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1. Define decentralization of accounting in modern health care organizations. Identify the information id provided in responsibility accounting, and the value of responsibility account for the total organization’s financial and operational benefit. Identify the cost centers and briefly identify their functions and value for the overall organization’s administration. Use an example if you wish. Identify the various budgets involves in system’s responsibilities account approach. Briefly describe the cost centers’ information needed by the system administration. You may also wish to identify other additional financial performance measures.

Responsibility accounting in modern health care organization is a type of management accounting which collects and reports both planned and actual accounting information in terms of responsibility centers about the inputs and outputs of responsibility accounting.

A growing trend in the structure of health care organizations is decentralization.

Decentralization is the degree of dispersion of responsibility within a health care organization. In a decentralized organization, decision making is not confined to a few Top Executives but rather spread throughout the organization, with managers at various levels making key operating decisions within their sphere of responsibility.

Health care organizations are divided into responsibility centers, organizational units in which a manager is responsible for operations and evaluates the unit’s performance. For example, a nurse manager may be responsible for an inpatient pediatric unit, the manager for a home-care program is responsible for all home-care services that are delivered, and the manager of a housekeeping department is responsible for the cleanliness of the facility. Every program and department in a health care organization can be classified as a responsibility center.

Responsibility accounting provides the information necessary to assist a manager in operating a responsibility center. Responsibility accounting is defined as the classification of financial and statistical data according to the organizational unit that produces the revenue and incurs the expense. There are four major types of responsibility center and cost centers is one.

Cost centers are responsible for providing services and controlling their costs. The types of costs center in health care organizations are production, clinical and administrative cost centers. The production cost centers develop and/or cell products, such as laboratories. Clinical cost centers are responsible for providing health care related services to patients or clients, such as pharmacy, radiology (if services are covered), laboratory (same as radiology) and dietary services, and various nursing units. Administrative cost centers support the clinical cost centers and the organization as a whole. For example the housekeeping department, because it incurs costs, but does not generate revenue.

Within every organization today there is at least one responsibility center that helps the organization function and managers are held accountable for the performance of their responsibility centers. Responsibility refers to the tasks and obligations of a responsibility center; authority is the influence to carry out a given responsibility; and accountability means there are consequences for carrying out responsibilities.

Budget variances are the most universal measure for financial performance. A budget variance is a discrepancy between the predicted cost or revenue in a given account. It’s common for health care organizations to separate their total budget variance into the portion due to changes in revenue and the portion due to changes in expenses.

The revenue volume variance is the portion of total variance in revenues due to the actual volume being either higher or lower then the budget volume. It is the difference between the revenues forecast in the original budget and those in the flexible budget. The rate variance is the amount of the total revenue variance that occurs because the actual average rate received varies from that originally budget.

The expense volume variance is the portion of total variance in variable expenses due to the actual volume being either higher or lower than the budget volume. It is the difference between the expenses forecast in the original budget and those in the flexible budget.

Beyond variances are usually associated with the operating budget, which focuses on short-term revenue attainment and cost containment. A more long-term focus is necessary to affect major efficiencies in the organization. Measures must be implemented to promote revenue enhancement and cost avoidance in the long term.

Although budget variances are the most-used financial measure, various ratios are increasingly being used as financial performance measures for profit and investments center. Other additional financial performance measures are:

Compensation systems: The responsibilities, accountability, and authority components of responsibility accounting system do not operate in isolation and may be highly intertwined with the employee compensation system.

The fundamental attribute of the salary-based compensation system is that employees receive a guaranteed salary.

In a full At-risk compensation system, compensation is based totally on achieving certain targets, called performance goals.

In a mixed compensation system, a portion of compensation is at risk. If well designed, a system can provide for a base for certainty for part of compensation. However, if not well structured, it may have the disadvantage of each.

In compensation system design, a number of factors should be considered, including the goals of the system , which can generally be categorized into productivity and quality, financial viability, and general characteristics.

2. Name the three most commonly approaches used cost finding methods used by health care organizations. Define each approach and point out the weakness and advantages of the approach. Identify and explain the activities and kinds of information revealed by these reports. What is the value this information (if any) to the health care organization’s administration? How is this information related to providers and the health care organization? Of what value is it to patients and other users of the organization’s services? Identify and describe the advantage or disadvantage of the three approaches to finding cost for objects and services expended by the organization.

The purpose of costing is to make planning decisions more precise and meaningful. So, once the healthcare organization has allocated costs by a method that ensures that patients are paying for their fair share of costs, the organization chooses a method, of assembling costs in ways that are meaningful to management.

Providers generally use one of three approaches: the cost-to-charge ratio, the step down method, or activity based costing.

The cost-to-charge ratio is the easiest to implement, and maintain. The charge amount or service line level is the measure by which costs are disseminated. In the health care, it is assumed that reimbursement reflects the intensity of care, and therefore indirect costs are assigned accordingly.

Step-down method

The step-down method finds costs by allocating those costs that are not directly paid for into products or services to which payment is attached. It is a top-down approach because it begins with all costs and allocates them downward into various services for which payment will be received. As a result of methodological idiosyncrasies, those performing a step-down cost finding must pay considerable attention to the order of allocation, the allocation basis, and the number of cost centers. The step-down method is useful for pricing and reimbursement-related decisions but should not be used to control costs.

Activity-based costing

The concept of activity based costing is based on the assumption that the direct cause of the costs action, activities. Implementation of these actions results in consumption of resources, which are a quantitative reflection of the cost.

The key notation of the concept of activity based costing is a cost object, which is the object for which the cost is collected and counted. Depending on the needs of decision-maker the object may be a product, order, contract, supplier, customer, etc. Another word or phrase in the presented model is an activity cost driver. Each action has its own unique cost driver. The driver is a cost measure of use of discrete activities by cost objects. It is worth noting that the action is defined as the set of operations performed in the unit, which are useful from the viewpoint of cost accounting purposes. In the model there is also the notion of the resource costs driver. The cost drivers are things that cause a change in the cost of an activity.

Indirect costs are costs that an organization is not able to directly trace to a particular cost object. For example, many health care organizations have great difficulty tracing to a particular patient or service such items as the cost of the billing clerk, rent, or information systems. Direct costs are costs that an organization can trace to a particular cost object. Thus, a cost is not direct or indirect by its nature but by the ability of the organization to trace it to a cost object.

Advantages and disadvantages

The cost-to-charge ratio is primarily due to comfort level, based on experience, many financial managers have with reimbursement and the use of the cost-to-charge ratio method in Medicare cost reports.

Although cost-to-charge ratio has these advantages, it also has significant disadvantages. For one, the ratio used may be typical for the industry or a segment of the industry, it may not apply well to any particular organization. Additionally, if the ratio were determined by a study, to the extend that volume or service mix deviates from the figures used in the study, the CCR may become inaccurate. To the extend that the fixed or variable cost composition has changed, the ratio may provide an inaccurate measurement. Also, to the extend that an overall ratio is used for all procedures, the CCR may underestimated or overestimated the cost of individual procedures.

The advantage of the step down method is that is useful for pricing and reimbursement-related decisions, however, is less useful for controlling costs. Although the step-down method is the most widely used because of its legacy from Medicare, there are several other related methods available to providers to calculate costs. Most inpatient facilities use the step-down method to report their Medicare costs.

ABC offers advantages over traditional costing because it relates costs to activity drivers rather than just fixed and variable designations. Traditional methods of costing tend to bury overhead in product costs through very general allocations. In contrast, ABC attempts to tie areas usually thought of as overhead to their own activity measures. ABC attempts to reveal all activities contributing to cost, allowing managers to eliminate activities that do not add value, and thus ABC is often heard in connection with reengineering efforts. ABC is also often mentioned in connection with supply chain management, as a means of identifying non-value-adding steps in the supply chain.

In today’s competitive environment, a health care cost accounting system should accomplish cost efficiency without a negative impact on the quality of service delivery, provide information for management to maximize resources, and assist in continuous quality improvement.

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