1. Chapter 15
Product Costing

2. Learning Objectives
Describe the existing needs for cost information in health care firms.
Describe how cost information relates to the 3 key activities of management: planning, budgeting, and control
Describe the three main phases of the costing process.
Explain the two systems necessary to accurately cost healthcare encounters of care..
Describe the concept of relative value units. 2

3. Three Questions for HealthCare Cost Accounting
What are we trying to cost?
What time period is relevant?
How can we use existing cost systems? 3

4. What are the cost objects of HealthCare?
Health care firms produce a large number of products
Many of these products are bundled into an encounter of care
An encounter of care includes all products and services during a specific treatment or episode of care
Examples of encounters:
Inpatient – MSDRG’s (e.g. MSDRG #193 – Simple Pneumonia & pleurisy w/MCC)
Outpatient – APC’s (e.g. #0143 – Lower GI procedures) 4

5. What time period is relevant
Time periods will either be historical or future
Historical costing is by itself of little value
Future costs are most relevant but often rely on historical cost data. 5

6. How can present reporting systems be best utilized in costing encounters of care?
Present Financial accounting system will continue to exist because they fulfill reporting needs
Basics of most current financial accounting systems
A measure of facility cost (e.g. $100 million)
Allocation of facility cost to responsibility centers or departments
Dilemma of costing
How to take departmental cost measures and assign those values to encounters of care 6

7. Figure 15–1 The Planning-Budgeting-Control Process

8. Planning and Product Issues
Products versus product lines
A treated patient represents a product – or “encounter of care”
Strategic business units (SBU’s)
DRG’s or APC’s are not SBU’s or product lines
Clinical specialty areas may represent SBU’s 8

9. Budgeting and Resource Expectations
Budgeting translates product decisions into resource expectations
Two major objectives are
Assure financial viability of plan
Establish a basis for management control
Primary output of a budget is a set of departmental budgets outlining expected costs 9

10. Control and Corrective Action
Deviations or variances from budget are identified
Corrective action may be taken to correct the variance in future time periods
Sometimes variances may reflect changes in budget assumptions 10

11. Figure 15–2 The Cost Measurement Process

12. Valuation Areas What basis should be used
Most cases it is historical cost
Assigning cost to a time period can be an issue in 2 types of cases
Long lived assets such as building and equipment
Normal accruals where costs are recognized prior to expenditure, e.g. payroll 12

13. Allocation Areas
Primary task is assignment of costs charged to indirect departments to direct departments
Allocation of indirect costs require 2 decisions
Allocation basis, e.g. hours worked or square feet
Apportionment Method
Step down
Double distribution
Simultaneous equations 13

14. Production Phases
Actual process of creating products/services in a health setting is split into two stages
Stage 1 –
Departments/activity centers acquire resources and produce products “service units” (SU’s)
Some SU’s are traceable to the patient – others are not
Stage 2-
Consumption of SU’s in treatment process (e.g. surgeries, lab tests, etc.)
Physicians often direct this stage of production 14

15. Figure 15–3 The Production Process for Health Care Firms

16. Two Required Systems for Costing Encounters of Care
Standard cost profiles
Tells how much it did or will cost to produce specific service units (SU’s) such as lab tests or surgical procedures
Standard Treatment Protocols (STP)
Tells us how many units of a SU either were required or will be required to produce a specific encounter of care. 16

17. Table 15-1

18. Table 15-2

19. Relative Value Costing
Some departments such as lab have many products or service units (SU’s)
Relative values are often used to collapse many units to just one 19