Background Present Situation Problem Statement Methodology Process Conclusion References About the Author |
STEP-DOWN ALLOCATION AS A POWERFUL, YET SIMPLE, COST ASSESSMENT TOOL FOR HOSPITALS IN THE NIS / ECE*
* NIS: Newly Independent States of the former USSR; ECE: Eastern and Central Europe
BACKGROUND
Under the Soviet-style economy, health care in the republics of the former USSR was essentially free. There was no fee involved in any type of medical procedures performed in hospitals, pharmacies, or dispensaries. There was a sole health budget determined by the central government authorities in Moscow. Certainly, each republic's government did have its input in the process, however, the allocation of funds was essentially done by the central planning office, called the Central State Planning Agency. The planning office developed five-year plans for the entire Soviet Union. The funds were then distributed to each corresponding Republican Planning Agency (Armenian, Belorussian, Uzbekistanian, etc.), whose responsibility was confined to distributing the already estimated and allocated funds among the different ministries within republican governments. Also, the Republican Planning Agencies were monitoring, evaluating state programs, and reporting results to the Central State Planning Agency.
The system was neither efficient nor effective, primarily because the input of the republican governments was minimal. Often, leaders of each republic were visiting Moscow in hopes of increasing the republic's share of funds through informal and friendly discussions, or simply personal sympathy. Thus, the question, “How much does it cost a hospital to provide a given service?", was never raised, therefore, never answered. First, there was no need to do so, because the central government was deciding and doing almost everything. The local authorities were allowed to implement and evaluate the program. Subsequently, the local governments were to report all deficits or surpluses on a continual basis in order to ensure smooth operation of the systems, and make necessary projections for future plans.
PRESENT SITUATION
Today, however, with the new era of independent governance and free economy, the question of cost has become extremely vital for the entire health care system. The country is on the threshold of comprehensive health care reform. The problem is becoming even more important if time constraints are considered. The country simply cannot afford to operate by the past pattern anymore. Unfortunately, a new system has not yet been designed or implemented. It is impossible for the state to relinquish providing health care to the citizens.
PROBLEM ASSESSMENT
I focused on the problem of determining the appropriate measurement tools required for estimating the input of each department in the hospital towards the final product: providing a procedure or service. Subsequently, based on that, the health managers would be able to:
In this study, I tried to answer the cost-question based on the knowledge and skills I have learned in Accounting and Finance in Health Care, and Operations Management classes at the Department of Health Policy and Management of Emory University's School of Public Health.
The primary tool, accepted universally, is a step-down allocation process. In order to
conduct step-down allocation, the hospital managers would need to breakdown different
hospital departments into basically two types of centers: mission (or revenue) and support
(or expense). Revenue (mission) center are departments that have direct contact with
patients by providing health services. Support (expense) centers are departments which
provide services directly to the revenue centers, but do not deal directly with the
patient population. Examples of revenue centers are surgery, therapy, cardiology, urology,
pediatrics, etc. Likewise, departments such as laundry, housekeeping, medical records, and
administration are examples of support centers.
It is evident that patients are being admitted and treated at the revenue centers. Therefore, the departments' direct costs for treating patients and estimating charges for specific procedures can be relatively easily calculated.
However, the support centers provide “services” to the patients, too, by providing services to the revenue centers. Support centers also incur direct costs (expenses). Therefore, a manager must take into account the support centers' costs when charging patients. If not, charges will be underestimated and sooner or later the hospital will collapse.
PROCESS
Technically, step-down allocation requires appropriate bases of allocation for each
department. For example, the laundry’s expenses should be allocated on the basis of
kilograms of laundry consumed by each revenue center, housekeeping's expenses on the basis
of square meters, administration's expenses on the basis of aggregate
salaries, etc.
Thus, the first, direct or budgeted costs for each department, revenue and support, are
determined. Then, direct costs of support centers are allocated to the revenue centers.
This is being done on an appropriate basis of allocation, according to each support
center. For simplicity, assume that there are two revenue centers: surgery and therapy,
and three support centers: laundry, housekeeping, and medical records. Further, assume
that direct
cost for each centers is:
Surgery: $200,000
Therapy: $100,000
Housekeeping: $80,000
Laundry: $70,000
Medical Records: $50,000
------------------------------------
Total: $500,000
Area, in square meters, is distributed as follows:
Surgery: 200 sq.m.
Therapy: 150 sq.m.
Laundry: 100 sq.m.
Medical Records: 50 sq.m.
-------------------------------------
Total: 500 sq.m.
Then, assume that centers consume the following amounts of laundry per month:
Surgery: 70 kg
Therapy: 30 kg
Medical Records: 0 kg
-------------------------------
Total: 100 kg
Finally, assume that surgery treats 60 patients per month and therapy 40 patients; in total, 100 patients.
The following table illustrates the distribution of resources among the departments:
Allocation Table
--- |
Housekeeping |
Laundry |
Medical Records |
Surgery |
Therapy |
Total |
| Direct Cost | $80,000 |
$70,000 |
$50,000 |
$200,000 |
$100,000 |
$500,000 |
| Square Meters | --- |
100 |
50 |
200 |
150 |
500 |
| Kilograms of Laundry | --- |
--- |
0 |
70 |
30 |
100 |
| Number of Patients | --- |
--- |
--- |
60 |
40 |
100 |
The process of step-down cost allocation is best demonstrated by the following diagram:
|
First, one support center’s direct costs are allocated to every other center on a corresponding basis, i.e. housekeeping's cost is allocated to laundry, medical records, surgery, and therapy on the square meter basis. The calculations are as follows:
After that, the balance for housekeeping becomes zero, and the next support center’s (laundry) cost is allocated. Note that laundry's direct cost now increases by the proportion allocated from housekeeping's distribution, i.e. $70,000 (direct) + $16,000 (indirectly from housekeeping) = $86,000. That amount becomes the new total direct cost for the laundry. Now, the entire amount, $86,000, is allocated to the remaining three centers on an appropriate basis, which is kilograms of laundry for laundry.
Thus, all laundry costs are also allocated, and that center's balance becomes zero. The
remaining center to be allocated is medical records. Its cost has increased by the amounts
allocated from previous distributions from housekeeping, which is $8,000, and from
laundry, which, in this case is zero. The new amount of $58,000, will be allocated to the
remaining two centers, surgery and therapy, based on an appropriate basis, i.e. number of
patients treated in each revenue department.
After this is done, all support centers' costs are allocated. Now, aggregate costs for each revenue department can be calculated. These costs include the indirect costs incurred by the support centers' services to the revenue centers for treating the patients.
Note that grand total of $500,000 remains the same because all indirect costs have been
allocated to the revenue centers and have become direct costs. Having known the number of
patient days served by the specific revenue center during the same period of time the
expenses were incurred, a manager could then calculate the charge per patient per day for
each revenue department by simply dividing total costs of each revenue department by the
corresponding number of patient days. That charge would include not only the revenue
center’s direct expenses, but also costs incurred by the support departments in
providing services to the revenue department for implementing patient treatment.
CONCLUSION
The method of step-down allocation is a useful and powerful tool for utilization by health managers. It precisely determines the total costs for revenue departments, and enables a manager to make routine, and non-routine, cost accounting decisions. The method reflects the utilization of non-revenue departments' services by revenue departments and proportionally allocates the formers' expenses. The process could be easily computerized, which would enhance the capacities of the method and give more power and flexibility to the managers. The method is recommended as primary step to be implemented in the hospitals during comprehensive health care reform.
REFERENCES
Finkler, Steven R., Ph.D. 1994. Essentials of Cost Accounting for Health Care
Organizations. Gaithersburg, MD: Aspen Publication.
Gapenski, Louis C., Ph.D. 1993. Understanding Health Care Financial Management. Ann
Arbor, MI: AUPHA / Health Administration Press.
Anthony, Robert N., D.B.A. and Young, David W., D.B.A. 1994. Management Control in Non-Profit Organizations. Boston, MA: Irwin.
This Page Is Created And Maintained By:
Armen Asatryan, M.D., M.P.H.
E-mail: ararat AT geocities DOT com
This Page Has Been Accessed
Times
© Created: September 1996. Last Modified: December 1996.