels or volume of op-
erations change; rises will occur, but not in direct proportion.

Semivariable Costs: Those costs that vary when activity levels or volume of operations
change, but not in direct proportion. A supervisor’s salary is an example of a semi-
variable cost.

Situational Analysis: Management tool that reviews, assesses, and analyzes the organiza-
tion’s internal operations for strengths and weaknesses and the organization’s exter-
nal environment for opportunities and threats.

Solvency Ratios: Ratios that reflect the ability of the organization to pay the annual interest
and principal obligations on its long-term debt. These ratios determine ability to “be
solvent.”

Space Occupancy: Within the context of a forecast or projection, refers to the overall cost
of occupying the space required for the service or procedure. Considered to be an in-
direct cost.

Staffing: A term that means the assigning of staff to fill scheduled positions.

Statement of Cash Flows: One of the four basic financial statements, this statement reports
the current period cash flow by taking the accrual basis statements and converting
them to an effective cash flow. This is accomplished by a series of reconciling adjust-
ments that account for the noncash amounts.

Statement of Fund Balance/Net Worth: One of the four basic financial statements, this
statement reports the excess of revenue over expenses (or vice versa) for the period
as the excess flows into equity (or reduces equity, in the case of a loss for the period).

Statement of Revenue and Expense: One of the four basic financial statements, this state-
ment reports the inflow of revenue and the outflow of expense over a stated period of
time. The net result is also reported, either as excess of revenue over expense or, in
the case of a loss for the period, excess of expense over revenue.

Static Budget: A budget based on a single level of operations, or volume. After it is ap-
proved and finalized, the single level of operations (volume) is never adjusted; thus,
the budget is “static” or unchanging.

Stock Warrants: Warrants allow the owner of the warrant to purchase additional shares of
stock in the company, generally at a particular price and prior to an expiration date.

Subsidiary Journals: Documents that contain specific sets of transactions and that support
the general ledger.

Subsidiary Reports: Reports that support, and thus are subsidiary to, the four major
financial statements.

Supplies: Within the context of a forecast or projection, refers to the necessary supplies
that are required to perform a procedure or service. Considered to be a direct
expense.

Support Services Expenses: This type of expense provides support to both general services
expenses and to operations expenses. It is necessary for support, but it is neither di-
rectly related to patient care nor is it a service necessary to maintain the patient. Ex-
amples of support services are insurance and payroll taxes.

Glossary 353

354 GLOSSARY

SWOT Analysis: Acronym for a method of situational analysis assessing an organization’s
strengths-weaknesses-opportunities-and-threats; thus “SWOT.”

Target Operating Income: Allows the manager to determine, or target, how many units
must be sold in order to yield a particular operating income.

Three-Variance Method: A method of variance analysis that compares volume variance to
use (or quantity) variance and to spending (or price) variance.

Time Value of Money: The present value concept, which is that the value of a dollar today
is more than the value of a dollar in the future.

Trend Analysis: The process of comparing and analyzing figures over several time periods.
Also known as horizontal analysis.

Trial Balance: A document used to balance the general ledger accounts and to produce fi-
nancial statements.

Two-Variance Method: A method of variance analysis that compares volume variance to
budgeted costs (defined as standard hours for actual production)—thus the “two-
variance” method.

Unadjusted Rate of Return: An unsophisticated return on investment method, the answer
for which is an estimate containing no precision.

Unexpired Costs: Costs that are not yet used up and will be matched against future
revenues.

Useful Life: The useful life of a fixed asset determines the period over which the fixed
asset’s cost will be spread.

Variable Costs: Those costs that vary in direct proportion to changes in activity levels of vol-
ume of operations. Food for meal preparation is an example of variable cost.

Variance Analysis: A variance is the difference between standard and actual prices and
quantities. Variance analysis analyzes these differences.

Vertical Analysis: A process of converting dollar amounts to percentages to put informa-
tion on the same relative basis. Also known as common sizing.

Voluntary Organization: Indicates the taxable status of the organization. A voluntary (or
nonprofit) organization is exempt from paying income taxes.

The following examples and exercises include examples, practice exercises, and assign-
ment exercises. Solutions to the practice exercises are found at the end of this section. Ex-
ercises are designated by chapter number.

EXAMPLES AND EXERCISES

CHAPTER 1

Assignment Exercise 1–1

Review the chapter text about types of organizations and examine the list in Exhibit 1-1.

Require d

1. Obtain listings of healthcare organizations from the yellow pages of a telephone
book.

2. Set up a worksheet listing the classifications of organizations found in Exhibit 1-1.
3. Enter the organizations you found in the yellow pages onto the worksheet.
4. For each organization indicate the type of organization.
5. If some cannot be identified by type, comment on what you would expect them to be;

that is, proprietary, voluntary, or government owned.

Assignment Exercise 1–2

Review the chapter text about organization charts. Also examine the organization charts
appearing in Figures 1-2 and 1-3.

Require d

1. Refer to the Metropolis Health System (MHS) case study appearing in Chapter 25.
Read about the various types of services offered by MHS.

2. The MHS organization chart has seven major areas of responsibility, each headed by
a senior vice president. Select one of the seven areas and design additional levels of

355355

Examples and
Exercises,

Supplemental
Materials, and

S o l u t i o n s

356 EXAMPLES AND EXERCISES, SUPPLEMENTAL MATERIALS, AND SOLUTIONS

detail that indicate the managers. If you have considerable detail you may choose one
department (such as ambulatory operations) instead of the entire area of responsi-
bility for that senior vice president.

3. Do you believe your design of the detailed organization chart indicates centralized or
decentralized lines of authority for decision making? Can you explain your approach
in one to two sentences?

CHAPTER 2

Assignment Exercise 2–1: Health System Flowsheets

Review the chapter text about information flow and Figures 2-2 and 2-3.

Require d

1. Find an information flowsheet from a healthcare organization. It can be from a pub-
lished source or from an actual organization.

2. Based on this flowsheet, comment on what the structure of the organization’s infor-
mation system appears to be.

3. If you were a manager (at this organization), would you want to change the structure?
If so, why? If not, why not?

Assignment Exercise 2–2: Chart of Accounts

Review the chapter text about the chart of accounts and how it is a map of the company el-
ements. Also review Exhibits 2-1, 2-2, and 2-3.

Require d

1. Find an excerpt from a healthcare organization’s chart of accounts. It can be from a
published source or from an actual organization.

2. Based on this chart of accounts excerpt, comment on what the structure of the orga-
nization’s reporting system appears to be.

3. If you were a manager (at this organization), would you want to change the system? If
so, why? If not, why not?

CHAPTER 3

Example 3A: Assets and Liabilities

Study the chapter text concerning examples of assets and liabilities. Is the difference be-
tween short-term and long-term assets and liabilities clear to you?

Practice Exercise 3–I

Place an “X” in the appropriate classification for each balance sheet item listed below.

Assignment Exercise 3–1: Balance Sheet

Locate a healthcare-related balance sheet. The source of the balance sheet can be internal
(within a healthcare facility of some type) or external (from a published article or from a
company’s annual report, for example). Write your impressions and/or comments about
the assets, liabilities, and net worth found on your balance sheet. Would you have preferred
more detail in this statement? If so, why?

Assignment Exercise 3–2: Balance Sheet

Locate a second healthcare-related balance sheet. Again, the source of the balance sheet
can be either internal or external. Compare the balance sheet you acquired for Assignment
Exercise 3-1 with the second balance sheet you have now obtained. What is the same? What
is different? Which one do you find more informative? Why?

CHAPTER 4

Example 4A: Contractual Allowances

Contractual allowances represent the difference between the full established rate and the
agreed-upon contractual rate that will be paid. An example was given in the text of Chapter
4 by which the hospital’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 contractual allowance is $10 ($100 less $90 � $10). Assume instead
that Near-By Health Plan has negotiated its own managed care contract whereby this plan
pays $95 for that procedure. In this case the contractual allowance is $5 ($100 less $95 � $5).

Chapter 4 357

Short-Term Long-Term Short-Term Long-Term
Asset Asset Liability Liability

Payroll taxes due

Accounts receivable

Land

Mortgage payable
(non-current)

Buildings

Note payable
(due in 24 months)

Inventory

Accounts payable

Cash on hand

358 EXAMPLES AND EXERCISES, SUPPLEMENTAL MATERIALS, AND SOLUTIONS

Assignment Exercise 4–1: Contractual Allowances

Physician office revenue for visit code 99214 has a full established rate of $72.00. Of ten dif-
ferent payers, there are nine different contracted rates, as follows:

Contracted
Payer Rate

FHP $35.70
HPHP 58.85
MC 54.90
UND 60.40
CCN 70.20
MO 70.75
CGN 10.00
PRU 54.90
PHCS 50.00
ANA 45.00

Rates for illustration only.

Require d

1. Set up a worksheet with four columns: Payer, Full Rate, Contracted Rate, and Con-
tractual Allowance.

2. For each payer, enter the full rate and the contracted rate.
3. For each payer, compute the contractual allowance.

The first payer has been computed below:

Full Contracted Contractual
Payer Rate (less) Rate (equals) Allowance
FHP $72.00 $35.70 $36.30

Example 4B: Revenue Sources and Grouping Revenue

Sources of healthcare revenue are often grouped by payer. Thus, services might be grouped
as follows:

Revenue from the Medicare Program (payer � Medicare)
Revenue from the Medicaid Program (payer � Medicaid)
Revenue from Blue Cross Blue Shield (payer � Commercial Insurance)
or
Revenue from Blue Cross Blue Shield (payer � Managed Care Contract)

Assignment Exercise 4–2: Revenue Sources and Grouping Revenue

The Metropolis Health System has revenue sources from operations, donations, and inter-
est income. The revenue from operations is primarily received for services. MHS groups its
revenue first by cost center. Within each cost center the services revenue is then grouped
by payer.

Require d

1. Set up a worksheet with individual columns across the top for six revenue sources
(payers): Medicare, Medicaid, Other Public Programs, Patients, Commercial Insur-
ance, and Managed Care Contracts.

2. Certain situations concerning the Intensive Care Unit and the Laboratory are de-
scribed below.

Set up six vertical line items on your worksheet, numbered (1) through (6). Six
situations are described below. For each of the six situations, indicate its number
(1 through 6) and enter the appropriate cost center (either Intensive Care Unit or
Laboratory). Then place an X in the column(s) that represents the correct revenue
source(s) for the item. The six situations are as follows:

(1) ICU stay billed to employee’s insurance program.
(2) Lab test paid for by an individual.
(3) Pathology work performed for the state.
(4) ICU stay billed to member’s health plan.
(5) ICU stay billed for Medicare beneficiary.
(6) Series of allergy tests run for eligible Medicaid beneficiary.

Headings for your worksheet:

Other Public Commercial Managed
Medicare Medicaid Programs Patients Insurance Care Contracts

(1)

(2)

(3)

(4)

(5)

(6)

CHAPTER 5

Example 5A: Grouping Expenses by Cost Center

Cost centers are one method of grouping expenses. For example, a nursing home may con-
sider the Admitting department as a cost center. In that case the expenses grouped under
the Admitting department cost center may include:

Chapter 5 359

360 EXAMPLES AND EXERCISES, SUPPLEMENTAL MATERIALS, AND SOLUTIONS

• Administrative and Clerical Salaries
• Admitting Supplies
• Dues
• Periodicals and Books
• Employee Education
• Purchased Maintenance

Practice Exercise 5–I: Grouping Expenses by Cost Center

The Metropolis Health System groups expenses for the Intensive Care Unit into its own cost
center. Laboratory expenses and Laundry expenses are likewise grouped into their own
cost centers.

Require d

1. Set up a worksheet with individual columns across the top for the three cost centers:
Intensive Care Unit, Laboratory, and Laundry.

2. Indicate the appropriate cost center for each of the following expenses:
• Drugs Requisitioned
• Pathology Supplies
• Detergents and Bleach
• Nursing Salaries
• Clerical Salaries
• Uniforms (for Laundry Aides)
• Repairs (parts for microscopes)

(Hint: One of the expenses will apply to more than one cost center.)

Headings for your worksheet:

Intensive Care Unit Laboratory Laundry

Assignment Exercise 5–1: Grouping Expenses by Cost Center

The Metropolis Health System’s Rehabilitation and Wellness Center offers outpatient ther-
apy and return-to-work services plus cardiac and pulmonary rehabilitation to get people
back to a normal way of living. The Rehabilitation and Wellness Center expenses include
the following:

• Nursing Salaries
• Physical Therapist Salaries
• Occupational Therapist Salaries
• Cardiac Rehab Salaries
• Pulmonary Rehab Salaries
• Patient Education Coordinator Salary
• Nursing Supplies
• Physical Therapist Supplies

• Occupational Therapist Supplies
• Cardiac Rehab Supplies
• Pulmonary Rehab Supplies
• Training Supplies
• Clerical Office Supplies
• Employee Education

Require d

1. Decide how many cost centers should be used for the above expenses at the Center.
2. Set up a worksheet with individual columns across the top for the cost centers you

have chosen.
3. For each of the expenses listed above, indicate to which of your cost centers it should

be assigned.

Example 5B

Study the chapter text concerning grouping expenses by diagnoses and procedures. Refer
to Exhibits 5-3 and 5-4 (about major diagnostic categories), Exhibit 5-5 (about DRGs and
MDCs), and Table 5-1 (about procedure codes) for examples of different ways to group ex-
penses by diagnoses and procedures.

Assignment Exercise 5–2

Require d

Find a listing of expenses by diagnosis or by procedure. The source of the list can be inter-
nal (within a healthcare facility of some type) or external (such as a published article, re-
port, or survey). Comment upon whether you believe the expense grouping used is
appropriate. Would you have grouped the expenses in another way?

CHAPTER 6

Example 6A: Direct and Indirect Costs

Review the chapter text regarding direct and indirect costs. In particular, review the exam-
ple of freestanding dialysis center direct costs (Exhibit 6-1) and indirect costs (Exhibit 6-2).
Remember that indirect costs are shared and are sometimes called joint costs or common
costs. Because such costs are shared they must be allocated. Also, remember that one test
of a direct cost is to ask: “If the operating unit (such as a department) did not exist, would
this cost not be in existence?”

Practice Exercise 6–I: Identifying Direct and Indirect Costs

Make a worksheet with two columns labeled: Direct Cost and Indirect Cost. Place each of
the following items in the appropriate column:

Chapter 6 361

362 EXAMPLES AND EXERCISES, SUPPLEMENTAL MATERIALS, AND SOLUTIONS

• Managed care marketing expense
• Real estate taxes
• Liability insurance
• Clinic telephone expense
• Utilities (for the entire facility)
• Emergency room medical supplies

Assignment Exercise 6–1: Allocating Indirect Costs

Study Table 6-1, “Example of Radiology Departments Direct and Indirect Cost Totals,” and
Table 6-2, “Example of Indirect Costs Allocated to Radiology Departments,” and review the
chapter text describing how the indirect cost is allocated. This assignment will change the
allocation bases: A) Volumes, B) Direct Costs, and C) Number of Films.

Required

1. Compute the costs allocated to cost centers #557, 558, 559, 560, and 561 using the
new allocation bases shown below. Use a worksheet replicating the setup in Table 6-2.
Total the new results.

The new allocation bases are:

A) Volumes 120,000 130,000 70,000 110,000 70,000 500,000
B) Direct costs $1,100,000 $700,000 $1,300,000 $1,600,000 $1,300,000 $6,000,000
C) No. of films 400,000 20,000 55,000 25,000 20,000 520,000

2. Using a worksheet replicating the setup in Table 6-1, enter the new direct cost and the
new totals for indirect costs resulting from your work. Total the new results.

Practice Exercise 6–II: Responsibility Centers

The Metropolis Health System has one director who supervises the areas of Security, Com-
munications, and Ambulance Services. This director also supervises the medical records
relevant to Ambulance Services, the educational training for Security and Ambulance Ser-
vices personnel, and the human resources for Security, Communications, and Ambulance
Services personnel.

Require d

Of the duties and services described above, all of which are supervised by one director,
which areas should be responsibility centers and which areas should be support centers?
Draw them in a visual and indicate the reporting requirements.

Assignment Exercise 6–2: Responsibility Centers

Choose between the physician’s practice in Mini-Case Study 2 or the clinic in Mini-Case
Study 3. Designate the responsibility centers and the support centers for the organization
selected. Prepare a rationale for the structure you have designed.

CHAPTER 7

Example 7A: Fixed, Variable, and Semivariable Distinction

Review the chapter text for the distinction between fixed, variable, and semivariable costs.
Pay particular attention to the accompanying Figures 7-1, 7-2, 7-3, 7-4, and 7-5.

Practice Exercise 7–I: Analyzing Mixed Costs

The Metropolis Health System has a system-wide training course for nurse aides. The course
requires a packet of materials that MHS calls the training pack. Due to turnover and because
the course is system-wide, there is a monthly demand for new packs. In addition, the local
community college also obtains the training packs used in their credit courses from MHS.

The education coordinator needs to know how much of the cost is fixed and how much
of the cost is variable for these training packs. She decides to use the high-low method of
computation.

Require d

Using the monthly utilization information presented below, find the fixed and variable por-
tion of costs through the high-low method.

Number of
Month Training Packs Cost

January 1,000 $6,200
February 200 1,820
March 250 2,350
April 400 3,440
May 700 4,900
June 300 2,730
July 150 1,470
August 100 1,010
September 1,100 7,150
October 300 2,850
November 250 2,300
December 100 1,010

Assignment Exercise 7–1: Analyzing Mixed Costs

The education coordinator decides that the community college packs may be unduly in-
fluencing the high-low computation. She decides to re-run the results, omitting the com-
munity college volume.

Require d

1. Using the monthly utilization information presented below, and omitting the com-
munity college training packs, find the fixed and variable portion of costs through

Chapter 7 363

364 EXAMPLES AND EXERCISES, SUPPLEMENTAL MATERIALS, AND SOLUTIONS

the high-low method. Note that the college only acquires packs in three months of
the year: January, May, and September. These dates coincide with the start dates of
their semesters and summer school.

2. The reason the education coordinator needs to know how much of the cost is fixed
is because she is supposed to collect the appropriate variable cost from the commu-
nity college for their packs. For her purposes, which computation do you believe is
better? Why?

Total Number of Total Community College Community College
Month Training Packs Cost Number Packs Cost

January 1,000 $6,200 200 $1,240
February 200 1,820
March 250 2,350
April 400 3,440
May 700 4,900 300 2,100
June 300 2,730
July 150 1,470
August 100 1,010
September 1,100 7,150 300 1,950
October 300 2,850
November 250 2,300
December 100 1,010

Example 7B: Contribution Margin

Computation of a contribution margin is simplified if the fixed and variable expense has al-
ready been determined. Examine Table 7-1, which contains Operating Room fixed and
variable costs. We can see that the total costs are $1,217,756. Of this amount, $600,822 is
designated as variable cost and $616,934 is designated as fixed ($529,556 + $87,378 =
$616,934). For purposes of our example, assume the Operating Room revenue amounts to
$1,260,000. The contribution margin is computed as follows:

Amount

Revenue $1,260,000
Less Variable Cost (600,822)
Contribution Margin $659,178

Thus, $659,178 is available to contribute to fixed costs and to profit. (In this example
fixed costs amount to $616,934, so there is an amount left to contribute toward profit.)

Practice Exercise 7–II: Calculating the Contribution Margin

Greenside Clinic has revenue totaling $3,500,000. The clinic has costs totaling $3,450,000.
Of this amount, 40% is variable cost and 60% is fixed cost.

Require d

Compute the contribution margin for Greenside Clinic.

Assignment Exercise 7–2: Calculating the Contribution Margin

The Mental Health program for the Community Center has just completed its fiscal year
end. The program director determines that his program has revenue for the year of
$1,210,000. He believes his variable expense amounts to $205,000 and he knows his fixed
expense amounts to $1,100,000.

Require d

1. Compute the contribution margin for the Community Center Mental Health Pro-
gram.

2. What does the result tell you about the program?

Example 7C: Cost-Volume-Profit (CVP) Ratio and Profit-Volume (PV) Ratio

Closely review the examples of ratio calculations in the chapter text. Also note that exam-
ples are presented in visuals as well as text.

Practice Exercise 7–III: Calculating the PV Ratio

The profit-volume (PV) ratio is also known as the contribution margin (CM) ratio. Use the
same assumptions for the Community Center Mental Health Program. In addition to the
contribution margin figures already computed, now compute the PV ratio (also known as
the CM ratio).

Assignment Exercise 7–3: Calculating the PV Ratio and the CVP Ratio

Use the same assumptions for the Greenside Clinic. One more assumption will be added:
the clinic had 35,000 visits.

Required

1. In addition to the contribution margin figures already computed, now compute the
PV ratio (also known as the CM ratio).

2. Add another column to your worksheet and compute the clinic’s per-visit revenue
and costs.

3. Create a Cost-Volume-Profit chart. Refer to the chapter text along with Figure 7-6.

CHAPTER 8

Assignment Exercise 8–1: FIFO and LIFO Inventory

Study the FIFO and LIFO explanations in the chapter.

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366 EXAMPLES AND EXERCISES, SUPPLEMENTAL MATERIALS, AND SOLUTIONS

Require d

a.1. Use the format in Exhibit 8-1 “FIFO Inventory Effect” to compute the ending
FIFO inventory and the cost of goods sold, assuming $90,000 in sales.

a.2. Also compute the cost of goods sold percentage of sales.
b.1. Use the format in Exhibit 8-2 “LIFO Inventory Effect” to compute the ending

LIFO inventory and the cost of goods sold, assuming $90,000 in sales.
b.2. Also compute the cost of goods sold percentage of sales.

c. Comment on the difference in outcomes.

Assignment Exercise 8–2: Inventory Turnover

Study the “Calculating Inventory Turnover” portion of the chapter closely, whereby the cost
of goods sold divided by the average inventory equals the inventory turnover.

Require d

Compute two inventory turnover calculations as follows:
1. Use the LIFO information in the previous assignment to first compute the average

inventory and then to compute the inventory turnover.

2. Use the FIFO information in the previous assignment to first compute the average

inventory and then to compute the inventory turnover.

Example 8A: Depreciation Concept

Assume that MHS purchased equipment for $200,000 cash on April 1st (the first day of its
fiscal year). This equipment has an expected life of 10 years. The salvage value is 10 percent
of cost. No equipment was traded in on this purchase.

Straight-line depreciation is a method that charges an equal amount of depreciation for
each year the asset is in service. In the case of this purchase, straight-line depreciation
would amount to $18,000 per year for 10 years. This amount is computed as follows:

Step 1. Compute the cost net of salvage or trade-in value: 200,000 less 10 percent salvage
value or 20,000 equals 180,000.

Step 2. Divide the resulting figure by the expected life (also known as estimated useful
life): 180,000 divided by 10 equals 18,000 depreciation per year for 10 years.

Accelerated depreciation represents methods that are speeded up, or accelerated. In
other words a greater amount of depreciation is taken earlier in the life of the asset. One
example of accelerated depreciation is the double declining balance method. Unlike
straight-line depreciation, trade-in or salvage value is not taken into account until the end
of the depreciation schedule. This method uses book value, which is the net amount re-
maining when cumulative previous depreciation is deducted from the asset’s cost. The com-
putation is as follows:

Step 1. Compute the straight-line rate: 1 divided by 10 equals 10 percent.
Step 2. Now double the rate (as in double declining method): 10 percent times 2 equals

20 percent.

Step 3. Compute the first year’s depreciation expense: 200,000 times 20 percent equals
40,000.

Step 4. Compute the carry-forward book value at the beginning of the second year:
200,000 book value beginning Year 1 less Year 1 depreciation of 40,000 equals
book value at the beginning of the second year of 160,000.

Step 5. Compute the second year’s depreciation expense: 160,000 times 20 percent
equals 32,000.

Step 6. Compute the carry-forward book value at the beginning of the third year:
160,000 book value beginning Year 2 less Year 2 depreciation of 32,000 equals
book value at the beginning of the third year of 128,000.
—Continue until the asset’s salvage or trade-in value has been reached.
—Do not depreciate beyond the salvage or trade-in value.

Practice Exercise 8–I: Depreciation Concept

Assume that MHS purchased equipment for $600,000 cash on April 1st (the first day of its
fiscal year). This equipment has an expected life of 10 years. The salvage value is 10 percent
of cost. No equipment was traded in on this purchase.

Required

1. Compute the straight-line depreciation for this purchase.
2. Compute the double declining balance depreciation for this purchase.

Assignment Exercise 8–3: Depreciation Concept

Assume that MHS purchased two additional pieces of equipment on April 1st (the first day
of its fiscal year), as follows:

(1) The laboratory equipment cost $300,000 and has an expected life of 5 years. The sal-
vage value is 5 percent of cost. No equipment was traded in on this purchase.

(2) The radiology equipment cost $800,000 and has an expected life of 7 years. The sal-
vage value is 10 percent of cost. No equipment was traded in on this purchase.

Require d

For both pieces of equipment:

1. Compute the straight-line depreciation.
2. Compute the double declining balance depreciation.

Example 8B: Depreciation

This example shows straight-line depreciation computed at a five-year useful life with no sal-
vage value. Straight-line depreciation is the method commonly used for financing projec-
tions and funding proposals.

Depreciation Expense Computation: Straight Line

5-year useful life; no salvage value

Chapter 8 367

368 EXAMPLES AND EXERCISES, SUPPLEMENTAL MATERIALS, AND SOLUTIONS

Annual Remaining
Year # Depreciation Balance

Beginning Balance � 60,000
1 12,000 48,000
2 12,000 36,000
3 12,000 24,000
4 12,000 12,000
5 12,000 -0-

Example 8C: Depreciation

This example shows straight-line depreciation computed at a five-year useful life with a remain-
ing salvage value of $10,000. Note the difference in annual depreciation between 16B and 16C.

Depreciation Expense Computation: Straight Line

5-year useful life; $10,000 salvage value

Annual Remaining
Year # Depreciation Balance

Beginning Balance � 60,000
1 10,000 50,000
2 10,000 40,000
3 10,000 30,000
4 10,000 20,000
5 10,000 10,000

Example 8D: Depreciation

This example shows double declining depreciation computed at a five-year useful life with
no salvage value. As is often the case with a five-year life, the double declining method is
used for the first three years and the straight-line method is used for the remaining two
years. The double declining method first computes what the straight-line percentage would
be. In this case 100 percent divided by five years equals 20 percent. The 20 percent is then
doubled. In this case 20 percent times 2 equals 40 percent. Then the 40 percent is multi-
plied by the remaining balance to be depreciated. Thus 60,000 times 40 percent for year
one equals 24,000 depreciation, with a remaining balance of 36,000. Then 36,000 times 40
percent for year two equals 14,400 depreciation, and 36,000 minus 14,400 equals 21,600 re-
maining balance, and so on.

Now note the difference in annual depreciation between 8B, using straight-line for all
five years, and 8D, using the combined double declining and straight-line methods.

Depreciation Expense Computation: Double Declining Balance

5-year useful life; $10,000 salvage value

Annual Remaining
Year # Depreciation Balance

Beginning Balance � 60,000
1 24,000* 36,000
2 14,400* 21,600
3 8,640* 12,960
4 6,480** 6,480
5 6,480** 6,480

* � double declining balance depreciation
** � straight-line depreciation for remaining two years (12,960 divided by 2 � 6,480/yr)

Practice Exercise 8–II: Depreciation

Compute the straight-line depreciation for each year for equipment with a cost of $50,000,
a 5-year useful life, and a $5,000 salvage value.

Assignment Exercise 8–4: Depreciation

Set up a purchase scenario of your own and compute the depreciation with and without sal-
vage value.

Assignment Exercise 8–5: Depreciation Computation: Units-of-

Service

Study the “Units-of-Service” portion of the chapter closely.

Require d

1. Using the format in Table 8-7, compute units-of-service depreciation using the fol-
lowing assumptions:

Cost to be depreciated � $50,000
Salvage value � zero
Total units of service � 10,000
Units of service per year: Year 1 � 2,200; Year 2 � 2,100;

Year 3 � 2,300; Year 4 � 2,200; Year 5 � 200

2. Using the same format, compute units-of-service depreciation using adjusted as-
sumptions as follows:

Cost to be depreciated � $50,000
Salvage value � $5,000
Total units of service � 10,000
Units of service per year: Year 1 � 2,200; Year 2 � 2,100;

Year 3 � 2,300; Year 4 � 2,200; Year 5 � 200

Chapter 8 369

370 EXAMPLES AND EXERCISES, SUPPLEMENTAL MATERIALS, AND SOLUTIONS

CHAPTER 9

Example 9A

Review the chapter text about annualizing positions. In particular review Exhibit 9-2, which
contains the annualizing calculations.

Practice Exercise 9–I: FTEs to Annualize Staffing

The office manager for a physicians’ group affiliated with Metropolis Health System is
working on her budget for next year. She wants to annualize her staffing plan. To do so she
needs to convert her staff’s net paid days worked to a factor. Their office is open and staffed
seven days a week, per their agreement with two managed care plans.

The office manager has the MHS worksheet, which shows 9 holidays, 7 sick days, 15 va-
cation days, and 3 education days, equaling 34 paid days per year not worked. The physi-
cians’ group allows 8 holidays, 5 sick days, and 1 education day. An employee must work one
full year to earn 5 vacation days. An employee must have worked full time for three full
years before earning 10 annual vacation days. Because the turnover is so high, nobody on
staff has earned more than 5 vacation days.

Require d

1. Compute net paid days worked for a full-time employee in the physicians’ group.
2. Convert net paid days worked to a factor so the office manager can annualize her

staffing plan.

Assignment Exercise 9–1: FTEs to Annualize Staffing

The Metropolis Health System managers are also working on their budgets for next year.
Each manager must annualize his or her staffing plan, and thus must convert staff net paid
days worked to a factor. Each manager has the MHS worksheet, which shows 9 holidays, 7
sick days, 15 vacation days, and 3 education days, equaling 34 paid days per year not worked.

The Laboratory is fully staffed seven days per week and the 34 paid days per year not
worked is applicable for the lab. The Medical Records department is also fully staffed seven
days per week. However, Medical Records is an outsourced department so the employee
benefits are somewhat different. The Medical Records employees receive 9 holidays plus 21
personal leave days which can be used for any purpose.

Required

1. Compute net paid days worked for a full-time employee in the Laboratory and in
Medical Records.

2. Convert net paid days worked to a factor for the Laboratory and for Medical Records
so these MHS managers can annualize their staffing plans.

Example 9B

Review the chapter text about staffing requirements to fill a position. In particular review
Exhibit 9-4, which contains (at the bottom of the exhibit) the staffing calculations. Re-
member this method uses a basic work week as the standard.

Practice Exercise 9–II: FTEs to Fill a Position

Metropolis Health System (MHS) uses a basic work week of 40 hours throughout the sys-
tem. Thus, one full-time employee works 40 hours per week. MHS also uses a standard 24-
hour scheduling system of three 8-hour shifts. The Admissions manager needs to compute
the staffing requirements to fill his departmental positions. He has more than one Admis-
sions office staffed within the system. The West Admissions office typically has two Admis-
sions officers on duty during the day shift, one Admissions officer on duty during the
evening shift, and one Admissions officer on duty during the night shift. The day shift also
has one clerical person on duty. Staffing is identical for all seven days of the week.

Require d

1. Set up a staffing requirements worksheet, using the format in Exhibit 9-4.
2. Compute the number of FTEs required to fill the Admissions officer position and the

clerical position at the West Admissions office.

Assignment Exercise 9–2: FTEs to Fill a Position

Metropolis Health System (MHS) uses a basic work week of 40 hours throughout the sys-
tem. Thus, one full-time employee works 40 hours per week. MHS also uses a standard 24-
hour scheduling system of three 8-hour shifts. The Director of Nursing needs to compute
the staffing requirements to fill the Operating Room positions. Since MHS is a trauma cen-
ter the OR is staffed 24 hours a day, 7 days a week. At present, staffing is identical for all
seven days of the week, although the Director of Nursing is questioning the efficiency of
this method.

The Operating Room department is staffed with two nursing supervisors on the day shift
and one nursing supervisor apiece on the evening and night shifts. There are two techni-
cians on the day shift, two technicians on the evening shift, and one technician on the night
shift. There are three RNs on the day shift, two RNs on the evening shift, and one RN plus
one LPN on the night shift. In addition, there is one aide plus one clerical worker on the
day shift only.

Require d

1. Set up a staffing requirements worksheet, using the format in Exhibit 9-4.
2. Compute the number of FTEs required to fill the Operating Room staffing positions.

Chapter 9 371

372 EXAMPLES AND EXERCISES, SUPPLEMENTAL MATERIALS, AND SOLUTIONS

CHAPTER 10

Practice Exercise 10–I: Components of Balance Sheet and Statement of Net Income

Financial statements for Doctors Smith and Brown are provided below. Use the doctors’ bal-
ance sheet, statement of revenue and expenses, and statement of capital for this assignment.

Require d

Identify the following doctors’ balance sheet and statement of net income components. List
the name of each component and its amount(s) from the appropriate financial statement.

Current Liabilities
Total

Assets

Income from Operations
Accumulated Depreciation
Total Operating Revenue
Current Portion of Long-Term Debt
Interest Income
Inventories

Assignment Exercise 10–1: Components of Balance Sheet and Statement
of Net Income

Refer to the Metropolis Health System (MHS) supplemental information at the back of the
Examples and Exercises section. Use the MHS comparative balance sheet, statement of rev-
enue and expenses, and statement of fund balance for this assignment.

Require d

Identify the following MHS balance sheet components. List the name of each component
and its amount(s) from the appropriate MHS financial statement.

Current Liabilities
Total Assets
Income from Operations
Accumulated Depreciation
Total Operating Revenue
Current Portion of Long-Term Debt
Interest Income
Inventories

Doctors Smith and Brown:
Statement of Net Income

for the Three Months Ended March 31, 2___

Revenue
Net patient service revenue 180,000
Other revenue -0-

Total Operating Revenue 180,000

Expenses
Nursing/PA salaries 16,650
Clerical salaries 10,150
Payroll taxes/employee benefits 4,800
Medical supplies and drugs 15,000
Professional fees 3,000
Dues and publications 2,400
Janitorial service 1,200
Office supplies 1,500
Repairs and maintenance 1,200
Utilities and telephone 6,000
Depreciation 30,000
Interest 3,100
Other 5,000

Total Expenses 100,000

Income from Operations 80,000

Nonoperating Gains (Losses)
Interest Income -0-

Nonoperating Gains, Net -0-

Net Income 80,000

Chapter 10 373

374 EXAMPLES AND EXERCISES, SUPPLEMENTAL MATERIALS, AND SOLUTIONS

Doctors Smith and Brown
Balance Sheet
March 31, 2___

Assets
Current Assets

Cash and cash equivalents 25,000
Patient accounts receivable 40,000
Inventories—supplies and drugs 5,000

Total Current Assets 70,000

Property, Plant, and Equipment
Buildings and Improvements 500,000
Equipment 800,000

Total 1,300,000
Less Accumulated Depreciation (480,000)
Net Depreciable Assets 820,000
Land 100,000

Property, Plant, and Equipment, Net 920,000

Other Assets 10,000

Total Assets 1,000,000

Liabilities and Capital

Current Liabilities
Current maturities of long-term 10,000

debt
Accounts payable and accrued 20,000

expenses

Total Current Liabilities 30,000

Long-Term Debt 180,000
Less Current Portion of Long-Term Debt (10,000)
Net Long-Term Debt 170,000

Total Liabilities 200,000

Capital 800,000

Total Liabilities and Capital 1,000,000

Doctors Smith and Brown
Statement of Changes in Capital

for the Three Months Ended March 31, 2___

Beginning Balance $720,000
Net Income 80,000
Ending Balance $800,000

The MHS Balance Sheet

Example 10A: Components of Balance Sheet and Income Statement

The “Accounts Receivable (net)” in Exhibit 10-1 means the accounts receivable figure of
$250,000 on the balance sheet is net of the allowance for bad debts. If the allowance for bad
debts is raised on the balance sheet, then bad debt expense (a.k.a provision for doubtful ac-
counts) on the income statement (a.k.a. statement of revenue and expense) also rises.
Think of these two accounts as a pair.

Practice Exercise 10–II: Components of Balance Sheet and Income Statement

Refer to Doctors Smith and Brown’s balance sheet, where patient accounts receivable is
stated at $40,000. Do you think this figure is net of an allowance for bad debts?

Assignment Exercise 10–2: Components of Balance Sheet and Income Statement

Refer to the Metropolis Health System (MHS) balance sheet and statement of revenue and
expense in Chapter 25’s MHS Case Study. Patient accounts receivable of $7,400,000 is
shown as net of $1,300,000 allowance for bad debts (8,700,000 � 1,300,000 � 7,400,000).
(a) What percent of gross accounts receivable is the allowance for bad debts? (b) If the al-
lowance for bad debts is raised to $1,500,000, where does the extra $200,000 go?

Example 10B: Components of Balance Sheet and Income Statement

Refer to Exhibit 10-1 and Exhibit 10-2’s Westside Clinic statements. The “Property, Plant,
and Equipment (net)” total in Exhibit 10-1 means the property, plant, and equipment fig-
ure of $360,000 on the balance sheet is net of the reserve for depreciation. If the reserve
for depreciation is raised on the balance sheet, then the depreciation expense on the in-
come statement (a.k.a. statement of revenue and expense) also rises. Think of these two ac-
counts as another pair.

Practice Exercise 10–III: Components of Balance Sheet and Income Statement

Refer to Doctors Smith and Brown’s balance sheet, where buildings and equipment are
both stated as net (the $820,000 figure), but land is not. Do you recall why this is so?

Assignment Exercise 10–3: Components of Balance Sheet and Income Statement

Refer to the Metropolis Health System (MHS) balance sheet and statement of revenue and
expense in Chapter 25’s MHS Case Study. Property, plant, and equipment of $19,300,000 is
shown as “net,” meaning net of the reserve for depreciation. If the $19,300,000 is reduced
by $200,000 (meaning the reserve for depreciation has risen), what happens on the income
statement?

Chapter 10 375

376 EXAMPLES AND EXERCISES, SUPPLEMENTAL MATERIALS, AND SOLUTIONS

CHAPTER 11

Example 11A

To better understand how the information for the numerator and the denominator of
each calculation is obtained, Figure 11-1, “Examples of Liquidity Ratio Calculations,” il-
lustrates the process. This figure takes the balance sheet and the statement of revenue and
expense that were discussed in the preceding chapter and illustrates the source of each fig-
ure in the four liquidity ratios. The multiple computations in days cash on hand and in
days receivables are further broken out into a three-step process to better illustrate sources
of information.

Practice Exercise 11–I: Liquidity Ratios

Two of the liquidity ratios are illustrated in this practice exercise. Refer to Doctors Smith
and Brown’s financial statements presented in the preceding Chapter 10.

Required

1. Set up a worksheet for the current ratio and the quick ratio.
2. Compute the ratios for Doctors Smith and Brown.

Assignment Exercise 11–1: Liquidity Ratios

Refer to the Metropolis Health System (MHS) case study in Chapter 25.

Require d

1. Set up a worksheet for the liquidity ratios.
2. Compute the four liquidity ratios using the Chapter 25 MHS financial statements.

Example 11B

To better understand how the information for the numerator and the denominator of each
calculation is obtained, Figure 11-2, “Examples of Solvency and Profitability Ratio Calcula-
tions,” illustrates the process. This figure takes the balance sheet and the statement of rev-
enue and expense that were discussed in the preceding chapter and illustrates the source of
each figure in the two solvency ratios. Any multiple computations are further broken out to
better explain sources of information.

Practice Exercise 11–II:

Solvency Ratios

Refer to Doctors Smith and Brown’s financial statements presented in the preceding Chap-
ter 10.

Require d

1. Set up a worksheet for the solvency ratios.

2. Compute these ratios for Doctors Smith and Brown. To do so, you will need one ad-
ditional piece of information that is not present on the doctors’ statements: their
maximum annual debt service is $22,200.

Assignment Exercise 11–2: Solvency Ratios

Refer to the Metropolis Health System (MHS) case study in Chapter 25.
Require d

1. Set up a worksheet for the liquidity ratios.
2. Compute the solvency ratios using the Chapter 25 MHS financial statements.

Example 11C

To better understand how the information for the numerator and the denominator of each
calculation is obtained, study Figure 11-2, “Examples of Solvency and Profitability Ratio Cal-
culations.” This figure takes the balance sheet and the statement of revenue and expense
that were discussed in the preceding chapter and illustrates the source of each figure in the
two profitability ratios. Any multiple computations are further broken out to better explain
sources of information.

Practice Exercise 11–III: Profitability Ratios

Refer to Doctors Smith and Brown’s financial statements presented in the preceding Chap-
ter 10.
Require d

1. Set up a worksheet for the profitability ratios.
2. Compute these ratios for Doctors Smith and Brown. All the necessary information is

present on the doctors’ statements.
[Hint: “Operating Income (Loss)” is also known as “Income from Operations.”]

Assignment Exercise 11–3: Profitability Ratios

Refer to the Metropolis Health System (MHS) case study in Chapter 25.
Require d

1. Set up a worksheet for the liquidity ratios.
2. Compute the profitability ratios using the Chapter 25 MHS financial statements.

Chapter 11 377

378 EXAMPLES AND EXERCISES, SUPPLEMENTAL MATERIALS, AND SOLUTIONS

CHAPTER 12

Example 12A: Unadjusted Rate of Return

A s s u m p t i o n s :

• Average annual net income �

$100,000

• Original investment amount � $1,000,000
• Unrecovered asset cost at the end of useful life (salvage value) � $100,000

Calculation using original investment amount:

$100,000

$1,000,000
� 10% Unadjusted Rate of Return

Calculation using average investment amount:

First Step: Compute average investment amount for total unrecovered asset cost.

At beginning of estimated useful life � $1,000,000
At end of estimated useful life � $ 100,000

Sum $1,100,000

Divided by 2 � $550,000 average investment amount

Second Step: Calculate unadjusted rate of return.

$100,000

$550,000
� 18.2% Unadjusted Rate of Return

Practice Exercise 12–I: Unadjusted Rate of Return

A s s u m p t i o n s :

• Average annual net income � $100,000
• Original investment amount � $500,000
• Unrecovered asset cost at the end of useful life (salvage value) � $50,000

Required

1. Compute the unadjusted rate of return using the original investment amount.
2. Compute the unadjusted rate of return using the average investment method.

Assignment Exercise 12–1: Unadjusted Rate of Return

Metropolis Health Systems’ Laboratory Director expects to purchase a new piece of equip-
ment. The assumptions for the transaction are as follows:

• Average annual net income � $70,000
• Original investment amount � $410,000
• Unrecovered asset cost at the end of useful life (salvage value) � $41,000

Require d
1. Compute the unadjusted rate of return using the original investment amount.
2. Compute the unadjusted rate of return using the average investment method.

Example 12B: Finding the Future Value (with a Compound Interest Table)

Betty Dylan is Director of Nurses at Metropolis Health System. Her oldest son will be enter-
ing college in five years. Today Betty is trying to figure what his college fund will amount to
in five more years. (Hint: Compound interest means interest is not only earned on the prin-
cipal, but also is earned on the previous interest earnings that have been left in the account.
Interest is thus compounded.)

The college fund savings account presently has a balance of $9,000 and any interest
earned over the next five years will be left in the account. Betty assumes the annual interest
rate will be 6 percent. How much money will be in the account at the end of five more years?

Solution to Example

Step 1. Refer to the Compound Interest Table found in Appendix 12-B at the back of
this chapter. Reading across, or horizontally, find the 6% column. Reading
down, or vertically, find Year 5. Trace across the Year 5 line item to the 6% col-
umn. The factor is 1.338.

Step 2. Multiply the current savings account balance of $9,000 times the factor of 1.338
to find the future value of $12,042. In five years at compound interest of 6% the
college fund will have a balance of $12,042.

Practice Exercise 12–II: Finding the Future Value (with a Compound Interest Table)

Assume the college savings fund in the preceding example presently has a balance of
$11,000 and any interest earned will be left in the account. Assume the annual interest rate
will be 7%.

Required

Compute how much money will be in the account at the end of six more years. (Use the Fu-
ture Value or Compound Interest Table found at the back of this chapter.)

Assignment Exercise 12–2: Finding the Future Value
(with a Compound Interest Table)

John Whitten is one of the physicians on staff at Metropolis Health System. His practice is
six years old. He has set up an office savings account to accumulate the funds to replace
equipment in his practice. Today John is trying to figure what his equipment fund will
amount to in four more years.

The equipment fund savings account presently has a balance of $63,500 and any interest
earned over the next four years will be left in the account. John assumes the annual interest
rate will be 5 percent. How much money will be in the account at the end of four more years?

Chapter 12 379

380 EXAMPLES AND EXERCISES, SUPPLEMENTAL MATERIALS, AND SOLUTIONS

Required

Compute how much money will be in the account at the end of four more years. (Use the
Future Value or Compound Interest Table found at the back of this chapter.)

Example 12C: Finding the Present Value (with a Present Value Table)

Betty Dylan is taking an adult education night course in personal finance at the community
college. The class is presently studying retirement planning. Each student is to estimate the
amount of funds (in addition to pension plans and social security) they believe will be
needed at retirement. Then they are to make a retirement plan.

Betty has estimated she would need $100,000 fifteen years from now. In order to com-
plete her assignment she needs to know the present value of the $100,000. Betty further as-
sumes an interest rate of 6 percent.

Solution to Example

Step 1. Refer to the Present Value Table found in Appendix 12-A at the back of this
chapter. Reading across, or horizontally, find the 6% column. Reading down, or
vertically, find Year 15. Trace across the Year 15 line item to the 6% column. The
factor is 0.4173.

Step 2. Multiply $100,000 times the factor of 0.4173 to find the present value of $41,730.

Practice Exercise 12–III: Finding the Present Value (with a Present Value Table)

Betty isn’t finished with her assignment. Now she wants to find the present value of $150,000
accumulated fifteen years from now. She further assumes a better interest rate of 7 percent.

Require d

Compute the present value of $150,000 accumulated fifteen years from now. Assume an in-
terest rate of 7 percent. (Use the Present Value Table found at the back of this chapter.)

Assignment Exercise 12–3: Finding the Present Value (with a Present Value Table)

Part 1—Dr. John Whitten is still figuring out his equipment fund. According to his calcula-
tions he needs $250,000 to be accumulated six years from now. John is now trying to find
the present value of the $250,000. He continues to assume an interest rate of 5 percent.

Require d

Compute the present value of $250,000 accumulated fifteen years from now. Assume an in-
terest rate of 5 percent. (Use the Present Value Table found at the back of this chapter.)

Part 2—John doesn’t like the answer he gets. What if he can raise the interest rate to
7 percent? How much difference would that make?

Require d

Compute the present value of $250,000 accumulated fifteen years from now assuming an
interest rate of 7 percent. Compare the difference between this amount and the present
value at 5 percent.

Example 12D: Internal Rate of Return

Review the chapter text to follow the steps set out to compute the internal rate of return.

Practice Exercise 12–IV: Internal Rate of Return

Metropolis Health System (MHS) is considering purchasing a tractor to mow the grounds.
It would cost $16,950 and have a 10-year useful life. It will have zero salvage value at the end
of 10 years. The head of the MHS grounds crew estimates it would save $3,000 per year. He
figures this savings because just one of the present maintenance crew would be driving the
tractor, replacing the labor of several men now using small household-type lawn mowers.
Compute the internal rate of return for this proposed acquisition.

Assignment Exercise 12–4: Computing an Internal Rate of Return

Dr. Whitten has decided to purchase equipment that has a cost of $60,000 and will produce
a pretax net cash inflow of $30,000 per year over its estimated useful life of six years. The
equipment will have no salvage value and will be depreciated by the straight-line method.
The tax rate is 50%. Determine Dr. Whitten’s approximate after-tax internal rate of return.

Example 12E: Payback Period

Review the chapter text and follow the Doctor Green detailed example of payback period
computation.

Practice Exercise 12–V: Payback

The MHS Chief Financial Officer is considering a request by the Emergency Room depart-
ment for purchase of new equipment. It will cost $500,000. There is no trade-in. Its useful
life would be 10 years. This type of machine is new to the department but it is estimated that
it will result in $84,000 annual revenue and operating costs would be one quarter of that
amount. The CFO wants to find the payback period for this piece of equipment.

Assignment Exercise 12–5: Payback Period

The MHS Chief Financial Officer is considering alternate proposals for the hospital Radi-
ology department. The Director of Radiology has suggested purchasing one of two pieces
of equipment. Machine A costs $15,000 and Machine B costs $12,000. Both machines are
estimated to reduce radiology operating costs by $5,000 per year.

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382 EXAMPLES AND EXERCISES, SUPPLEMENTAL MATERIALS, AND SOLUTIONS

Require d

Which machine should be purchased? Make your payback calculations to provide the answer.

CHAPTER 13

Example 13A: Common Sizing

Common sizing converts numbers to percentages so that comparative analysis can be per-
formed. Reread the chapter text about common sizing and examine the percentages shown
in Table 13-1.

Practice Exercise 13–I: Common Sizing

The worksheet below shows the assets of two hospitals.

Require d

Perform common sizing for the assets of the two hospitals.

Same Year for Both Hospitals
Hospital A Hospital B

Current Assets $ 2,000,000 $ 8,000,000
Property, Plant, & Equipment 7,500,000 30,000,000
Other Assets 500,000 2,000,000
Total Assets $10,000,000 $40,000,000

Assignment Exercise 13–1: Common Sizing

Refer to the Metropolis Health System (MHS) comparative financial statements at the back
of the Examples and Exercises section.

Require d

Common size the MHS statement of revenue and expenses.

Example 13B: Trend Analysis

Trend analysis allows comparison of figures over time. Reread the chapter text about trend
analysis and examine the difference columns shown in Table 13-3.

Practice Exercise 13–II: Trend Analysis

The worksheet below shows the assets of Hospital A over two years.

Require d

Perform trend analysis for the assets of Hospital A.

Hospital A
Year 1 Year 2

Current Assets $1,600,000 $ 2,000,000
Property, Plant, & Equipment 6,000,000 7,500,000
Other Assets 400,000 500,000
Total Assets $8,000,000 $10,000,000

Assignment Exercise 13–2: Trend Analysis

Refer to the Metropolis Health System (MHS) comparative financial statements at the back
of the Examples and Exercises section.
Require d

Perform trend analysis on the MHS statement of revenue and expenses.

Practice Exercise 13–III: Contractual Allowance

A s s u m p t i o n s :

1. Your unit’s gross charges for the period to date amount to $200,000.
2. The uniform gross charge for each procedure in your unit is $100.00.
3. The unit receives revenue from four major payers. For purposes of this exercise, as-

sume the revenue volume from each represents 25% of the total. (The equal propor-
tion is unrealistic, but serves the purpose for this exercise.)

4. The following contractual payment arrangements are in effect for the current period.
The percentage of the gross charge that is currently paid by each payer is as follows:
Payer 1 � 90%
Payer 2 � 80%
Payer 3 � 70%
Payer 4 � 50%

Q: How many procedures has your unit recorded for the period to date?

Q: Of these, how many procedures are attributed to each payer?

Q: How much is the net revenue per procedure for each payer, and how much is the
contractual allowance per procedure for each payer?

Assignment Exercise 13–3

As a follow-up to the Practice Exercise above, new assumptions are as follows:
1. Your unit’s gross charges for the period to date amount to $200,000.
2. The uniform gross charge for each procedure in your unit is $100.00.

Chapter 13 383

384 EXAMPLES AND EXERCISES, SUPPLEMENTAL MATERIALS, AND SOLUTIONS

3. The unit receives revenue from four major payers. The number of procedures per-
formed for the period totals 2,000. Of that total, the number of procedures per payer
(stated as a percentage) is as follows:
Payer 1 � 30%
Payer 2 � 40%
Payer 3 � 20%
Payer 4 � 10%

4. The following contractual payment arrangements are in effect for the current period.
The percentage of the gross charge that is currently paid by each payer is as follows:
Payer 1 � 80% [Medicare]
Payer 2 � 70% [Commercial managed care plans]
Payer 3 � 50% [Medicaid]
Payer 4 � 90% [Self-pay]

Q: How many procedures are attributed to each payer?

Q: How much is the net revenue per procedure for each payer, and how much is the con-
tractual allowance per procedure for each payer?

Q: How much is the total net revenue for each payer, and how much is the total con-
tractual allowance for each payer?

Assignment Exercise 13–4.1: Forecast Capacity Levels

Review the information in Exhibit 13-1 “Capacity Level Checkpoints for an Outpatient In-
fusion Center.” The exhibit assumes three chairs and one 40-hour RN, for a realistic capac-
ity level of seven patients infused per day.

Require d

Prepare another Infusion Center Capacity Level Forecast as follows:
Assume the same three infusion chairs, but add another nurse for either four or six

hours per day. How would this change the daily capacity level for number of patients in-
fused per day?

Assignment Exercise 13–4.2

Require d

Prepare another Infusion Center Capacity Level Forecast as follows:
Increase the number of infusion chairs to four, and add another nurse for either four or

six hours per day. How would this change the daily capacity level for number of patients in-
fused per day?

CHAPTER 14

Assignment Exercise 14–1: Comparable Data in a Graph

Review Figures 14-1 through 14-5. Each of the five figures presents a graph depicting some
type of comparative data.

Required

Locate healthcare information that can reasonably be compared. (1) Prepare your com-
parative data. (2) Using your data, create one or more graphs similar to those found in Fig-
ures 14-1 through 14-5.

Assignment Exercise 14–2: Cumulative Inflation Factor for Comparable Data

Review Table 14-3 and the accompanying text.

A s s u m p t i o n s :

Two hospitals report their annual projected revenue for five years to the local newspaper
for a story on the area’s future economic outlook. However, Hospital 1 has applied a cu-
mulative inflation factor of five percent per year while Hospital 2 has not applied any infla-
tion factor. Thus the information is not properly comparable.

Projected Revenue

Year 1 Year 2 Year 3 Year 4 Year 5

Hospital 1 $20,000,000 $22,500,000 $27,500,000 $27,500,000 $30,000,000

Hospital 2 $20,000,000 $21,000,000 $25,000,000 $24,000,000 $26,000,000

Require d

Revise Hospital 2’s projections by applying a cumulative inflation factor of five percent per
year.

Assignment Exercise 14–3

The head of your department is a prominent researcher. A health research foundation has
asked him travel to London to give an important speech at a conference. He will then travel
to Paris to tour a research facility before returning home. Although his travel expenses are
being funded by the foundation, he will still need to take along some personal money. Con-
sequently, he asks you to figure the exchange rates for $500 and for $1,000 in both pounds
and euros. He explains that he is trying to judge the spending power of U.S. dollars when
converted to the other currencies so he can decide how much personal money to take on
the trip.

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386 EXAMPLES AND EXERCISES, SUPPLEMENTAL MATERIALS, AND SOLUTIONS

Require d

Locate the current exchange rates for pounds and euros and compute the currency con-
version for $500 and for $1,000.

Assignment Exercise 14–4: The Discovery

The Chief Financial Officer at Sample Hospital has just discovered that the hospital’s Chief
of the Medical Staff’s son Jason, a student at the local community college, is paid $100 per
week year round for grounds maintenance at the hospital’s Outpatient Center.

The CFO, no fan of the Chief of Medical Staff, now wants you to prepare a report that
compares the relative costs of lawn care at each of three locations; the hospital itself, the
outpatient center, and the hospital-affiliated nursing home down the block.

Require d

Review the available information for grounds maintenance at the three facilities. Decide
how to convert this information into comparable data. Then prepare a report, based on
your assumptions, that presents comparable costs of grounds care. Also provide your as-
sessment of what the best future course of action should be.

Relevant Information

So far you have assembled the following information. Now you need to decide how it can
be converted into comparable data.

Introduction to the Three Facilities

Sample Hospital is an older 100-bed hospital. The new Outpatient Center, built last year, is
across the street and the Golden Age Nursing Facility is down one block, on the corner. All
three facilities are part of the Metropolis Health System. (Appendix 25-A contains some fi-
nancial details about Sample Hospital.) The hospital is located in the midwestern sunbelt;
there is occasional frost in the winter but no snow.

Grounds Maintenance Tasks That Should Be Performed at All Three Sites

• Mowing and edging
• Walk sweeping
• Raking leaves
• Blowing off parking lot
• Flower bed maintenance (where necessary)
• Hedge trimming and minor tree pruning (major tree trimming is performed by a

contractor on an as-needed basis and thus should be disregarded)

Figure Ex-1 provides a map that illustrates the layout of the grounds for each facility and
their proximity to each other.

Grounds Maintenance Arrangements for the Three Facilities

The current grounds maintenance arrangements vary among the three facilities as follows:
1. Sample Hospital uses its Maintenance department employees for grounds care. The

hospital pays these employees $15 per hour plus 15% employee benefits; it is estimated they
spend 1,000 hours per year on grounds maintenance work. Another estimated 120 hours
per year are spent on maintaining the lawn care equipment. The employees use a riding
lawn mower, edger, and blower, all owned by the hospital. The hospital just bought a new
mower for $2,995 less a ten percent discount. It is expected that the mower should last for
five years.

2. The hospital’s Chief of the Medical Staff’s son Jason, a student at the local community
college, is paid $100 per week year round for grounds maintenance at the hospital’s Out-
patient Center. A friend sometimes helps, but when that happens Jason pays him out of his
weekly $100. It takes about one-and-a-half hours to mow, edge, and blow. Jason uses his
dad’s riding mower and blower, but Jason recently bought his own edger. Jason also buys
fertilizer for the grass twice a year.

3. The Nursing Facility contracts with a landscape service on a seasonally adjusted sliding
scale. The landscape service is paid $600 per month from April to October (mowing season);
$400 per month for February, March, and November; and $200 per month for November,

Chapter 14 387

Parking

E
n
tra

n
ce

Golden Age Center

Service

Jefferson Street

Washington Street

Jackson Street

7
th

A
ve

n
u
e

8
th

A
ve
n
u
e

9
th

A
ve
n
u
e

Outpatient

Parking

Sample Hospital

Parking

T
re

e
s

Figure Ex–1 Sample Hospital Map

388 EXAMPLES AND EXERCISES, SUPPLEMENTAL MATERIALS, AND SOLUTIONS

December, and January. The landscape service provides all their own equipment. They also
provide fertilizer and provide annuals to plant in the flower beds every quarter.

Sample Hospital Property Description

The grounds to be maintained are as follows:

• The front lawn is grass in two sections on either side of the front entrance. Each sec-
tion is about 50� by 60�.

• There is a hedge along the front of the building that is about 50� on either side of the
front entrance.

• There are two small matching flower beds on either side of the front entrance.
• Another strip of grass alongside of the building is 30� by 100�.
• A third small strip of grass about 5� by 25� is by the Emergency entrance.
• The walkway dimensions are as follows: about 50� of front walk; about 30� of staff en-

trance walk, both of which are 5� wide.
• The Emergency Department’s paved patient drop-off area is about 25� by 30�.
• The parking lot surface is about 200� by 250�. Along one side are overhanging trees

that drop leaves and debris and are a constant sweeping problem. These are the only
trees on the hospital site.

Outpatient Center Property Description

The grounds to be maintained are as follows:

• There is a strip of grass at the front of the building that is 12� wide and 65� long, split
in the middle by a walkway 5� wide.

• There is a strip of grass at the back of the building between the building and the park-
ing lot that is 5� wide and 50� long

• All the rest of the property is paved.

Nursing Center Property Description

Golden Age Nursing Center occupies one whole block. The grounds have many large trees.
Flowerbeds have been planted around the trees as well as along the front walk and en-
trance. There are also two secured patio areas at the side of the building, screened by
hedges, and each has a small bed of annuals. Because of the unique design of the building,
grounds maintenance requires considerable handwork such as edging with a weed eater.

CHAPTER 15

Example 15A: Budgeting

A static budget is based on a single level of operations, which is never adjusted. Therefore,
the static budgeted expense amounts will not change, even though actual volume does
change during the year.

The computation of a static budget variance only requires one calculation, as follows:

Actual Static Budget Static Budget
Results

minus
Amount

equals
Variance

We can set up the example in the chapter text in this format as follows:
Use patient days as an example of level of volume, or output. Assume that the budget an-

ticipated 40,000 patient days this year at an average of $600 revenue per day, or $2,400,000.
Further assume that expenses were budgeted at $560 per patient day, or $22,400,000. The
budget would look like this:

As Budgeted

Revenue $24,000,000
Expenses 22,400,000
Excess of Revenue over Expenses $1,600,000

Now assume that only 36,000, or 90%, of the patient days are going to actually be
achieved for the year. The average revenue of $600 per day will be achieved for these 36,000
days (thus 36,000 times 600 equals 21,600,000). Further assume that, despite the best ef-
forts of the Chief Financial Officer, the expenses will amount to $22,000,000. The actual re-
sults would look like this:

Actual

Revenue $21,600,000
Expenses 22,000,000
Excess of Expenses over Revenue $ (400,000)

The budgeted revenue and expenses still reflect the original expectation of 40,000 pa-
tient days; the budget report would look like this:

Static Budget
Actual Budget Variance

Revenue $21,600,000 $24,000,000 $(2,400,000)
Expenses 22,000,000 22,400,000 (400,000)
Excess of Expenses over Revenue $ (400,000) $ 1,600,000 $(2,000,000)

Note: The negative actual result of (400,000) combined with the positive budget expecta-
tion of 1,600,000 amounts to the negative net variance of (2,000,000).

This example has shown a static budget, geared toward only one level of activity and re-
maining constant or static.

Practice Exercise 15–I: Budgeting

Budget assumptions for this exercise include both inpatient and outpatient revenue and ex-
pense.

Assumptions are as follows:

As to the initial budget:

Chapter 15 389

390 EXAMPLES AND EXERCISES, SUPPLEMENTAL MATERIALS, AND SOLUTIONS

• The budget anticipated 30,000 inpatient days this year at an average of $650 revenue
per day.

• Inpatient expenses were budgeted at $600 per patient day.
• The budget anticipated 10,000 outpatient visits this year at an average of $400 revenue

per visit.
• Outpatient expenses were budgeted at $380 per visit.

As to the actual results:

• Assume that only 27,000, or 90%, of the inpatient days are going to actually be
achieved for the year.

• The average revenue of $650 per day will be achieved for these 270,000 inpatient days.
• The outpatient visits will actually amount to 110%, or 11,000 for the year.
• The average revenue of $400 per visit will be achieved for these 11,000 visits.
• Further assume that, due to the heroic efforts of the Chief Financial Officer, the ac-

tual inpatient expenses will amount to $11,600,000 and the actual outpatient expenses
will amount to $4,000,000.

Required

1. Set up three worksheets that follow the format of those in Example 15A. However, in
each of your worksheets make two lines for revenue; label one as Revenue-Inpatient
and the other Revenue-Outpatient. Add a Revenue Subtotal line. Likewise, make two
lines for expense; label one as Expense-Inpatient and the other Expense-Outpatient.
Add an Expense Subtotal line.

2. Using the new assumptions, complete the first worksheet for “As Budgeted.”
3. Using the new assumptions, complete the second worksheet for “Actual.”
4. Using the new assumptions, complete the third worksheet for “Static Budget Vari-

ance.”

Assignment Exercise 15–1: Budgeting

Select an organization; either Metropolis Health System from the Chapter 25 Case Study or
one of the organizations presented in the Mini-Case Studies in Chapters 26–28.

Require d

1. Using the organization selected, create a budget for the next fiscal year. Set out the
details of all assumptions you needed in order to build this

budget.

2. Use the “Checklist for Building a Budget” (Exhibit 15-2) and critique your own
budget.

Assignment Exercise 15–2: Budgeting

Find an existing budget from a published source. Detail should be extensive enough to
present a challenge.

Require d

1. Using the existing budget, create a new budget for the next fiscal year. Set out the de-
tails of all the assumptions you needed in order to build this budget.

2. Use the “Checklist for Building a Budget” (Exhibit 15-2) and critique your own effort.
3. Use the “Checklist for Reviewing a Budget” (Exhibit 15-1) and critique the existing

budget.

Assignment Exercise 15–3: Transactions outside the Operating Budget

Review Figure 15-2 and the accompanying text.
Metropolis Health System has received a wellness grant from the charitable arm of an

area electronics company. The grant will run for twenty-four months, beginning at the first
of the next fiscal year. Two therapists and two registered nurses will each be spending half
of their time working on the wellness grant. All four individuals are full-time employees of
MHS. The electronics company has only recently begun to operate the charitable organi-
zation that awarded the grant. While they have gained all the legal approvals necessary, they
have not yet provided the manuals and instructions for grant transactions that MHS usually
receives when grants are awarded. Consequently, guidance about separate accounting is
not yet forthcoming from the grantor.

Require d

How would you handle this issue on the MHS operating budget for next year?

Assignment Exercise 15–4: Identified versus Allocated Costs in Budgeting

Review Figure 15-3 and the accompanying text.
Metropolis Health System is preparing for a significant upgrade in both hardware and

software for its information systems. As part of the project, the Chief of Information Oper-
ations (CIO) has indicated that the Information Systems (IS) department can change the
format of the MHS operating budgets and related reports before the operating budget is
constructed for the coming fiscal year. The Chief Financial Officer (CFO) has long wanted
to modify what costs are identified and what costs are allocated (along with the method of
allocation). This is a golden opportunity to do so. To gain ammunition for the change, the
CFO is preparing to conduct a survey. The survey will obtain a variety of suggestions for po-
tential changes in allocation methods for the new operating budget report formats. You
have been selected as one of the employees who will be surveyed.

Require d

You may choose your role for this assignment, as follows:
Refer to the “MHS Executive-Level Organization Chart” (Figure 25-2 in the MHS Case

Study). (1) Either (a) choose any type of patient service that would be under the direction

Chapter 15 391

392 EXAMPLES AND EXERCISES, SUPPLEMENTAL MATERIALS, AND SOLUTIONS

of the Senior Vice President of Service Delivery Operations or (b) choose any other func-
tion shown on the organization chart. (Your function could be a whole department or a di-
vision or unit of that department. For example, you might choose Community Outreach or
Human Resources Operations or the Emergency department, etc.) (2) Make up your own
organization chart for other employee levels within the function you have chosen. (3) Now
make up another chart that indicates the operating budget costs you think would be mostly
identifiable for the department or unit or division you have chosen and what other operat-
ing budget costs you think would be mostly allocated to it. (You may use Figure 15-3 as a
rough guide, but do not let it limit your imagination. Model the detail on your “identifiable
versus allocated costs” chart after a real department if you so choose.) Use MHS hospital
statistics shown in Exhibit 25-8 of the MHS Case Study as a basis for allocation if these sta-
tistics are helpful. If they are not, make a note of what other statistics you would like to have.

Note: As an alternative approach, you may choose a function from the “Nursing Practice
and Administration Organization Chart” as shown in Figure 25-1 of the MHS Case Study in-
stead of choosing from the Executive-Level Organization Chart.

CHAPTER 16

Example 16A: Description of Capital Expenditure Proposals Scoring System

Worthwhile Hospital has a total capital expenditure budget for next year of five million dol-
lars. Of this amount, three million is already committed as spending for capital assets that
have already been acquired and are in place. The remaining two million dollars is available
for new assets and for new projects or programs.

Worthwhile Hospital typically divides the available capital expenditure funds into monies
available for inpatient purposes and monies available for outpatient purposes. This year the
split is proposed to be 50-50.

The hospital’s CFO is also proposing that a scoring system be used to evaluate this year’s
proposals. She has set up a scoring system that allows a maximum of five points. Thus the
low is a score of one point and the high is a score of five points.

In addition to the points earned by a funding proposal, the CFO will allow one “bonus
point” for upgrading existing equipment and one “bonus point” for funding expansion of
existing programs.

Practice Exercise 16–I: Capital Expenditure Proposals

Jody Smith, the director who supervises the Intensive Care Units, wants to secure as much
of the one million dollars available for inpatient purposes as is possible for the ICU. At the
same time Ted Jones, the director who supervises the Surgery Unit, also wants to secure as
much of the one million dollars available for inpatient purposes as is possible for his
Surgery Unit.

Given the CFO’s new scoring system, how should Jody go about choosing exactly what to
request?

Assignment Exercise 16–1: Capital Expenditure Proposals

Ted Jones, the Surgery Unit Director, is about to choose his strategy for creating a capital
expenditure funding proposal for the coming year. Ted’s unit needs more room. The
Surgery Unit is running at over 90% capacity. In addition, a prominent cardiology surgeon
on staff at the hospital wants to create a new cardiac surgery program that would require
extensive funding for more space and for new state-of-the-art equipment. The surgeon has
been campaigning with the hospital board members.

Require d

What should Ted decide to ask for? How should he go about crafting a strategy to justify his
request, given the hospital’s new scoring system?

CHAPTER 17

Example 17A: Variance Analysis

Our variance analysis example and practice exercise use the flexible budget approach. A
flexible budget is one that is created using budgeted revenue and/or budgeted cost
amounts. A flexible budget is adjusted, or flexed, to the actual level of output achieved (or
perhaps expected to be achieved) during the budget period. A flexible budget thus looks
toward a range of activity or volume (versus only one level in the static budget).

Examples of how the variance analysis works are contained in Figure 17-1 (the ele-
ments), in Figure 17-2 (the composition), and in Figures 17-3 and 17-4 (the calculation).
Study these examples before undertaking the Practice Exercise.

Practice Exercise 17–I: Variance Analysis

Exhibit 17-4 presents a summary variance report for the nursing activity center of St. Joseph
Hospital for the month of September. For our practice exercise we will duplicate this report
for the month of March.

Assumptions are as follows:

• Actual Activity Level is 687,000.
• Budgeted Activity Level is 650,000.
• Actual Cost per RVU is $4.70.
• Budgeted Cost per RVU is $5.00.
• Actual Overhead Costs are $3,228,900.
• Budgeted Overhead Costs are $3,250,000.

Require d

1. Set up a worksheet for the month of March like that shown in Exhibit 17-4 for the
month of September.

2. Insert the March input data (per assumptions given above) on the worksheet.
3. Complete the “Actual Costs,” “Flexible Budget,” and “Budgeted Costs” sections at the

top of the worksheet.

Chapter 17 393

394 EXAMPLES AND EXERCISES, SUPPLEMENTAL MATERIALS, AND SOLUTIONS

4. Compute the price variance and the quantity variance in the middle of the worksheet.
5. Indicate whether the price and the quantity variances are favorable or unfavorable

for March.

O p t i o n a l

Can you compute how the $3,228,900 actual overhead costs and the $3,250,000 budgeted
overhead costs were calculated?

Assignment Exercise 17–1: Variance Analysis

Greenview Hospital operated at 120% of normal capacity in two of its departments during
the year. It operated 120% times 20,000 normal capacity direct labor nursing hours in rou-
tine services and it operated 120% times 20,000 normal capacity equipment hours in the
laboratory. The lab allocates overhead by measuring minutes and hours the equipment is
used; thus equipment hours.

Assumptions:
For Routine Services Nursing:

• 20,000 hours � 120% � 24,000 direct labor nursing hours.
• Budgeted Overhead at 24,000 hours � $42,000 fixed plus $6,000 variable � $48,000

total.
• Actual Overhead at 24,000 hours � $42,000 fixed plus $7,000 variable � $49,000 total.
• Applied Overhead for 24,000 hours at $2.35 � $56,400.

For Laboratory:

• 20,000 hours � 120% � 24,000 equipment hours.
• Budgeted Overhead at 24,000 hours � $59,600 fixed plus $11,400 variable � $71,000

total.
• Actual Overhead at 24,000 hours � $59,600 fixed plus $11,600 variable � $71,200

total.
• Applied Overhead for 24,000 hours at $3.455 � $82,920.

Require d

1. Set up a worksheet for applied overhead costs and volume variance with a column for
Routine Services Nursing and a second column for Laboratory.

2. Set up a worksheet for actual overhead costs and budget variance with a column for
Routine Services Nursing and a second column for Laboratory.

3. Set up a worksheet for volume variance and budget variance totaling net variance
with a column for Routine Services Nursing and a second column for Laboratory.

4. Insert input data from Assumptions.
5. Complete computations for all three worksheets.

Example 17B

Review the “Sensitivity Analysis Overview” section and Figure 17-5 in Chapter 17.

Assignment Exercise 17–2: Three-Level Revenue Forecast

Three eye-ear-nose-and-throat physicians decide to hire an experienced audiologist in
order to add a new service line to their practice.* They ask the practice manager to prepare
a three-level volume forecast as a first step in their decision-making.

Assumptions: for the base level (most likely) revenue forecast, assume $200 per proce-
dure times four procedures per day times five days equals 20 procedures per week times 50
weeks per year equals 1,000 potential procedures per year.

For the best case revenue forecast, assume an increase in volume of one procedure per
day average, for an annual increase of 250 procedures (5 days per week times 50 weeks
equals 250). (The best case is if the practice gains a particular managed care contract.)

For the worst case revenue forecast, assume a decrease in volume of two procedures per
day average, for an annual decrease of 500 procedures. (The worst case is if the practice
loses a major payer.)

*Audiologists were designated as “eligible for physician and other prescriber incentives” as
discussed in Chapter 20. Thus the new service line was a logical move.

Require d

Using the above assumptions, prepare a three-level forecast similar to the example in Fig-
ure 17-5 and document your calculations.

Practice Exercise 17–II

Closely study the chapter text concerning target operating income.
The necessary inputs for target operating income include the following:

• Desired (target) operating income amount � $20,000
• Unit price for sales � $500
• Variable cost per unit � $300
• Total fixed cost � $10,000

Compute the required revenue to achieve the target operating income and compute a
contribution income statement to prove the totals.

Assignment Exercise 17–3: Target Operating Income

Acme Medical Supply Company desires a target operating income amount of $100,000,
with assumption inputs as follows:

• Desired (target) operating income amount � $100,000
• Unit price for sales � $80
• Variable cost per unit � $60
• Total fixed cost � $60,000

Compute the required revenue to achieve the target operating income and compute a
contribution income statement to prove the totals.

Chapter 17 395

396 EXAMPLES AND EXERCISES, SUPPLEMENTAL MATERIALS, AND SOLUTIONS

CHAPTER 18

Assignment Exercise 18–1: Estimate of Loss

You are the practice manager for a four-physician office. You arrive on Monday morning to
find the entire office suite flooded from overhead sprinklers that malfunctioned over the
weekend. Water stands ankle-deep everywhere. The computers are fried and the contents
of all the filing cabinets are soaked. Your own office, where most of the records were stored,
has the worst damage.

The practice carries valuable papers insurance coverage for an amount up to $250,000.
It is your responsibility to prepare an estimate of the financial loss so that a claim can be
filed with the insurance company. How would you go about it? What would your summary
of the losses look like?

Assignment Exercise 18–2: Estimate of Replacement Cost

The landlord carries contents insurance that should cover the damage to the furnishings,
equipment, and to the computers, and the insurance company adjuster will come tomor-
row to assess the furnishings and equipment damage. However, your boss is sure that the in-
surance settlement will not cover replacement costs. Consequently, you have been
instructed to prepare an estimate of what has been lost and/or damaged plus an estimate of
what the replacement cost might be. How would you go about it? What would your sum-
mary of these losses look like?

Assignment Exercise 18–3: Benchmarking

Review the chapter text about benchmarking.

Require d

1. Select either the MHS case study in Chapter 25 or one of the organizations repre-
sented by a mini-case study in Chapters 27, 28, or 29.

2. Prepare a list of measures that could be benchmarked for this organization. Com-
ment on why these items are important for benchmarking purposes.

3. Find another example of benchmarking for a healthcare organization. The example
can be an organization report or it can be taken from a published source such as a
journal article.

Assignment Exercise 18–4: Pareto Rule

Review the chapter text about the Pareto rule and examine Figure 18-4. Note that the text
says Pareto diagrams are often drawn to reflect before and after results.

Assume that Figure 18-4 is the before diagram for the Billing department. Further as-
sume that the after results are as follows:

Activity Activity Code Number

Process Denied Bills PDB 12
Review with Supervisor RWS 10
Locate Documentation LD 6
Copy Documentation CD 5

33
Require d

1. Redo the Pareto diagram with the after results. (Use Figure 18-4 as a guide.)
2. Comment on the before and after results for the Billing department.

CHAPTER 19

Assignment Exercise 19–1: Physician Incentive Payments and Costs under ARRA

Refer to the description of physician incentives under the American Recovery and Reinvest-
ment Act of 2009 (ARRA) within the chapter text. See, for example, that the maximum
amount a physician can receive in year 1 is $15,000, except if the first year is 2011 or 2012 the
year 1 payment is $18,000, and so on. See also the definition of physicians who are “mean-
ingful electronic health records users” (and thus eligible for payment under this program).

Require d

Locate additional information about electronic health records systems that are being sold
to physicians based on their qualification under the ARRA program. Attempt to determine
what the net cost of hardware, software, and installation would be for an average physician
practice. Compare this cost with the payments that an eligible physician who is a meaning-
ful electronic health records user would receive over a five-year period. Determine the ap-
proximate net technology cost to the physician after such incentive payments.

As an extension of this assignment you might also determine what start-up costs other
than the technology costs may be incurred by the physician.

Assignment Exercise 19–2: Hospital Conversion to ICD-10

Try to locate sufficient detail about a healthcare organization; enough that you can per-
form a make-believe SWOT analysis about a conversion of electronic systems to ICD-10 as
required. Write a description of the organization’s background, including its information
system. (Add imaginary details if you need to.) This description will then lead into the ICD-
10 conversion’s situation analysis. Perform the make-believe SWOT analysis, using the four-
part format (internal strengths and weaknesses and external opportunities and threats).

As an alternative approach, you can use the Sample Hospital information in Appendix
25-A as a starting point and use your personal experience and observations to fill out the
rest of the details you would need in order to commence a make-believe SWOT analysis for
this hospital’s ICD-10 conversion.

Chapter 19 397

398 EXAMPLES AND EXERCISES, SUPPLEMENTAL MATERIALS, AND SOLUTIONS

CHAPTER 20

Practice Exercise 20–I

The productivity loss section of Chapter 20 describes how the dollar amount of such loss
was computed after determining that it took coders an extra 1.7 minutes per claim in the
first month of ICD-10 transition.

Assume a hospital’s coders are dealing with 1,500 claims within a certain period. What
would the dollar amount of productivity loss be if the coders took an extra two minutes (in-
stead of 1.7 minutes) per claim?

Assignment Exercise 20–1: Information about the ICD-10-CM and
ICD-10-PCS Transition

Require d

Locate some articles and/or government Web sites that describe the ICD-10-CM and ICD-
10-PCS diagnosis codes and tools for their implementation over a period of years. Write a
summary of whether the materials you have found fully explain the breadth and depth of
the transition challenge for managers who must live through the transition.

Assignment Exercise 20–2: Hospital Costs to Implement

Refer to the scenario entitled “ICD-10 Conversion Costs for a Midwestern Community Hos-
pital,” located in the Supplemental Materials section of this book.

Require d

Within this scenario the productivity loss for the six-month learning period is calculated to
be $1,233. Beginning with month one at $353 ($1.41 times 250 equals $353), compute the
cost of productivity loss for the remaining five months as explained in the scenario, to total
an overall amount of $1,233. Be prepared to show and explain your computations.

Later in the scenario CMS states that the hospital’s total cost amounts to $303,990. Study
the explanation and summarize the totals of each type of cost discussed. When you are fin-
ished your total should amount to $303,990. Be prepared to show and explain how you ar-
rived at this total.

CHAPTER 21

Assignment Exercise 21–1

Review the information about public companies and stock exchanges in the Chapter 21
text.

Require d

Obtain a copy of the Wall Street Journal. Locate the “Stock Tables” section of the Journal. Re-
view the column headings in the tables and locate the names of various stock exchanges

that are included in the findings. See if you can find the abbreviated names and the stock
exchange symbols for healthcare companies that are publicly held.

Alternatively, explore the Web sites of three or four publicly held healthcare organiza-
tions. Somewhere on the Web site they should identify their stock exchange symbol. Then
go onto a Web-based stock exchange listing of the market for the day, locate the symbols,
and determine their current stock prices according to the listing.

CHAPTER 22

Example 22A: Loan Amortization

This example illustrates the initial monthly payments of a loan with a principal balance of
50,000, an interest rate of ten percent, and a payment period of three years or thirty-six
months.
Loan Amortization Schedule
Principal borrowed: 50,000
Total payments: 36
Annual interest rate 10.00% (monthly rate � 0.8333%)

Principal Interest Expense Remaining
Payment Total Portion of Portion of Principal

# Payment Payment Payment Balance

Beginning balance � 50,000.00

1 1,613.36 1,196.69 416.67 48,403.31
2 1,613.36 1,206.67 406.69 47,596.64
3 1,613.36 1,216.72 396.64 46,379.92
4 1,613.36 1,226.86 386.50 45,153.06
5 1,613.36 1,237.08 376.28 43,915.98
6 1,613.36 1,247.39 365.97 42,668.58

Practice Exercise 22–I: Loan Amortization

This exercise illustrates a different principal amount than Example 22A, but computed at
the same monthly interest rate and the same number of payments.

Require d

Compute the first six months of a loan amortization schedule with a principal balance of
60,000, an interest rate of ten percent, and a payment period of three years or thirty-six
months.
Loan Amortization Schedule
Principal borrowed: 60,000
Total payments: 36
Annual interest rate 10.00% (monthly rate � 0.8333%)

Chapter 22 399

400 EXAMPLES AND EXERCISES, SUPPLEMENTAL MATERIALS, AND SOLUTIONS

Principal Interest Expense Remaining
Payment Total Portion of Portion of Principal
# Payment Payment Payment Balance

Beginning balance � 60,000.00

1
2
3
4
5
6

Assignment Exercise 22–1: Financial Statement Capital Structures

Require d

Find three different financial statements that have varying capital structures. Write a para-
graph about each that explains the debt-equity relationship and that computes the percent
of debt and the percent of equity represented.

Also note whether the percent of annual interest on debt is revealed in the notes to the
financial statements. If so, do you believe the interest rate is fair and equitable? Why?

CHAPTER 23

Practice Exercise 23–I: Cost of Leasing

A cost of leasing table is reproduced below.

Require d

Using the appropriate table from the Chapter 12 Appendices, record the present value fac-
tor at 6% for each year and compute the present value cost of leasing.

Cost of Leasing: Suburban Clinic—Comparative Present Value

Not-for-Profit Cost of Leasing: Year 0 Year 1 Year 2 Year 3 Year 4 Year 5

Net Cash Flow (11,000) (11,000) (11,000) (11,000) (11,000) —-
Present value factor (at 6%)
Present value answer �
Present value cost of leasing �

Assignment Exercise 23–1: Cost of Owning and Cost of Leasing

Cost of owning and cost of leasing tables are reproduced below.

Require d

Using the appropriate table from the Chapter 12 Appendices, record the present value fac-
tor at 10% for each year and compute the present value cost of owning and the present
value of leasing. Which alternative is more desirable at this interest rate? Do you think your
answer would change if the interest rate was six percent instead of ten percent?

Cost of Owning: Anywhere Clinic—Comparative Present Value

For-Profit Cost of Owning: Year 0 Year 1 Year 2 Year 3 Year 4 Year 5

Net Cash Flow (48,750) 2,500 2,500 2,500 2,500 5,000
Present value factor
Present value answers �
Present value cost of owning �

Cost of Leasing: Anywhere Clinic—Comparative Present Value

Line For-Profit Cost
# of Leasing: Year 0 Year 1 Year 2 Year 3 Year 4 Year 5

19 Net Cash Flow (8,250) (8,250) (8,250) (8,250) (8,250) —-
20 Present value factor
21 Present value answers �
22 Present value cost of leasing �

Assignment Exercise 23–2

Great Docs, a three-physician practice with two office sites, is considering whether to buy or
lease a new computer system. Currently they own a low-tech (and low-cost) information sys-
tem. The new system will have to meet all government specifications for an electronic
health record system and will also have to connect the two office sites. It will be consider-
ably more sophisticated than the current hardware and software and thus will require train-
ing for office staff, clinical staff, and the physicians. Everyone agrees there will be a learning
curve in order to reach the system’s full potential.

Doctor Smith, the majority owner of the practice, wants to buy a medical records system
from Sam’s Club. He argues that the package is supposed to electronically prescribe, track
billings, set appointments, and keep records, so it should meet their needs. The cost of the
first installed system is supposed to be $25,000, plus $10,000 for each additional system.*
The doctors are not sure if this means $25,000 for one office site plus $10,000 for the (con-
nected) second office site for a total of $35,000, or if this means $25,000 for the first in-
stalled system plus $10,000 each for three more doctors, for a total of $55,000. There is also
supposed to be $4,000 to $5,000 in maintenance costs each year as part of the purchased

Chapter 23 401

*Details about this system were announced in a Wall Street Journal story as quoted in Chapter 20. The prices
in this exercise are fictitous.

402 EXAMPLES AND EXERCISES, SUPPLEMENTAL MATERIALS, AND SOLUTIONS

package. Doctor Smith proposes to pay twenty percent down and obtain a five-year install-
ment loan from the local bank for the remaining eighty percent at an interest rate of eight
percent.

Doctor Jones, the youngest of the three physicians, has been recently added to the prac-
tice. A computer nerd, he wants to lease a complete system from the small company his col-
lege roommate began last year. While he has received a quote of $20,000 for the entire
system including first year maintenance, it does not meet the government requirements for
an electronic health record system. Consequently, the other two doctors have outvoted Doc-
tor Jones and this system will not be seriously considered.

Doctor Brown, the usual peace-maker between Doctor Smith and Doctor Jones, wants to
lease a system. He argues that leasing will place the responsibility for upgrades and mainte-
nance upon the lessor company, and that removing the responsibilities of ownership is ad-
vantageous. He has received a quote of $20,000 per year for a five-year lease that includes
hardware and software for both offices, that meets the government requirements for an
electronic health record system, and that includes training, maintenance, and upgrades.

Require d

Summarize the costs to the practice of owning a system (per Doctor Smith) versus leasing
(per Doctor Brown). Include a computation of comparative present value. (Refer to As-
signment 23-1 for setting up a comparative present value table.)

Assignment Exercise 23–3

Metropolis Health System has to do something about their ambulance situation. They have
to (a) buy a new ambulance; (b) lease a new one; or (c) renovate an existing ambulance
that MHS already owns. Rob Lackey, the Assistant Controller, has been asked to gather per-
tinent information in order to make a decision. So far Rob has found these facts:

1. It will cost at least $250,000 to purchase a new ambulance, although the cost varies
widely depending upon the quantity and sophistication of the emergency equipment con-
tained on the vehicle.

2. In order to renovate the existing vehicle, it will cost at least $100,000 to purchase and
install a new “box.” (In other words, a new emergency-equipped body is installed on the ex-
isting chassis.) Rob has found this existing ambulance has an odometer reading of 80,000
miles. The vehicle will also need a new fuel pump and new tires, but he believes these items
would be recorded as repair and maintenance operating expenses and thus would not be
included in his calculations.

3. Lease terms for ambulances also vary widely, but so far Rob believes a cost of $60,000
per year is a ball-park figure.

Require d

How much more information should Rob have before he begins to make any calculations?
Make a list. Which alternative do you believe would be best? Give your reasons.

CHAPTER 24

Example 24A: Assumptions

Types of assumptions required for the financial portion of a business plan typically include
answers to the following questions:
Example of Typical Income Statement Assumption Information Requirements:

• What types of revenue?
• How many services will be offered to produce the revenue? (by month)
• How much labor will be required? (FTEs)
• What will the labor cost?
• How many and what type of supplies, drugs, and/or devices will be required to offer

the service?
• What will the supplies, drugs, and/or devices cost?
• How much space will be required?
• What will the required space occupancy cost?
• Is special equipment required?
• If so, how much will it cost?
• Is staff training required to use the special equipment?
• If so, how much time is required, and what will it cost?

Practice Exercise 24–I: Assumptions

Refer to the proposal to add a retail pharmacy Mini-Case Study in Chapter 26.

Require d

Identify how many of the assumption items listed in the example above can be found in the
retail pharmacy proposal worksheets.

Assignment Exercise 24–1: Business Plan

Refer to the proposal to add a retail pharmacy Mini-Case Study in Chapter 26.
Require d

Build a business plan for this proposal. Prepare the service description using your con-
sumer knowledge of a retail pharmacy (if necessary). Of course this retail pharmacy will be
located within the hospital, but its purpose is to dispense prescriptions to carry off-site and
use at home. Thus, it operates pretty much like the neighborhood retail pharmacy that you
use yourself.

Use the information provided in Chapter 26 to prepare the financial section of the busi-
ness plan. Use your imagination to create the marketing segment and the organization
segment.

Chapter 24 403

404 EXAMPLES AND EXERCISES, SUPPLEMENTAL MATERIALS, AND SOLUTIONS

SUPPLEMENTAL MATERIALS

Present Value of an Annuity of $1

Periods 2% 4% 6% 8% 10% 12% 14% 16% 18% 20% Periods

1 .980 .962 .943 .926 .909 .893 .877 .862 .848 .833 1
2 1.942 1.886 1.833 1.783 1.736 1.690 1.647 1.605 1.566 1.528 2
3 2.884 2.775 2.673 2.577 2.487 2.402 2.322 2.246 2.174 2.107 3
4 3.808 3.630 3.465 3.312 3.170 3.037 2.914 2.798 2.690 2.589 4
5 4.713 4.452 4.212 3.993 3.791 3.605 3.433 3.274 3.127 2.991 5
6 5.601 5.242 4.917 4.623 4.355 4.111 3.889 3.685 3.498 3.326 6
7 6.472 6.002 5.582 5.206 4.868 4.564 4.288 4.039 3.812 3.605 7
8 7.325 6.733 6.210 5.747 5.335 4.968 4.639 4.344 4.078 3.837 8
9 8.162 7.435 6.802 6.247 5.759 5.328 4.946 4.607 4.303 4.031 9

10 8.983 8.111 7.360 6.710 6.145 5.650 5.216 4.833 4.494 4.193 10
15 12.849 11.118 9.712 8.560 7.606 6.811 6.142 5.576 5.092 4.676 15
20 16.351 13.590 11.470 9.818 8.514 7.469 6.623 5.929 5.353 4.870 20
25 19.523 15.622 12.783 10.675 9.077 7.843 6.873 6.097 5.467 4.948 25

Metropolis Health System
Balance Sheet

March 31, 20X3 and 20X2

Assets

Current Assets
Cash and cash equivalents 1,150,000 400,000
Assets whose use is limited 825,000 825,000
Patient accounts receivable 8,700,000 8,950,000
Less allowance for bad debts (1,300,000) (1,300,000)
Other receivables 150,000 100,000
Inventories of supplies 900,000 850,000
Prepaid expenses 200,000 150,000

Total Current Assets 10,625,000 9,975,000

Assets Whose Use Is Limited
Corporate funded depreciation 1,950,000 1,800,000
Under bond indenture agreements—
held by trustee 1,425,000 1,475,000

Total Assets Whose Use Is Limited 3,375,000 3,275,000
Less Current Portion (825,000) (825,000)
Net Assets Whose Use Is Limited 2,550,000 2,450,000

Property, Plant, and Equipment, Net 19,300,000 19,200,000

Other Assets 325,000 375,000

Total Assets 32,800,000 32,000,000

Metropolis Health System
Balance Sheet
March 31, 20X3 and 20X2

Liabilities and Fund Balance

Current Liabilities
Current maturities of long-term debt 525,000 500,000
Accounts payable and accrued expenses 4,900,000 5,300,000
Bond interest payable 300,000 325,000
Reimbursement settlement payable 100,000 175,000

Total Current Liabilities 5,825,000 6,300,000

Long-Term Debt 6,000,000 6,500,000
Less Current Portion of Long-Term Debt (525,000) (500,000)
Net Long-Term Debt 5,475,000 6,000,000

Total Liabilities 11,300,000 12,300,000

Fund Balances
General Fund 21,500,000 19,700,000

Total Fund Balances 21,500,000 19,700,000

Total Liabilities and Fund Balances 32,800,000 32,000,000

Supplemental Materials 405

406 EXAMPLES AND EXERCISES, SUPPLEMENTAL MATERIALS, AND SOLUTIONS

Metropolis Health System
Statement of Revenue and Expenses

for the Years Ended March 31, 20X3 and 20X2

Revenue
Net patient service revenue 34,000,000 33,600,000
Other revenue 1,100,000 1,000,000

Total Operating Revenue 35,100,000 34,600,000

Expenses
Nursing services 5,025,000 5,450,000
Other professional services 13,100,000 12,950,000
General services 3,200,000 3,220,000
Support services 8,300,000 8,340,000

Depreciation 1,900,000 1,800,000

Amortization 50,000 50,000

Interest 325,000 350,000
Provision for doubtful accounts 1,500,000 1,600,000

Total Expenses 33,400,000 33,760,000

Income from Operations 1,700,000 840,000

Nonoperating Gains (Losses)
Unrestricted gifts and memorials 20,000 70,000
Interest income 80,000 40,000

Nonoperating Gains, Net 100,000 110,000

Revenue and Gains in Excess of
Expenses and Losses 1,800,000 950,000

Metropolis Health System
Statement of Changes in Fund Balance

for the Years Ended March 31, 20X3 and 20X2

General Fund Balance April 1st $19,700,000 $18,750,000

Revenue and Gains in Excess of
Expenses and Losses 1,800,000 950,000

General Fund Balance March 31st $21,500,000 $19,700,000

Metropolis Health System
Schedule of Property, Plant, and Equipment

for the Years Ended March 31, 20X3 and 20X2

Buildings and Improvements 14,700,000 14,000,000

Land Improvements 1,100,000 1,100,000

Equipment 28,900,000 27,600,000

Total 44,700,000 42,700,000

Less Accumulated Depreciation (26,100,000) (24,200,000)

Net Depreciable Assets 18,600,000 18,500,000

Land 480,000 480,000

Construction in Progress 220,000 220,000

Net Property, Plant, and Equipment 19,300,000 19,200,000

Supplemental Materials 407

408 EXAMPLES AND EXERCISES, SUPPLEMENTAL MATERIALS, AND SOLUTIONS

Metropolis Health System
Schedule of Patient Revenue

for the Years Ended March 31, 20X3 and 20X2

Patient Services Revenue
Routine revenue 9,850,000 9,750,000
Laboratory 7,375,000 7,300,000
Radiology and CT scanner 5,825,000 5,760,000
OB–nursery 450,000 445,000
Pharmacy 3,175,000 3,140,000
Emergency service 2,200,000 2,180,000
Medical and surgical supply and IV 5,050,000 5,000,000
Operating rooms 5,250,000 5,200,000
Anesthesiology 1,600,000 1,580,000
Respiratory therapy 900,000 890,000
Physical therapy 1,475,000 1,460,000
EKG and EEG 1,050,000 1,040,000
Ambulance services 900,000 890,000
Oxygen 575,000 570,000
Home health and hospice 1,675,000 1,660,000
Substance abuse 375,000 370,000
Other 775,000 765,000

Subtotal 48,500,000 48,000,000

Less Allowances and Charity Care 14,500,000 14,400,000

Net Patient Service Revenue 34,000,000 33,600,000

Metropolis Health System
Schedule of Operating Expenses

for the Years Ended March 31, 20X3 and 20X2

Nursing Services
Routine Medical-Surgical 3,880,000 4,200,000
Operating Room 300,000 325,000
Intensive Care Units 395,000 430,000
OB–Nursery 150,000 165,000
Other 300,000 330,000
Total 5,025,000 5,450,000

Other Professional Services
Laboratory 2,375,000 2,350,000
Radiology and CT Scanner 1,700,000 1,680,000
Pharmacy 1,375,000 1,360,000
Emergency Service 950,000 930,000
Medical and Surgical Supply 1,800,000 1,780,000
Operating Rooms and Anesthesia 1,525,000 1,515,000
Respiratory Therapy 525,000 530,000
Physical Therapy 700,000 695,000
EKG and EEG 185,000 180,000
Ambulance Services 80,000 80,000
Substance Abuse 460,000 450,000
Home Health and Hospice 1,295,000 1,280,000
Other 130,000 120,000
Total 13,100,000 12,950,000

General Services
Dietary 1,055,000 1,060,000
Maintenance 1,000,000 1,010,000
Laundry 295,000 300,000
Housekeeping 470,000 475,000
Security 50,000 50,000
Medical Records 330,000 325,000
Total 3,200,000 3,220,000

Support Services
General 4,600,000 4,540,000
Insurance 240,000 235,000
Payroll Taxes 1,130,000 1,180,000
Employee Welfare 1,900,000 1,950,000
Other 430,000 435,000
Total 8,300,000 8,340,000

Supplemental Materials 409

410 EXAMPLES AND EXERCISES, SUPPLEMENTAL MATERIALS, AND SOLUTIONS

Depreciation 1,900,000 1,800,000
Amortization 50,000 50,000

Interest Expense 325,000 350,000

Provision for Doubtful Accounts 1,500,000 1,600,000

Total Operating Expenses 33,400,000 33,760,000

EXCERPTS FROM METROPOLITAN HEALTH SYSTEM NOTES TO FINANCIAL
STATEMENTS

Note 1—Nature of Operations and Summary of Significant Accounting Policies

General

Metropolitan Hospital System (Hospital) currently operates as a general acute care hospi-
tal. The hospital is a municipal corporation and body politic created under the hospital dis-
trict laws of the state.

Cash and Cash Equivalents

For purposes of reporting cash flows, the hospital considers all liquid investments with an
original maturity of three months or less to be cash equivalents.

I n v e n t o r y

Inventory consists of supplies used for patients and is stated as the lower of cost or market.
Cost is determined on the basis of most recent purchase price.

I n v e s t m e n t s

Investments, consisting primarily of debt securities, are carried at market value. Realized
and unrealized gains and losses are reflected in the statement of revenue and expenses. In-
vestment income from general fund investments is reported as nonoperating gains.

Income Ta x e s

As a municipal corporation of the state, the hospital is exempt from federal and state in-
come taxes under Section 115 of the Internal Revenue Code.

P ro p e r t y, Plant, and Equipment

Expenditures for property, plant, and equipment, and items that substantially increase the
useful lives of existing assets are capitalized at cost. The hospital provides for depreciation
on the straight-line method at rates designed to depreciate the costs of assets over estimated
useful lives as follows:

Years

Equipment 5 to 20
Land Improvements 20 to 25
Buildings and Improvements 40

Funded Depreciation

The hospital’s Board of Directors has adopted the policy of designating certain funds that
are to be used to fund depreciation for the purpose of improvement, replacement, or ex-
pansion of plant assets.

Unamortized Debt Issue Costs

Revenue bond issue costs have been deferred and are being amortized.

Revenue and Gains in Excess of Expenses and Losses

The statement of revenue and expenses includes revenue and gains in excess of expenses
and losses. Changes in unrestricted net assets that are excluded from excess of revenue over
expenses, consistent with industry practice, would include such items as contributions of
long-lived assets (including assets acquired using contributions that by donor restriction
were to be used for the purposes of acquiring such assets) and extraordinary gains and
losses. Such items are not present on the current financial statements.

Net Patient Service Revenue

Net patient service revenue is reported as the estimated net realizable amounts from pa-
tients, third-party payers, and others for services rendered, including estimated retroactive
adjustments under reimbursement agreements with third-party payers. Retroactive adjust-
ments are accrued on an estimated basis in the period the related services are rendered and
adjusted in future periods as final settlements are determined.

Contractual Agreements with Third-Party Payers

The hospital has contractual agreements with third-party payers, primarily the

Medicare

and Medicaid programs. The Medicare program reimburses the hospital for inpatient ser-
vices under the Prospective Payment System, which provides for payment at predetermined
amounts based on the discharge diagnosis. The contractual agreement with the

Medicaid

program provides for reimbursement based upon rates established by the state, subject to
state appropriations. The difference between established customary charge rates and re-
imbursement is accounted for as a contractual allowance.

Gifts and Bequests

Unrestricted gifts and bequests are recorded on the accrual basis as nonoperating gains.

Donated Services

No amounts have been reflected in the financial statements for donated services. The hos-
pital pays for most services requiring specific expertise. However, many individuals volun-
teer their time and perform a variety of tasks that assists the hospital with specific assistance
programs and various committee assignments.

Excerpts from Metropolitan Health System Notes to Financial Statements 411

412 EXAMPLES AND EXERCISES, SUPPLEMENTAL MATERIALS, AND SOLUTIONS

Note 2—Cash and Investments

Statutes require that all deposits of the hospital be secured by federal depository insurance
or be fully collateralized by the banking institution in authorized investments. Authorized
investments include those guaranteed by the full faith and credit of the United States of
America as to principal and interest; or in bonds, notes, debentures, or other similar obli-
gations of the United States of America or its agencies; in interest-bearing savings accounts,
interest-bearing certificates of deposit; or in certain money market mutual funds.

At March 31, 20X3, the carrying amount and bank balance of the hospital’s deposits with
financial institutions were $190,000 and $227,000, respectively. The difference between the
carrying amount and the bank balance primarily represents checks outstanding at March
31, 20X3. All deposits are fully insured by the Federal Deposit Insurance Corporation or
collateralized with securities held in the hospital’s name by the hospital agent.

Carrying Amount

20X3 20X2

U.S. Government Securities or
U.S. Government Agency Securities 4,325,000 3,575,000
Total Investments 4,325,000 3,575,000
Petty Cash 3,000 3,000
Deposits 190,000 93,000
Accrued Interest 7,000 4,000
Total 4,525,000 3,675,000
Consisting of
Cash and Cash Equivalents—General Fund 1,150,000 400,000
Assets Whose Use Is Limited
Corporate Funded Depreciation 1,950,000 1,800,000
Held by Trustee under Bond Indenture Agreements 1,425,000 1,475,000
Total 4,525,000 3,675,000

Note 3—Charity Care

The hospital voluntarily provides free care to patients who lack financial resources and are
deemed to be medically indigent. Such care is in compliance with the hospital’s mission.
Because the hospital does not pursue collection of amounts determined to qualify as char-
ity care, they are not reported as revenue.

The hospital maintains records to identify and monitor the level of charity care it pro-
vides. These records include the amount of charges forgone for services and supplies fur-
nished under its charity care policy. During the years ended March 31, 20X3, and 20X2
such charges forgone totaled $395,000 and $375,000, respectively.

Note 4—Net Patient Service Revenue

The hospital provides healthcare services through its inpatient and outpatient care facili-
ties. The mix of receivables from patients and third-party payers at March 31, 20X3, and
20X2 is as follows:

20X3 20X2

Medicare 30.0% 28.5%
Medicaid 15.0 16.0
Patients 13.0 12.5
Other third-party payers 42.0 43.0

Total 100.0% 100.0%

The hospital has agreements with third-party payers that provide for payments to the
hospital at amounts different from its established rates. Contractual adjustments under
third-party reimbursement programs represent the difference between the hospital’s es-
tablished rates for services and amounts paid by third-party payers. A summary of the pay-
ment arrangements with major third-party payers follows:

Medicare

Inpatient acute care rendered to Medicare program beneficiaries is paid at prospectively de-
termined rates-per-discharge. These rates vary according to a patient classification system that
is based on clinical, diagnostic, and other factors. Inpatient nonacute care services and certain
outpatient services are paid based upon either a cost reimbursement method, established fee
screens, or a combination thereof. The hospital is reimbursed for cost reimbursable items at a
tentative rate with final settlement determination after submission of annual cost reports by the
hospital and audits by the Medicare fiscal intermediary. At the current year end, all Medicare
settlements for the previous two years are subject to audit and retroactive adjustments.

Medicaid

Inpatient services rendered to Medicaid program beneficiaries are reimbursed at prospec-
tively determined rates-per-day. Outpatient services rendered to Medicaid program benefi-
ciaries are reimbursed at prospectively determined rates-per-visit.

Blue Cro s s

Inpatient services rendered to Blue Cross subscribers are reimbursed under a cost reimburse-
ment methodology. The hospital is reimbursed at a tentative rate with final settlement deter-
mined after submission of annual cost reports by the hospital and audits by Blue Cross. The
Blue Cross cost report for the prior year end is subject to audit and retroactive adjustment.

The hospital has also entered into payment agreements with certain commercial insur-
ance carriers, health maintenance organizations, and preferred provider organizations.
The bases for payment under these agreements include discounts from established charges
and prospectively determined daily rates.

Gross patient service revenue for services rendered by the hospital under the Medicare,
Medicaid, and Blue Cross payment agreements for the years ended March 31, 20X3, and
20X2 is approximately as follows:

Excerpts From Metropolitan Health System Notes to Financial Statements 413

414 EXAMPLES AND EXERCISES, SUPPLEMENTAL MATERIALS, AND SOLUTIONS

20X3 20X2

Amount %

Medicare $20,850,000 43.0 $19,900,000 42.0
Medicaid 10,190,000 21.0 10,200,000 21.5
All other payers 17,460,000 36.0 17,300,000 36.5

$48,500,000 100.0 $47,400,000 100.0

Note 5—Property, Plant, and Equipment

The hospital’s property, plant, and equipment at March 31, 20X3, and 20X2 are as follows:

20X3 20X2

Buildings and improvements $14,700,000 $14,000,000
Land improvements 1,100,000 1,100,000
Equipment 28,900,000 27,600,000
Total $44,700,000 $42,700,000
Accumulated depreciation (26,100,000) (24,200,000)
Net Depreciable Assets $18,600,000 $18,500,000
Land 480,000 480,000
Construction in progress 220,000 220,000
Net Property, Plant, Equipment $19,300,000 $19,200,000

Construction in progress, which involves a renovation project, has not progressed in the
last twelve-month period because of a zoning dispute. The project will not require signifi-
cant outlay to reach completion, as anticipated additional expenditures are currently esti-
mated at $100,000.

Note 6—Long-Term Debt

Long-term debt consists of the following:
Hospital Facility Revenue Bonds (Series 1995) at varying
interest rates from 4.5% to 5.5%, depending on date of
maturity through 2020. 20X3 20X2

$6,000,000 $6,500,000

The future maturities of long-term debt are as follows:

Years Ending March 31

20X2 $ 475,000
20X3 500,000
20X4 525,000
20X5 550,000
20X6 575,000
20X7 600,000
Thereafter 3,750,000

Under the terms of the trust indenture the following funds (held by the trustee) were
established:

Interest Fund

The hospital deposits (monthly) into the interest fund an amount equal to one sixth of the
next semi-annual interest payment due on the bonds.

Bond Sinking Fund

The hospital deposits (monthly) into the bond sinking fund an amount equal to one
twelfth of the principal due on the next July 1.

Debt Service Reserve Fund

The debt service reserve fund must be maintained at an amount equal to 10 percent of the
aggregate principal amount of all bonds then outstanding. It is to be used to make up any
deficiencies in the interest fund and bond sinking fund.

Assets held by the trustee under the trust indenture at March 31, 20X3, and 20X2 are as
follows:

20X3 20X2
Interest Fund $ 300,000 $ 325,000
Bond Sinking Fund 525,000 500,000
Debt Service Reserve 600,000 650,000
Total $1,425,000 $1,475,000

Note 7—Commitments

At March 31, 20X3, the hospital had commitments outstanding for a renovation project at
the hospital of approximately $100,000. Construction in progress on the renovation has not
progressed in the last twelve-month period because of a zoning dispute. Upon resolution of
the dispute, remaining construction costs will be funded from corporate funded deprecia-
tion cash reserves.

ICD-10 CONVERSION COSTS FOR A MIDWESTERN COMMUNITY HOSPITAL

Authors’ Note
This CMS example illustrates the computation of hospital training costs and productivity

loss costs and estimates a cost for system changes and upgrades in order to arrive at a total
hospital ICD-10 conversion cost. We have numbered the paragraphs for easy reference.
(And FYI, when the scenario below says “we” it means CMS, not the authors.)

Introduction

To further illustrate the computation of hospital ICD-10 conversion costs, CMS staff devel-
oped a scenario for a typical community hospital in the Midwest. The material presented
below was published in the proposed rule as an example of costs that might be incurred by
a hospital. The data were drawn from the American Hospital Directory, available at

Solution to Practice Exercise 5–I 415

416 EXAMPLES AND EXERCISES, SUPPLEMENTAL MATERIALS, AND SOLUTIONS

www.AHD.com. While based on an actual hospital in a midwestern state, the data have been
altered to make calculations simpler.

The Scenario

1. The hospital has 100 beds, 4,000 discharges annually, and gross revenues of $200 mil-
lion. Using the factors presented in the impact analysis, we estimated training costs
(including the cost of the actual training as well as lost time away from the job), pro-
ductivity loss for the first six months resulting from becoming familiar with the diag-
nostic and procedure codes, and the cost of system changes.

2. For our scenario, we assumed that the hospital employs three full-time coders who
will require eight hours of training at $500 per coder for $1,500 ($500 times 3). While
they are in training, the hospital will have to substitute other staff, either by hiring
temporary coders if possible, or shifting staff. The estimated cost at $50 per hour is
$1,200 (8 hours times 3 staff times $50 per hour).

3. In estimating the productivity loss, we are only looking at the initial six months after
implementation. Therefore, we divided the annual number of discharges of 4,000 by
2 to equal 2,000. We assume that three quarters of the discharges are surgical, giving
us 1,500 discharges requiring use of PCS codes. Dividing this by six months yields an
average monthly discharge rate of 250.

4. We performed a similar calculation for outpatient claims. Of the 13,000 outpatient
claims, the monthly average is 1,083 (we do not distinguish between medical and sur-
gical outpatient claims).

5. Applying the 1.7 extra minutes per discharge, we estimated it would take an extra 425
minutes (1.7 times 250) to code the discharges in the first month. At $50 per hour,
the cost per minute is $0.83 ($50 divided by 60 minutes) and the cost per claim is
$1.41 ($0.83 times 1.7). For the first month, the productivity loss for inpatient coding
is $353 ($1.41 times 250). Assuming for simplicity’s sake that the resumption of pro-
ductivity over the six month period would increase in a straight line, we divide the
$353 by six to come up with $59. We reduce the productivity loss by this amount each
month through the sixth month. The total loss for the six-month period is $1,233.

6. We apply the same method to determine the outpatient productivity loss. Based on
our assumption that outpatient claims will require one hundredth of the time for hos-
pital inpatient claims, when applying the 0.17 extra minutes per claim, we estimate it
would take an extra 18.41 minutes (0.017 times 1,083) to code the discharges in the
first month. At $50 per hour, the cost per minute is $0.83 ($50 divided by 60 minutes)
and the cost per claim is $0.14 ($0.83 times 0.017). For the first month, the produc-
tivity loss for outpatient coding is $15.28 ($0.014 times 1,083). Assuming for simplic-
ity sake that the resumption of productivity over the six-month period would increase
in a straight line, we divide the $15.28 by six; to come up with $2.55. We reduce the
productivity loss by this amount each month through the sixth month. Thus the total
loss for the first six months will equal $53.

7. In estimating the cost of system changes and software upgrades, we deliberately chose
a value that we think overstates the cost. We assumed that the hospital will have to
spend $300,000 on its data infrastructure to accommodate the new codes. Summing

the training costs, productivity losses, and system upgrades, we estimate the total cost
to the hospital will equal approximately $303,990. Finally, in order to determine the
percent of the hospital’s revenue that would be diverted to funding the conversion to
the ICD-10 we compared the estimated cost associated with the conversion to ICD-10
to the total hospital revenue of $200 million. The costs amount to 0.15% of the hos-
pital’s annual revenues.

8. We note that although the impact in our scenario of 0.15% is significantly larger than
the estimated impact of 0.03% for inpatient facilities (set out in the rule), it is still sig-
nificantly below the threshold the Department considers a significant economic im-
pact. We are of the opinion that, for most providers and suppliers, payers and
computer firms involved in facilitating the transition, the costs will be relatively small.

Source: 73 Federal Register 49830 (August 22, 2008).

SOLUTIONS TO PRACTICE EXERCISES

SOLUTION TO PRACTICE EXERCISE 3-I

Short-term assets: cash on hand; accounts receivable; inventory
Long-term assets: land; buildings
Short-term liabilities: payroll taxes due; accounts payable
Long-term liabilities: mortgage payable (non-current); note payable (due in 24 months)

SOLUTION TO PRACTICE EXERCISE 5–I

Intensive Care Unit Laboratory Laundry

Drugs requisitioned X
Pathology supplies X
Detergents and bleach X
Nursing salaries X
Clerical salaries X X X
Uniforms (for laundry aides) X
Repairs (parts for microscopes) X

Note: If no clerical salaries are assigned to Laundry, this is an acceptable alternative solution.

SOLUTION TO PRACTICE EXERCISE 6–I

Direct Cost Indirect Cost

Managed care marketing expense X
Real estate taxes X
Liability insurance X
Clinic telephone expense X
Utilities (for the entire facility) X
Emergency room medical supplies X

Solution to Practice Exercise 6–I 417

418 EXAMPLES AND EXERCISES, SUPPLEMENTAL MATERIALS, AND SOLUTIONS

SOLUTION TO PRACTICE EXERCISE 6–II

In real life the solution to this exercise will depend upon factors unique to the particular
organization. The following solution is a generic one.

Responsibility Center Support Center

Security X
Communications X
Ambulance services X
Medical records X
Educational resources X
Human resources X

Reporting: Each responsibility center has a manager. All report to the director.

SOLUTION TO PRACTICE EXERCISE 7–I

Step 1. Find the highest volume of 1,100 packs at a cost of $7,150 in September and the
lowest volume of 100 packs at a cost of $1,010 in August.

Step 2. Compute the variable rate per pack as:

# of Packs Training Pack Cost

Highest volume 1,100 $7,150
Lowest volume 100 1,010
Difference 1,000 $6,140

Step 3. Divide the difference in cost ($6,140) by the difference in # of packs (1,000) to
arrive at the variable cost rate:

$6,140 divided by 1,000 packs � $6.14 per pack

Step 4. Compute the fixed overhead rate as follows:
At the highest level:
Total cost $7,150
Less: Variable portion
[1,100 packs � $6.14] (6,754)
Fixed Portion of Cost $ 396

At the lowest level:
Total cost $1,010
Less: Variable portion
[100 packs � $6.14] (614)
Fixed Portion of Cost $ 396

Proof totals: $396 fixed portion at both levels.

SOLUTION TO PRACTICE EXERCISE 7–II

Step 1. Divide costs into variable and fixed portions. In this case $3,450,000 times 40%
equals $1,380,000 variable cost and $3,450,000 times 60% equals $2,070,000
fixed cost.

Step 2. Compute the contribution margin:

Amount

Revenue $3,500,000
Less variable cost (1,380,000)
Contribution margin $2,120,000
Less fixed cost 2,070,000
Operating income $ 50,000

SOLUTION TO PRACTICE EXERCISE 7–III

Amount %

Revenue $1,210,000 100.00
Less variable cost (205,000) 16.94
Contribution margin $1,005,000 83.06 � PV or CM Ratio
Less fixed cost (1,100,000) 90.91
Operating loss $(95,000) 7.85

SOLUTION TO PRACTICE EXERCISE 8–I

1. Straight-line depreciation would amount to $54,000 per year for 10 years. This
amount is computed as follows:
Step 1. Compute the cost net of salvage or trade-in value: 600,000 less 10% salvage

value or 60,000 equals 540,000.
Step 2. Divide the resulting figure by the expected life (also known as estimated use-

ful life): 540,000 divided by 10 equals 54,000 depreciation per year for 10
years.

2. Double declining depreciation is computed as follows:
Step 1. Compute the straight-line rate: 1 divided by 10 equals 10%.
Step 2. Now double the rate (as in “double declining method”): 10% times 2 equals

20%.
Step 3. Compute the first year’s depreciation expense: 600,000 times 20% � 120,000.
Step 4. Compute the carry-forward book value at the beginning of the second year:

600,000 book value beginning year 1 less year 1 depreciation of 120,000
equals book value at beginning of the second year of 480,000.

Step 5. Compute the second year’s depreciation expense: 480,000 times 20% �
96,000.

Solution to Practice Exercise 8–I 419

420 EXAMPLES AND EXERCISES, SUPPLEMENTAL MATERIALS, AND SOLUTIONS

Step 6. Compute the carry-forward book value at the beginning of the third year:
480,000 book value beginning year 2 less year 2 depreciation of 96,000 equals
book value at beginning of the third year of 384,000.
—Continue until the asset’s salvage or trade-in value has been reached.

Book Value at
Beginning of Year Depreciation Expense Book Value at End of Year

600,000 600,000 � 20% � 120,000 600,000 � 120,000 � 480,000
480,000 480,000 � 20% � 96,000 480,000 � 96,000 � 384,000
384,000 384,000 � 20% � 76,800 384,000 � 76,800 � 307,200
307,200 307,200 � 20% � 61,440 307,200 � 61,440 � 245,760
245,760 245,760 � 20% � 49,152 245,760 � 49,152 � 196,608
196,608 196,608 � 20% � 39,322 196,608 � 39,322 � 157,286
157,286 157,286 � 20% � 31,457 157,286 � 31,457 � 125,829
125,829 125,829 � 20% � 25,166 125,829 � 25,166 � 100,663
100,663 100,663 � 20% � 20,132 100,663 � 20,132 � 80,531
80,531 80,561 at 10th year: 80,561 � 20,561 � 60,000

—Balance remaining at end of tenth year represents the salvage or trade-in
value.

Note: Under the double declining balance method, book value never reaches
zero. Therefore, a company typically adopts the straight-line method at the point
where straight line would exceed the double declining balance.

SOLUTION TO PRACTICE EXERCISE 8–II

Straight-line depreciation would amount to $9,000 per year for five years. This amount is
computed as follows:

Step 1. Compute the cost of salvage or trade-in value: 50,000 less 10% salvage value or
5,000 equals 45,000.

Step 2. Divide the resulting figure by the expected life (also known as the estimated use-
ful life): 45,000 divided by 5 equals 9,000 depreciation per year for 5 years

SOLUTION TO PRACTICE EXERCISE 9–I

1. Compute Net Paid Days Worked

Total days in business year 364
Less two days off per week 104
# Paid days per year 260

Less paid days not worked
Holidays 8
Sick days 5
Education day 1
Vacation days 5

19
Net paid days worked 241

2. Convert Net Paid Days Worked to a Factor

Total days in business year divided by net paid days worked equals factor

364/241 � 1.510373

SOLUTION TO PRACTICE EXERCISE 9–II

24-Hour
Shift 1 Shift 2 Shift 3 � Scheduling

Day Evening Night Total

Position: Admissions officer 2 1 1 four 8-hour shifts
FTEs—to cover position
7 days/week equals 2.8 1.4 1.4 5.6 FTEs

Position: Clerical 1 0 0 one 8-hour shift
FTEs—to cover position
7 days/week equals 1.4 0 0 1.4 FTEs

SOLUTION TO PRACTICE EXERCISE 10–I

Current Liabilities 30,000
Total Assets 1,000,000
Income from Operations 80,000
Accumulated Depreciation 480,000
Total Operating Revenue 180,000
Current Portion of Long-Term Debt 10,000
Interest Income -0-
Inventories 5,000

SOLUTION TO PRACTICE EXERCISE 10–II

No, Doctors Smith and Brown’s patient accounts receivable does not appear to be net of an
allowance for bad debts, because we cannot find an equivalent bad debt expense on their
statement of net income. Do you think the doctors should have an allowance for bad debts
on their statement? Why do you think they do not?

Solution to Practice Exercise 10–II 421

422 EXAMPLES AND EXERCISES, SUPPLEMENTAL MATERIALS, AND SOLUTIONS

SOLUTION TO PRACTICE EXERCISE 10–III

As mentioned in the chapter text, land is not stated at “net” because land is never depreciated.

SOLUTION TO PRACTICE EXERCISE 11–I

Current Ratio

The current ratio is represented as Current Ratio = Current Assets divided by Current Lia-
bilities. This ratio is considered to be a measure of short-term debt-paying ability. However,
it must be carefully interpreted.

Current Ratio Computation

Current Assets
�

$70,000
� 2.33 to 1

Current Liabilities $30,000

Quick Ratio

The quick ratio is represented as Quick Ratio � Cash � Short-Term Investments � Net Re-
ceivables divided by Current Liabilities. This ratio is considered to be an even more severe
test of short-term debt-paying ability (even more severe than the current ratio). The quick
ratio is also known as the acid-test ratio, for obvious reasons.

Cash & Cash Equivalents � Net Receivables
�

$65,000
� 2.167 to 1

Current Liabilities $30,000

SOLUTION TO PRACTICE EXERCISE 11–II

Solvency Ratios

Debt Service Coverage Ratio (DSCR)

The Debt Service Coverage Ratio (DSCR) is represented as change in unrestricted net as-
sets (net income) plus interest, depreciation, and amortization divided by maximum an-
nual debt service. This ratio is universally used in credit analysis.

Change in Unrestricted Net Assets (net income)
plus Interest, Depreciation, Amortization

�
$113,100

� 5.1
Maximum Annual Debt Service $22,200

Note: $80,000 � $3,100 � $30,000 � $113,100.

Liabilities to Fund Balance (or Debt to Net Worth)

The liabilities to fund balance or net worth computation is represented as total liabilities di-
vided by unrestricted net assets (fund balances or net worth) � total debt divided by tangi-
ble net worth. This figure is a quick indicator of debt load.

Total Liabilities
�

$200,000
� 2.5

Unrestricted (Fund Balance) $800,000

SOLUTION TO PRACTICE EXERCISE 11–III

Profitability Ratios

Operating Margin

The operating margin, which is generally expressed as a percentage, is represented as op-
erating income (loss) divided by total operating revenues. This ratio is used for a number of
managerial purposes and also sometimes enters into credit analysis. It is therefore a multi-
purpose measure.

Operating Income (Loss)
�

$80,000
� 44.4%

Total Operating Revenues $180,000

Return on To t a l A s s e t s
The return on total assets is represented as earnings before interest and taxes (EBIT) di-
vided by total assets. This is a broad measure in common use.

EBIT (Earnings before Interest & Taxes)
�

$83,100
� 8.3%

Total Assets $1,000,000

Note: $80,000 � $3,100 � $83,100.

SOLUTION TO PRACTICE EXERCISE 12–I: UNADJUSTED RATE OF RETURN

1. Calculation using original investment amount:

$100,000

$500,000
� 20% Unadjusted Rate of Return

2. Calculation using average investment amount:
Step 1. Compute average investment amount for total unrecovered asset cost:

At beginning of estimated useful life � $500,000
At end of estimated useful life � $ 50,000
Sum $550,000

Divided by 2 � $275,000 average investment amount

Step 2. Calculate unadjusted rate of return:

$100,000

$275,000
� 36.4% Unadjusted Rate of Return

Solution to Practice Exercise 12–I: Unadjusted Rate of Return 423

424 EXAMPLES AND EXERCISES, SUPPLEMENTAL MATERIALS, AND SOLUTIONS

SOLUTION TO PRACTICE EXERCISE 12–II: FINDING THE FUTURE VALUE
(WITH A COMPOUND INTEREST TABLE)

Step 1. Refer to the Compound Interest Table found in Appendix 12-B at the back of
this chapter. Reading across, or horizontally, find the 7% column. Reading
down, or vertically, find Year 6. Trace across the Year 6 line item to the 7% col-
umn. The factor is 1.501.

Step 2. Multiply the current savings account balance of $11,000 times the factor of 1.501
to find the future value of $16,511. In six years at compound interest of 7%, the
college fund will have a balance of $16,511.

SOLUTION TO PRACTICE EXERCISE 12–III: FINDING THE PRESENT VALUE

Step 1. Refer to the Present Value Table found in Appendix 12-A at the back of this
chapter. Reading across, or horizontally, find the 7% column. Reading down, or
vertically, find Year 15. Trace across the Year 15 line item to the 7% column. The
factor is 0.3624.

Step 2. Multiply $150,000 times the factor of 0.3624 to find the present value of $54,360.

SOLUTION TO PRACTICE EXERCISE 12–IV

Assemble the assumptions in an orderly manner:

Assumption 1: Initial cost of the investment � $16,950.
Assumption 2: Estimated annual net cash inflow the investment will generate � $3,000.
Assumption 3: Useful life of the asset � 10 years.

Perform calculation:

Step 1. Divide the initial cost of the investment ($16,950) by the estimated annual net
cash inflow it will generate ($3,000). The answer is a ratio amounting to 5.650.

Step 2. Now use the abbreviated look-up table for the Present Value of an Annuity of $1,
which is found at the back of the Examples and Exercises section. Find the line
item for the number of periods that matches the useful life of the asset (10 years
in this case).

Step 3. Look across the 10 year line on the table and find the column that approximates
the ratio of 5.650 (as computed in Step 1). That column contains the interest
rate representing the rate of return. In this case the rate of return is 12%.

SOLUTION TO PRACTICE EXERCISE 12–V

Assemble assumptions in an orderly manner:

Assumption 1: Purchase price of the equipment � $500,000.
Assumption 2: Useful life of the equipment � 10 years.

Assumption 3: Revenue the machine will generate per year � $84,000.
Assumption 4: Direct operating costs associated with earning the revenue � $21,000.
Assumption 5: Depreciation expense per year (computed as purchase price per assump-

tion 1 divided by useful life per assumption 2) � $50,000.
Perform computation:
Step 1. Find the machine’s expected net income after taxes:

Revenue (Assumption 3) $84,000
Less
Direct operating costs (Assumption 4) $21,000
Depreciation (Assumption 5) 50,000

71,000
Net income $13,000

Note: No income taxes for this hospital.

Step 2. Find the net annual cash inflow the machine is expected to generate (in other
words, convert the net income to a cash basis).

Net income $13,000
Add back depreciation (a noncash expenditure) 50,000
Annual net cash inflow after taxes $63,000

Step 3. Compute the payback period:

Investment
�

$500,000 Machine Cost*
� 7.9 Year Payback Period

Net Annual Cash Inflow $63,000

*Assumption 1 above.
**Per Step 2 above.

The machine will pay back its investment under these assumptions in 7 9⁄10 years.

SOLUTION TO PRACTICE EXERCISE 13–I

Common sizing for the assets of the two hospitals appears on the worksheet below. Note
that their gross numbers are very different, yet the proportionate relationships of the per-
centages (20%, 75%, and 5%) are the same for both hospitals.

Same Year for Both Hospitals
Hospital A Hospital B

Current assets $ 2,000,000 20% $ 8,000,000 20%
Property, plant, and equipment 7,500,000 75% 30,000,000 75%
Other assets 500,000 5% 2,000,000 5%
Total assets $10,000,000 100% $40,000,000 100%

Solution to Practice Exercise 13–I 425

426 EXAMPLES AND EXERCISES, SUPPLEMENTAL MATERIALS, AND SOLUTIONS

SOLUTION TO PRACTICE EXERCISE 13–II

Hospital A
Year 1 Year 2 Difference

Current assets $1,600,000 $ 2,000,000 $ 400,000 25%
Property, plant, and equipment 6,000,000 7,500,000 1,500,000 25%
Other assets 400,000 500,000 100,000 25%
Total assets $8,000,000 $10,000,000 $2,000,000 —

Note: The worksheet below shows Hospital A with both common sizing and trend analysis:

Hospital A
Year 1 Year 2 Difference

Current assets $1,600,000 20% $ 2,000,000 20% $ 400,000 25%
Property, plant, and equipment 6,000,000 75% 7,500,000 75% 1,500,000 25%
Other assets 400,000 5% 500,000 5% 100,000 25%
Total assets $8,000,000 100% $10,000,000 100% $2,000,000 —

SOLUTION TO PRACTICE EXERCISE 13–III

Q: How many procedures has your unit recorded for the period to date?

Solution: The unit has recorded 2,000 procedures ($200,000 divided by $100 apiece
equals 2,000 procedures).

Q: Of these, how many procedures are attributed to each payer?

Solution: At 25% of the volume per payer, each payer accounts for 500 procedures
(2,000 times 25% equals 500 procedures). Proof total: 500 procedures apiece times four
payers equals 2,000 procedures.

Q: How much is the net revenue per procedure for each payer, and how much is the con-
tractual allowance per procedure for each payer?

Solution: The computation is as follows:

Payer # Gross % Paid by Net Revenue Contractual Allowance
Charges Each Payer per Procedure per Procedure

1 $100.00 90% $90.00 $10.00

2 $100.00 80% $80.00 $20.00

3 $100.00 70% $70.00 $30.00

4 $100.00 50% $50.00 $50.00

SOLUTION TO PRACTICE EXERCISE 15–I

Your initial budget assumptions were as follows:
Assume the budget anticipated 30,000 inpatient days this year at an average of $650 rev-

enue per day, or $19,500,000. Further assume that inpatient expenses were budgeted at
$600 per patient day, or $18,000,000. Also assume the budget anticipated 10,000 outpatient
visits this year at an average of $400 revenue per visit, or $4,000,000. Further assume that
outpatient expenses were budgeted at $380 per visit, or $3,800,000. The budget worksheet
would look like this:

As Budgeted

Revenue—Inpatient $19,500,000
Revenue—Outpatient 4,000,000
Subtotal $23,500,000
Expenses—Inpatient $18,000,000
Expenses—Outpatient 3,800,000
Subtotal $21,800,000
Excess of revenue over expenses $1,700,000

Now assume that only 27,000, or 90%, of the patient days are going to actually be
achieved for the year. The average revenue of $650 per day will be achieved for these 27,000
days (thus 27,000 times 650 equals 17,550,000). Also assume that outpatient visits will actu-
ally amount to 110%, or 11,000 for the year. The average revenue of $400 per visit will be
achieved for these 11,000 visits (thus 11,000 times 400 equals 4,400,000). Further assume
that, due to the heroic efforts of the Chief Financial Officer, the actual inpatient expenses
will amount to $11,600,000 and the actual outpatient expenses will amount to $4,000,000.
The actual results would look like this:

Actual

Revenue—Inpatient $17,550,000
Revenue—Outpatient 4,400,000
Subtotal $21,950,000
Expenses—Inpatient 16,100,000
Expenses—Outpatient 4,000,000
Subtotal $20,100,000
Excess of revenue over expenses $1,850,000

Since the budgeted revenues and expenses still reflect the original expectations of
30,000 inpatient days and 10,000 outpatient visits, the budget report would look like this:

Solution to Practice Exercise 15–I 427

428 EXAMPLES AND EXERCISES, SUPPLEMENTAL MATERIALS, AND SOLUTIONS

Static Budget
Actual Budget Variance

Revenue—Inpatient $17,550,000 $19,500,000 $(1,950,000)
Revenue—Outpatient 4,400,000 4,000,000 400,000
Subtotal $21,950,000 $23,500,000 $(1,550,000)

Expenses—Inpatient $16,100,000 $18,000,000 $(1,900,000)
Expenses—Outpatient 4,000,000 3,800,000 200,000
Subtotal $20,100,000 $21,800,000 $(1,700,000)

Excess of revenue over
expenses $ 1,850,000 $ 1,700,000 $ 150,000

Note: The negative effect of the $1,550,000 net drop in revenue is offset by the greater effect
of the $1,700,000 net drop in expenses, resulting in a positive net effect of $150,000.

PRACTICE EXERCISE 16-I

Because there is no one right answer, students will approach this exercise in different ways.

REQUIRED SOLUTION TO PRACTICE EXERCISE 17–II

The Price Variance is $206,100 (3,435,000 less 3,228,900 equals 206,100).
The Quantity Variance is $185,000 (3,435,000 less 3,250,000 equals 185,000).

OPTIONAL SOLUTION TO PRACTICE EXERCISE 17–I

The $3,228,900 actual overhead costs represent 687,000 RVUs times $4.70 per RVU.
The $3,250,000 budgeted overhead costs represent 650,000 RVUs times $5.00 per RVU.

SOLUTION TO PRACTICE EXERCISE 17-II

The required revenue to achieve a target operating income of $20,000 amounts to revenue
of $75,000.

The contribution income statement to prove the formula results is as follows:
Revenue $500/unit x 150 units � $75,000
Variable costs $300/unit x 150 units � 45,000_______
Contribution margin $30,000
Fixed costs 10,000_______
Desire (Target) Operating Income � $20,000

SOLUTION TO PRACTICE EXERCISE 20–I

$50 per hour divided by 60 minutes equals $0.8333; thus 2 minutes equals $1.6667. If a hos-
pital’s coders are dealing with 1,500 claims, then the dollar amount of productivity loss is
$2,499 (1.6667 per claim times 1,500 claims equals $2,499).

SOLUTION TO PRACTICE EXERCISE 22-I

With beginning principal of $60,000, the monthly payment is $1,936.03 and the remaining
principal balance at the end of six payments is $51,202.30.

SOLUTION TO PRACTICE EXERCISE 23-I

The present value cost of leasing for Suburban Clinic amounts to $49,116.

SOLUTION TO PRACTICE EXERCISE 24-I

All of the assumption items listed in Example 23A are present in the retail pharmacy mini-
case study in Chapter 26.

Solution to Practice Exercise 24-I 429

Index

Accelerated book depreciation methods,
84–85, 87–91

Accounting
recording inventory in, 76
types of, 7, 9

Accounting income inputs, 186
Accounting rate of return, 179, 186
Account numbers, 15
Accounts, groupings of, 14
Accounts payable, 27, 42
Accounts receivable, 26, 33
Acid-test ratio, 117
Admissions

analyzing referral activity, 331–332
areas to automate, 330
assessing, 329–330
case studies, 290, 329–332
fax and document management, 330
referral tracking and approval, 331
saving time with automated, 332

Allocation basis, 52
Alternative Depreciation System, 86
Ambulatory care systems, 12
American Hospital Association, 165
American Recovery and Reinvestment Act of

2009 (ARRA)
hospital incentives under, 219–220
physician incentives under, 220

Amortization schedules, 258, 259, 261–262
Annual management cycles, 19–20
Annual year-end reports, 19–20
Annuities, 133

431

ARRA. See American Recovery and
Reinvestment Act of 2009 (ARRA)

Assets
on balance sheets, 107–108
capital, 178, 182, 183
description of, 25
examples, 26
fixed, and depreciation expense, 81
lease-purchase agreements, 263–264
long-term, 26, 108
return on, 120–121
short-term, 26

Assisted living services, 37
Assumptions, forecasts and, 141–144
Authority, lines of, 7, 42, 52–55, 145
Averages, 186, 213–214

Bad debts, 33
Balance sheets, 107–108

in business plans, 275–276
case study, 284
checklist for review of, 113
liquidity ratio calculations, 119
profitability ratios, 121
solvency ratios, 121

Behavioral health, 39
Benchmarking, 210–211

case study, 293–298
financial, 211

Billing departments, 212
Board of Trustees, 306
Bonds, 251–252, 258

432 INDEX

Bonds payable, 27
Books and records, 18–19
Book values, 27, 81–83
Break even points, 68–70
Budgets, 165–176

building, 168–171
capital expenditure, 177–184
checklists, 165, 176
comparative budgets, 152–154
construction tools, 178–180
forecasts and, 141
managerial accounting and, 9
reviewing, 166–168, 175–176
types of, 165–168

Buildings, 26
Burden approach, 96
Bureau of Economic Analysis, 254
Business loans, 257–262
Business plans, 271–278

assembly of, 276–277
cash flow assumptions, 305
elements of, 271
executive summaries, 276
financial analysis segment, 273–276
formats, 277
“knowledgeable reader” approach, 276
marketing segment, 273
monthly income statements, 304
organization segment, 272–273
planning stage, 271–272
presentation, 277
for retail pharmacies, 301–306

Buy-or-lease decisions, 264–269

Capacity issues, staffing and, 145, 147
Capital

asset acquisition, 183
costs of, 185, 188
definition, 257
sources of, 257–258

Capital budgets, 185–188
Capital expenditures

budgets, 177–184
evaluating proposals, 182–183
spending plans, 177–178
types of proposals, 181–182

Capital Stock, 28
Capital structures, 257

Care settings, grouping by, 36–37, 45–46
Case mix adjustments, 210
Case studies

admissions, 290, 329–332
balance sheets, 284
benchmarking, 293–298
expansions, 301–306
financial ratios, 293–298
improving quality of care, 308–314
Metropolis Health System, 281–298
pharmacy addition, 301–306
physicians offices, 308–322
resource misallocation, 323–328
Schedule of Operating Expenses, 289
Schedule of Patient Revenue, 288
Schedule of Property, Plant, and Equip-

ment, 287
solvency ratios, 295, 297
statement of revenue and expense, 284, 285
technology in healthcare, 229, 245–246

Cash, as asset, 26
Cash equivalents, 249–250
Cash flow

budgeting and, 178
cumulative, 178
discounted, 125
equipment purchase and, 185
monthly detail and assumptions, 301
net annual inflow, 126
owning v. leasing equipment, 265, 267
payback methods, 179
projections, 274
reporting methods, 179
for retail pharmacies, 302
statement of, 111–113

Cash flow statement, 286
Cash/noncash concept, 111
CDs (certificates of deposit), 250
Centers for Disease Control and Prevention

(CDC), 221
Centers for Medicare and Medicaid Services

(CMS), 221, 222, 317. See also Medicaid
Program (Title XIX); Medicare
Advantage; Medicare Program
(Title XVIII)

Certificates of deposit (CDs), 250
Changes in Fund Balance, 287
Charity services, 33

Charts of accounts, 14–17
Chief executive officers, 42
Chief financial officers, 257
Clinical viewpoint, 4
Closing costs, 259
Coders, and ICD-10 training, 234–235, 236
Code users, and ICD-10 training, 235, 236
Coinsurance, 35
Commercial insurers, 36
Common costs, 49–50. See also Indirect costs
Common sizing, 137–138
Common stock, 252
Communication

in admissions, 330–331
financial information, 20
lines of, 7

Community health programs, 281–282
Company ownership, 253
Comparative analysis, 137–138, 175, 293–298
Comparative budget review, 152–153
Comparative data, 151–162

annualizing expenses, 158–159
comparability requirements, 151–152
comparing current expenses to current

budget, 153–154
comparing organization’s current actual

expenses to prior periods, 154–155
comparing to industry standards, 157–158
comparing to other organizations, 155–157
currency measures, 161
inflation factors, 159–160
manager’s view of, 152–153
standardized measures, 161
uses of, 153–154

Competition, 309
Competitors, 210, 293
Compound interest, 124, 131–132
Continuing care retirement communities

(CCRCs), 37–38
Contracts, types of, 35
Contractual allowances, 32–33
Contribution income statement, 199–200
Contribution margins, 68–73, 199–202

break-even point using, 201–202
contribution income statement and,

199–200
target operating income using, 200–201
worksheet example, 201

Index 433

Controller’s office, 49
Controlling, purpose of, 5
Cost centers, 42–44, 47
Cost objects, 49, 50, 55
Cost of goods sold, 76–77
Costs

assignment to cost objects, 50
of capital, 15, 185
case study, 294–296
classification, 49–56, 59–62
definition, 41
direct, 49, 50, 52
e-prescribing, 239
expired, 41
of financing, 258–259
fixed, 59–62
grouping, 168
ICD-10 training and lost productivity costs,

234–237
indirect, 49, 50, 52
of leasing/owning equipment, 266
reports, 46–48
of sales, 55
semifixed, 61–62
semivariable, 59–62
staffing and, 99–100
unexpired, 42
variable, 59–62

Cost-volume profit (CVP) ratios, 68–70
Credit analysis, 121
Credit losses, 33
Currency measures, 161
Current ratio, 116, 117

Daily operating reports, 19
Data repositories, 12
Days cash on hand (DCOH), 116, 118
Days receivables, 116, 118
Debentures, 252
Debt-equity relationships, 257
Debts

as liabilities, 27
long-term, 108, 258
short-term, 258
uncollectible, 33

Debt service coverage ratio (DSCR), 116,
118–119

Debt to fund balance, 120

434 INDEX

Decentralization, 7
Decision making

about business loans, 260
budgeting and, 178
in business plans, 272
controllable costs and, 144–145
lines of authority and, 6
purpose of, 6
rationing capital, 15

Deductibles, 35
Deflation, 254
Dell, Inc., 239
Demographics, 310
Department of Veterans’ Affairs, 35
Depreciation

of assets, 27
assumptions, 265
book value of fixed asset and reserve for,

81–83
calculations, 265
computing tax depreciation, 85–86
expenses, 112
interrelationship of expense of and reserve

for, 82
methods of computing, 83–85
overview, 81

Diagnoses
expense grouping by, 44–45
hospital department codes by, 46
technology issues and problems, 232–234

Diagnosis-related groups (DRGs)
expense grouping by, 44
flexible budgets and, 173
hospital department codes by, 46
profitability matrix, 72

Dialysis centers, 52
Direct costs, 49, 50, 52
Directing, purpose of, 5
Disbursements for services, 42
Discharges, case study, 290
Discounted cash flow, 125
Discounted fees for services, 31–32
Disease management, 39
Dispenser, defined, 237
Document management, 330
Donations, 36, 258
Double-Declining Balance (DDB), 84–85, 87,

89, 90

Doubtful accounts, 33
Drug and alcohol services, 35
Drug costs, 73

Earnings, time pattern of, 125–126
Earnings before interest and taxes (EBIT),

120–121
Economic measures, 211
Efficiency, specialization and, 3
Efficiency variance, 191
Electronic data information (EDI) links, 12
Electronic documents, 330
Electronic intercompatibility, 221
Electronic prescribing. See E-prescribing
Electronic records, 217–230

compliance requirements, 218–219
definitions, 217–218
slow adoption of, 218
standardized input and, 161

Emergency services, 39
Employee welfare cost centers, 43
E-prescribing

adoption rates, 238
benefits, 238
costs, 239
definitions, 237–238
“eligible professionals,” 241–242
implementation of, 240–241
incentives program, 241–242, 243
manner of reporting, 243–245
penalties, 242–243
qualified system of, 242
technical input example, 245
transactions, 237–238
Wal-Mart and, 239

Equipment
acquisition, 181, 276
as asset, 26
budgeting for, 178
decision making, 185
descriptions, 272
funding requests, 181–182
leasing, 263
owning v. leasing, 265, 267
purchasing, 263
replacing, 181–182
upgrading, 181

Equity, definition, 27–28

E-records. See Electronic records
E-referrals, 331
Expansions, 178, 301–306
Expenses (outflow), 41–48

administrative, 55
annualizing, 158–159
budgeted, 175
comparative analysis, 137
controllable, 144–145
definition, 41
depreciation as, 265
general, 55
grouping, 42–46
noncontrollable, 144–145
operating, 108, 110
physician practices, 316–322
for retail pharmacies, 302
statement of, 108, 110
trend analysis, 138, 139

Expired costs, 41

Fax management, 330
Federal Deposit Insurance Corporation

(FDIC), 250
Feedback, purpose of, 5
Fee schedules, 316–322
Fees for services, 31–32
FIFO inventory method, 77, 78, 151
Financial accounting, 7
Financially indigent patients, 33
Financial management

concept, 4
elements of, 5–6
history, 3–4
viewpoints, 4–5

Financial ratios, 293–298
Financial systems, 11
Financial viewpoint, 4
Financing, costs of, 258–259
First-In, First-Out (FIFO) inventory method,

77, 78, 151
Fiscal years, 20
Fixed assets, 81–84
Fixed costs

analysis, 72
budgeting, 168
description, 59–60
examples, 52–55

Index 435

high-low method, 66–68
operating room, 63–64

Flexible budgets, 168, 173–174, 196–198
Flexible costs, 168
Flowsheets, 12–14
Food costs, 60, 66, 73
Forecasts. See also Projections

building budgets, 169
in business plans, 273–274
equipment acquisition, 276
use of, 144–147

Foreign currency measures, 161
For-profit organizations

income taxes, 264–265
net worth terminology, 27–28
owning v. leasing decisions, 266, 267
revenue retention, 258

Freight in, 76
Full-time equivalent staff (FTES)

annualizing positions, 95–98
calculation of, 95–98
costs, 63–64

Fund balances, 28
on balance sheets, 107–108
revenues and, 41
statement of changes, 111

Fund designators, 17
Funding requests, 180–182

GDP (gross domestic product), 254
General Depreciation System (GDS), 85–86
General ledgers, 18–19
Generally accepted accounting principles

(GAAPs), 108
General obligation bonds, 251
General Purpose Simulation System, 325
General services, 43
Geographic practice cost indices (GPCIs),

320–322
Goods sold, inventory and costs of, 76–77
Government

perspectives of, 312
reporting to, 7
revenue sources, 33–35

Government securities, 250
Graphs

high-low method, 66–68
scatter, 66, 70, 72–73

436 INDEX

Gross domestic product (GDP), 254
Gross margins, 77, 303
Gross revenue, 32

Health Insurance for the Aged and Disabled.
See Medicare Program

Health Insurance Portability and
Accountability Act of 1996 (HIPAA),
221–223

Health maintenance organizations (HMOs).
See also Managed care

case study, 308–322
organizational perspectives, 312–314
plan descriptions, 35

Health systems, case study, 281–298
High-low graphs, 63, 66–68
Historical costs, 27
Home care systems, 13–14, 38–39
Horizontal analyses, 138–139, 141
Hospital care codes, 319
Hospital department codes, 45, 46
Hourly base rates, staff, 99
Housing and Urban Development (HUD)

subsidized independent housing, 38

ICD-9-CM, 232–234
ICD-10 e-records, 221–225

benefits and costs of, 223–225
developmental steps, 227–228
ICD-10-CM and ICD-10-PCs, 221
impact in the U.S., 221–223
managers and, 231
overview and impact of, 221–223
providers and suppliers impacted by

transition to, 223
situational analysis, 226–228
strategic steps, 226–227
system implementation planning,

225–226
training and lost productivity costs,

234–237
Income. See also Revenues (inflow)

accounting inputs, 186
monthly statements, 304
operating, 108
for retail pharmacies, 302

Independent living facilities, 37–38
“Indexed to inflation,” 254

Indian healthcare services, 35
Indirect costs

definition, 49
dialysis center example, 52
examples, 50, 52

Individual practice associations (IPAs)
models, 35

Inflation
comparative data and, 159–160
vs. deflation, 254

Inflow (revenues), 31–39
Information systems

ambulatory care example, 12
basic elements, 14–19
manager’s challenge in changes of,

231–246
reports and, 19
structure of, 11–12

Inpatient care settings, 45–46
Input-output analysis, 191–192
Inputs, into information systems, 12
Inside-out perspectives, 312
Insurance companies

databases, 12
perspectives, 314
verification systems, 12

Insurance cost centers, 43
Insurance verification, 331
Interest, 112

compound, 124
expenses, 258–259
points, 259

Interim reports, 19
Internal rates of return (IRRs), 125, 179–180,

187–188
Inventory, 26, 55–56

calculating turnover, 80–81
costs of goods sold and, 76–77
methods, 77–78
necessary adjustments, 80
overview, 75
tracking, 78–80
types of, 75

Investment indicators, 253–254
Investments

payback periods, 125–126
rates of return on, 123, 188
terminology of, 249–255

Joint costs, 49–50. See also Indirect costs

Labor market forecasts, 145
Land, as asset, 26
Last-In, First-Out (LIFO) inventory method,

77, 79, 151
Lease-purchase agreements, 263–264
Leases, capitalizing, 263–264
Least squares method, 73
Lengths of stay, 290, 294, 295, 296
Leverage ratios, 295, 297
Liabilities

on balance sheets, 107–108
comparative analysis, 138
description of, 25
examples of, 27
long- and short-term, 27
trend analysis, 139
types, 108

Liabilities to fund balance, 116, 120
LIFO inventory method, 77, 79, 151
Lines of authority

cost center designations, 42
nursing staff classification by, 145
organization charts and, 6–7
reports and, 52–55

Liquidity ratios, 117–118, 295, 297
Loans

amortization schedules, 259
costs of, 259
decision-making about, 260
short-term, 258

Long-term assets, 81
Long-term borrowing, 258
Long-term care, 37–38
Long-term debt instruments, 251

Major diagnostic categories (MDCs), 37, 44,
46

Malpractice insurance, 316–317
Managed care. See also Health maintenance

organizations (HMOs)
case study, 308–322
contractual allowances, 32–33
revenue sources, 35
standardized measures and, 161

Management, organization charts, 291
Management responsibilities, 52–55, 95–104

Index 437

Managerial accounting, 9
Managers

comparative data and, 152–153
ICD-10 and, 234
information systems changes and, 231–246

Market studies, 301–306
Master Staffing Plans, 98
Maternal and child health services, 35
Measurement tools, 211–213
Medicaid Program (Title XIX), 34–35, 46
Medical records division, 42
Medicare Advantage, 34
Medicare Program, 33–34
Medicare Program (Title XVIII), 46
Mental health services, 35, 282
Migrant healthcare services, 35
Mixed costs, 62

analysis of, 65–68
characteristics, 65
scatter graph analysis, 70, 72–73
step methods, 65

Modified Accelerated Cost Recovery System
(MACRS), 85

Monetary unit measurement, 152, 161
Money, time value of, 124
Money-market funds, 250
Mortgage bonds, 252
Mortgages, 27, 258
Municipal bonds, 251

National Center for Health Statistics, 221
Net book value, 82. See also Book values
Net cash flow, 178, 265
Net present value (NPV), 179, 187
Net purchases, 76
Net rates, staffing, 99
Net worth

on balance sheets, 107–108
definition of, 25
forms of, 27–28
statement of changes, 111
terminology, 28

No method inventory, 78
Noncompetitors, 210
Nonoperating gains (losses), 110
Nonproductive time, 96–97, 99
No-show rates, 310
Notes payable, 27

438 INDEX

Notes receivable, 26
Not-for-profit organizations

church-affiliated, 258
donations from, 36
governmental, 6
net worth terminology, 28
owning v. leasing decisions, 266, 267
revenue retention, 258
voluntary, 6

Nurse practitioners, 313
Nursing facilities, 37
Nursing practice and administration, 290
Nursing services cost centers, 43

Obsolete items, in inventory, 80
Occupancy rates, 294
Occupational health services, 282
Office visit costs, 65
150% Declining Balance accelerated

depreciation method, 85, 90–91
Operating data, analysis, 139–141
Operating expenses, 108, 110, 289
Operating income, 108, 110
Operating leases, 264
Operating margins, 116, 120
Operating reports, 19
Operating revenue, 108, 110
Operating rooms

comparative data analysis, 140
costs, 63–64

Opportunity costs, 183
Organization charts, 6–7

case study, 290, 291
charts of accounts and, 15
health system example, 8
physician’s office example, 7

Organizations, structure and types of, 6–7
Organizing, purpose of, 5
Original records, 18
Outflow (expenses), 41–48
Outpatient care settings, 45–46, 308–322
Outputs, information systems, 12
Outside-in perspectives, 312
Overhead, 275
Owner’s Equity, 28

Parametric analysis, 210
Pareto analyses, 211–213

Patient days, 290
Patient information, confirming, 331
Patient revenue, 288
Patients

information verification, 13, 14
satisfaction surveys, 311

Payback methods, 179–180, 185–186
Payback periods, 125–126
Payer mix, 33
Payers

changes, 144
definition, 32
private, 36

Payrolls
register, 101
taxes, 27
transaction records, 101

Peer groups, 210
Pension cost centers, 43
Percentile rankings, 293
Performance gaps, 210
Performance measures, 115–122

adjusted over time, 209
benchmarking, 210–211
variety of, 209–210

Period costs, 55–56
Periodic inventory system, 79–80
Perpetual inventory system, 79
Petty cash funds, 42
Pharmacy additions, 301–306
Physician fee schedules, geographical

adjustments, 320–322
Physician groups, 39
Physicians

e-prescribing for, 237–240
ICD-10 training and, 236

Physicians Current Procedural Terminology
(CPT), 44

Physicians offices, 33, 308–322
Planning, purpose of, 5
Point-of-service models, 35
Points, on loans, 259
Predetermined per-person payments, 32
Preferred provider organizations (PPOs), 35
Preferred stock, 252
Prescriber, defined, 237
Prescription Drug Benefit, 34
Prescriptions. See E-prescribing

Presentations, tips, 277
Present-value analysis, 124
Present value costs, 267–268
Present values, net, 179–180
Present value tables, 124, 129–130, 133, 187
Price variance, 192
Privately held companies, 253
Private payers, 36
Procedure codes, 46, 52

ICD-9-CM and ICD-10-CM comparison,
232–233

Procedures, expense grouping, 44–45
Process viewpoint, 4
Product costs, 55–56
Productive time, 96–97, 100
Professional services, 43
Profitability matrix, 72, 302–305
Profitability ratios

case study, 295, 297
description, 120–121
examples, 121
types of, 116

Profit centers, 53
Profit-volume (PV) ratios, 70, 71
Program cost center, 47
Programs

definition, 46
existing, 182
expenses grouped by, 46
new, 182

Projections, 9. See also Forecasts
Proprietary organizations, 6
Prospective payment reimbursement

methodology, 44
Providers, perspective of, 314
Public companies, 253
Public health clinics, 35

Quantity variance, 191–192
Quarterly reports, 19
Quartile competition, 213–214
Quick ratio, 117

Radiology departments, 46, 50, 51
Rate setting, 32
Rates of growth, 304
Rates of return

accounting, 179

Index 439

actual, 188
internal, 125, 179–180
unadjusted, 123

Rates per day, 42
Rate variance, 192
Ratio analysis, 115, 116
Real estate taxes, 259
Record-keeping systems, 3
Recovery services, 282
Referrals

analyzing referral activity, 331–332
assessing admissions process, 329
e-referrals, 331
HMOs and, 309–311
tracking and approval, 331

Regression lines, 72
Rehabilitation centers, 281
Relative value units (RVUs), 194, 195

facility total weight, 317
fee schedules and, 316–322
nonfacility total weight, 318
physician fee schedule reporting, 319

Remaining value, 185
Renovations, budgeting for, 178
Rent, 59
Reports

Director’s summary, 53, 54
external, 7
financial statements, 107–114
information systems and, 19
lines of, 7
staffing costs, 99–100

Reserve for depreciation, 82
Resource-Based Relative Value Scale

(RBRVS), 316
Resource utilization, 294, 295

case study, 295, 296
changes in, 143
evaluation of, 127
peak-load problem, 324–325
WIC program, 323–328

Responsibility centers, 36, 52–55
Retained Earnings, 28
Return on total assets, 116, 120–121
Returns on investment, 183
Revenue bonds, 251
Revenue centers, 36
Revenues (inflow), 31–39

440 INDEX

contractual allowances, 32–33
deductions from, 32–33
equity and, 41
grouping, 36–39
operating, 108
projections of, 274
for services, 31–33
sources, 33–36, 274
statement by source, 37
statement of, 108
types, 274

Revenue stream, 31

Salaries, 43
Salvage value, 81, 84, 185
Same-day surgery, 281
Sam’s Club, 239
Scatter graphs, 70, 72–73
Scheduled-position method, 98–99
Schedule of Operating Expenses, 289
Schedule of Patient Revenue, 288
Schedule of Property, Plant, and Equipment,

287
Scheduling systems, 12
School health programs, 35
Seawell’s Chart of Accounts for Hospitals, 15
Securities and Exchange Commission (SEC),

253
Security, in business plans, 275
Semifixed costs, 61–62
Semivariable costs, 59–65
Sensitivity analysis, 199–203

overview, 199
tools, 199–202

Service lines, 37–39, 45–46
Services

cost of, 55
descriptions, 262–263
disbursements for, 42
revenue for, 31–33

Shortages, of inventory, 80
Short-term borrowing, 258
Skilled nursing facilities, 37, 281
Social Security Act, 33
Social security taxes, 43
Solvency ratios, 118–120

case study, 295, 297
examples, 121
types of, 116

Space occupancy, 275
Specialization, efficiency and, 3
Spending variance, 192
St. Joseph Hospital Nursing Center variance

analysis, 195–196
Staffing

annualizing positions, 95–98
calculating FTEs, 95–98
capacity issues and, 145
classification by lines of authority, 145
comparative hours report, 103
costs, 61, 63–64, 65, 99–100
definition, 97
forecasts, 144–147
labor market and, 145
manager responsibility, 95–104
operating room example, 100
requirements, 95, 99
resource utilization and, 294

Standardized measures, 161
Startup cost concepts, 180
Statement of cash flows, 286
Statement of revenue and expense, 108

case study, 284, 285
checklist for review of, 113
liquidity ratio calculations, 119
profitability ratios, 121
solvency ratios, 121

State-only general assistance programs, 35
Static budgets, 172, 196
Statistical support, 12
Stockholders, 7
Stock investments, 252
Stock warrants, 252
Straight-line depreciation method, 83–84
Strategic planning, 7, 12, 37
Stub periods, 20
Subsidiary journals, 18–19, 99–100
Subsidiary reports, 113
Sum-of-the-Year’s Digits (SYD) depreciation

method, 84, 87, 88
Supplemental medical insurance (SMI), 34
Supplies, 65, 275
Support center reports, 54
Support services, 43, 44
SWOT analysis, 228–229

Target operating income, 200–201
Tax depreciation

computing, 85–86
defined, 83

Taxpayers, reporting to, 7
Tax revenues, 36
Tests, costs, 65
Three-variance analysis, 192–194
Time cards, 100, 102
Time periods, 55
Time value of money, 124
Title XIX. See Medicaid Program

(Title XIX)
Title XVIII. See Medicare program
Traffic flow, example, 326
Transaction records, 100
Transactions, progress of, 18
Treasury bills, 250
Treasury notes, 250
Trend analysis, 138–139, 144, 293
Trial balances, 18
Two-variance analysis, 192–194

Unadjusted rates of return, 123, 186–187
Units of Service or Units of Production

depreciation method, 85, 91, 93, 94
U.S. Securities and Exchange Commission

(SEC), 253
Useful life, 81, 185
Use variance, 191–192

Variable costs
behavior, 65
description, 59–62
examples, 52–55
operating room, 63
views of, 62–63

Index 441

Variance analysis, 191–199
calculation of, 192–193
composition, 192–193
elements of, 191–192
examples, 194–198
percentile rankings and, 293
price (or spending) variance, 192
quantity (or use) variance, 191–192
summary, 198–199
two-variance/three-variance analysis com-

pared, 192–194
volume variance, 191

Vendor software, and ICD-9 to ICD-10
transitions, 232

Vertical analysis, 137, 139, 141
Volume variance, 191
Voluntary organizations, 6
Vouchers, WIC, 323

Wages, 43
Wal-Mart, 239
Weekly operating reports, 19
Weighted average inventory method, 77
Wellness programs, 281–282
Wharton, Joseph, 3
Wharton School, 3
Women, Infants, and Children Public Health

Program (WIC)
appointments, 324
environment, 323
peak-load problem, 324–325
resource utilization, 324–325, 328
traffic flow, 325, 326
vouchers, 323

Workers’ compensation programs, 35, 39

Judith J. Baker, PhD, CPA, is Executive Director of Resource Group, Ltd., a Dallas-based
health care consulting firm. She earned her Bachelor of Science degree in Business Ad-
ministration at the University of Missouri, Columbia and her Master of Liberal Studies with
a concentration in Business Management at the University of Oklahoma, Norman. She
earned her Master of Arts and Doctorate in Human and Organizational Systems, with a
concentration in costing systems, at the Fielding Institute, Santa Barbara, California. She is
an adjunct faculty member at the Case Western Reserve University Frances Payne Bolton
School of Nursing.

Judith has over thirty years experience in health care and consults on numerous health
care systems and costing problems. She has worked with health care systems, costing, and
reimbursement throughout her career. As a CMS contractor she has assisted in validation of
costs for new programs and for rate setting and consults on cost report design.

Judith has written over 40 articles, manuals, and books. She served as Consulting Editor
for Aspen Publishers, Inc. Her books include Activity-Based Costing and Activity-Based
Management for Health Care, Prospective Payment for Long-Term Care: An Annual
Guide, and Prospective Payment for Home Health Agencies. She is editor emeritus of the
quarterly Journal of Healthcare Finance.

R.W. Baker, JD, is Managing Partner of Resource Group, Ltd., a Dallas-based health care
consulting firm. He has more than 30 years of experience in health care and has designed,
directed, and administered numerous financial impact studies for health care providers.
His recent studies have centered around facility-specific MDS data collection and analysis.
He and his firm subcontracted to the HCFA/CMS Nursing Home Case Mix and Quality
Demonstration for over nine years.

R.W. is the editor of continuing professional education seminar manuals and training
manuals for facility personnel and for research staff members. He served as a Consulting
Editor with Aspen Publishers, Inc. and is co-author of A Step-by-Step Guide to the Mini-
mum Data Set (Aspen Publishers, Inc.).

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