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|Table of Contents|
|List of Tables|
|List of Figures|
|II. The cost accounting system|
|III. Development of the uniform...|
|IV. Cost accounting system...|
|V. Conclusions and recommendations...|
|Appendix A. Preliminary list of...|
|Appendix B. General functional...|
|Appendix C. Partial list of final...|
|Appendix D. Comparison of participating...|
|Appendix E. Recommended chart of...|
|Appendix F. Selected cost centers...|
|Appendix G. Examples of data collection...|
|Appendix H. Step-down procedur...|
|Appendix I. Cost system output...|
|Appendix J. Evaluation interview...|
|Appendix K. Selected information...|
|Table of Contents|
Table of Contents
List of Tables
List of Figures
II. The cost accounting system
III. Development of the uniform cost accounting system
IV. Cost accounting system evaluation
V. Conclusions and recommendations for future research
Appendix A. Preliminary list of cost centers
Appendix B. General functional questionnaire - all cost centers and specific functional questionnaires
Appendix C. Partial list of final cost centers
Appendix D. Comparison of participating hospitals' charts of accounts (selected accounts)
Appendix E. Recommended chart of accounts (selected accounts)
Appendix F. Selected cost centers by category
Appendix G. Examples of data collection forms
Appendix H. Step-down procedure
Appendix I. Cost system output (reports)
Appendix J. Evaluation interview guide with responses
Appendix K. Selected information regarding participating hospitals and cost accounting system evaluators
THE DEVELOPMENT AND EVALUATION
OF A UNIFORM HOSPITAL COST
ACCOUNTING INFORMATION SYSTEM
GARY R. FANE
A DISSERTATION PRESENTED TO THE GRADUATE
COUNCIL OF THE UNIVERSITY OF FLORIDA IN PARTIAL
FULFILLMENT OF THE REQUIREMENTS FOR THE DEGREE OF
\ DOCTOR OF PHILOSOPHY
UNIVERSITY OF FLORIDA
A dissertation could never be accomplished without the encourage-
ment, guidance, and assistance of many individuals. For guidance and
assistance I am indebted to my dissertation committee, Dr. D. D. Ray,
Chairman, Dr. Ralph H. Blodgett, Dr. John M. Champion, and Dr. W. W.
Menke. An especial note of gratitude goes to Dr. D. D. Ray, Chairman,
for the many extra hours of counseling he provided, and to Dr. John M.
Champion whose expertise in the health care field was most beneficial
to the completion of this work.
To Mrs. Etta Cashwell, Mrs. Janice Hawley, and Miss Becky Medlin,
a note of appreciation is extended for the technical assistance
provided concerning table design, and the many hours of typing and
Finally, for all the encouragement, patience, and quiet accept-
ance of the most difficult situations during the whole period of
graduate study, I will never be able to find words to express my
gratitude to Sandy, Greg, and Mitch.
TABLE OF CONTENTS
ACKNOWLEDGMENTS . . . . ... . . ii
LIST OF TABLES . . . . ... .. .. vi
LIST OF FIGURES . . . . ... ...... vii
ABSTRACT . . . . ... ........ viii
I. INTRODUCTION . . . . ... ...... 1
Purpose of Research
Statement of General
Statement of Specific Problem 5
Justification for the Study 8
Related Literature 9
II. THE COST ACCOUNTING SYSTEM . . . ... 19
Definition of Terms
Current Industry Cost Accounting
Current Hospital Cost Accounting
Uniform Cost Accounting System
III. DEVELOPMENT OF THE UNIFORM COST ACCOUNTING SYSTEM ..... .38
Method Used to Develop the Uniform Cost
Accounting System 38
Evaluation and Results of the System
Development Method 44
iNo tes 59
TABLE OF CONTENTS--Continued
IV. COST ACCOUNTING SYSTEM EVALUATION . . ... 60
Method Related to Procedural Aspects and
Discussion of Results 61
Method Related to Output Evaluation and
Discussion of Results 81
Evaluation by Hospital Managers 81
Requirements of External Users 87
General Cost Information Requirements
Compared to System Output 103
V. CONCLUSIONS AND RECOMMENDATIONS FOR FUTURE RESEARCH
Recommended Future Research
A. PRELIMINARY LIST OF COST CENTERS . . .
B. GENERAL FUNCTIONAL QUESTIONNAIRE ALL COST CENTER
AND SPECIFIC FUNCTIONAL QUESTIONNAIRES . .
C. PARTIAL LIST OF FINAL COST CENTERS . .
D. COMPARISON OF PARTICIPATING HOSPITALS' CHARTS OF
ACCOUNTS (SELECTED ACCOUNTS) . ... ..
E. RECOMMENDED CHART OF ACCOUNTS (SELECTED'ACCOUNTS).
F. SELECTED COST CENTERS BY CATEGORY . .
G. EXAMPLES OF DATA COLLECTION FORMS . .
H. STEP DOWN PROCEDURE . . . .
I. COST SYSTEM OUTPUT (REPORTS) . . .
J. EVALUATION INTERVIEW GUIDE WITH RESPONSES .
K. SELECTED INFORMATION REGARDING PARTICIPATING HOSPI
AND COST ACCOUNTING SYSTEM EVALUATORS . .
TABLE OF CONTENTS--Continued
SELECTED BIBLIOGRAPHY . . . . .. 222
BIOGRAPHICAL SKETCH ... ......... .... ..... 229
LIST OF TABLES
1. Direct Expense Comparison . . . .
2. Adjusted Direct Expense Comparison . . .
3. Full Cost Comparison . . . .
4. Hospital Cost Summary Report . . . .
5. Comparative Hospital Cost Summary Report
Direct Expenses . . . . .
6. Comparative Hospital Cost Summary Report
Adjusted Direct Expenses . . . .
7. Comparative Hospital Cost Summary Report
Full Cost . . . . . .
8. Selected Information About Participating Hospitals. .
7 LIST OF FIGURES
1. Simplified manufacturing cost accounting system model .... .25
2. Expanded manufacturing cost accounting system model ... .26
3. Complete manufacturing cost accounting system model. .27
4. Programatic cost accounting model . . . 31
5. Cost accounting data uses . . ... .. .34
6. Proposed hospital cost accounting system model. ... .35
7. Example of step-down cost allocation procedure. . .. .65
8. Example of a completed Hospital Cost Report . ... .67
9. Example of a completed Comparative Hospital Cost Report .. .71
10. A partial copy of the Hospital Cost Summary Report. . .76
11. Example of a completed Hospital Cost Report. . . .196
12. Example of a completed Comparative Hospital Cost Report .. 199
Abstractof Dissertation Presented to the Graduate Council
of the University of Florida in Partial Fulfillment of the Requirements
fo, the-Degree of Doctor of Philosophy- S 7
THE DEVELOPMENT AND EVALUATION
OF A UNIFORM HOSPITAL COST
ACCOUNTING INFORMATION SYSTEM
Gary R. Fane
Chairman: D. D. Ray
Major Department: Accounting
The purpose of this research project was to develop and to evalu-
ate a uniform hospital cost accounting information system. The system
developed will generate cost accounting and statistical data based on
comparable information provided by the individual hospitals which can
be used to aid community-or area-wide hospital planning.
Rising health care costs have been a major problem in recent
years. A suggested approach to solving the problem has been to develop
regional or area-wide health care planning groups. Several recent in-
vestigations have concluded, however, that the comparable cost account-
ing data required to make regional decisions are not available. The
findings of the American Accounting Association's Committee on the
Accounting Practices of Not-For-Profit Organizations indicated the
lack of cost accounting throughout the not-for-profit sector generally.
That committee suggested an attempt be made to apply cost accounting
techniques as used in the profit-sector of the economy to the
not-for-profit sector. This research attempts to do that through the
development of a cost accounting system for a major segment of the not-
for-profit sector, the hospital industry, based upon the type of cost
accounting systems employed in the profit-sector. Additionally, such
a cost accounting system would provide comparable cost data to aid in
health care decision making.
In order to accomplish both objectives, the research was divided
into 4 major sections. First, models of cost accounting systems pres-
ently used in the profit-oriented sector and the hospital industry
were reviewed, compared, and contrasted. A new cost accounting system
model was proposed for the hospital industry.
Second, the elements necessary to make the proposed cost account-
ing system operational were defined and developed.
Third, data were collected from a group of community hospitals and
processed through the proposed cost accounting system.
Finally, the output of the system was evaluated to determine the
ability cf that output to aid decision making internally and exte'rnaliy.
This was accomplished by providing cost reports to a panel of eval-
uators consisting of hospital administrators and financial managers.
Further, the requirements of those external groups who use cost data
were examined, and the ability of the cost accounting system output to
meet those requirements was evaluated.
The conclusions are grouped into 3 major categories. The first
group of conclusions is concerned about the overall cost accounting
system. The system as proposed was developed. Cost data were pro-
cessed through the system in the manner indicated. All evaluators
agreed that the output was as anticipated and provided costs by prod-
ucts and by program.
Second, comparable output could only be achieved with comparable
input, and that was dependent upon proper definition of the elements
of the proposed system. All evaluators found that the activities for
which costs were collected were properly defined, and that the activity
measures selected properly reflected the output of each activity.
Further, where cost distributions were necessary, those distributions
were found to be appropriate.
Finally, the ability of the cost output to meet external user re-
quirements was reviewed. From published materials, a group of 4 re-
quirements of cost data for external users was developed. Those
requirements were: 1) specificity, 2) verifiability, 3) compa-
rability; and 4) consistency. The proposed cost accounting system
output was determined capable of meeting the 4 requirements, and as
such capable of being useful for external decision making, including
Purpose of Research
The purpose of this research project was to develop and to evalu-
ate a uniform hospital cost accounting information system. The system
developed will generate cost accounting and statistical data based on
comparable information provided by the individual hospitals which can
be used to aid community- or area-wide hospital planning.
Statement of General Problem
Health care expenditures in the United States have been increasing
dramatically over the past few years. In total dollar amounts the
figures have grown from $12 billion in 1949-50 to $75 billion in
1970-71.1 During the same period, total health care expenditures, as
a percentage of the gross national product, have risen from 4.6 percent
to 7.4 percent.2 Even though some of this increase may have been
brought about by welfare legislation which made it possible for people
to pay for services which previously had been, to some extent, rendered
without charge, the rate and amount of growth is still substantial.
This upward trend is expected to continue and it has been estimated
that by the early 1980's health care expenditures will have reached
Perhaps this steady increase in costs would not seem out of line
if the major portion of the increased outlay had been to provide more
or improved health care service. There is some doubt that such has
been the case. According to one researcher, 47 percent of the increase
in health care spending between 1949-50 and 1970-71 was consumed by
rising prices.4 While the cost-of-living index was rising by 61 percent
during this period, the index of medical care prices was rising twice
as fast: 125 percent.5 Even more significant was the increase in
hospital daily charges at that time: 398 percent.6
Another recent research study indicates that this rapid rise in
hospital charges may be attributed to price increases, the addition of
newer and more advanced technical services, and an expansion of already
existing services.7 This study indicates also that as much as 40
percent of the price increase may be due to "increased services per
discharge."8 Even allowing for this factor, hospital daily charges
have increased approximately 200 percent during the period 1950-70, a
rate far in excess of the price increase of the general cost-of-living
index and the index of medical care prices. Since almost one-half9
of all health care expenditures are paid directly to hospitals, the
importance of controlling costs in the hospital becomes significant.
The rapid increase in hospital costs has generated considerable
interest at the legislative, community, and individual level regarding
programs aimed at controlling costs. One manifestation of this concern
is the area-wide regional planning groups that have been formed. It is
the intent of these planning groups to oversee the entire "pool" of
health resources within a given geographical area and attempt to plan
for the orderly and economical growth of medical service within that
area. To date, most efforts at regional planning have been through
volunteer agencies. Somers, however, has suggested that the planning
groups be made regulatory agencies with extensive administrative
powers.10 Some states have already recognized the importance of
regional planning groups through "certificate of need" legislation.11
This approach means that area planning groups must issue a "certificate"
indicating a "need" for a proposed addition to medical facilities before
a hospital may embark upon an expansion program. For a hospital to
expand facilities or services without the certification would mean
incurring the risk of losing all state and Federal moneys, i.e., Medicare
and Medicaid payments. Recent amendments to the Social Security Act
have strengthened the planning groups' position in this matter.12
The area-wide planning concept is a basic philosophical change
concerning the way in which hospitals finance both their daily operations
and their capital expansions. Historically, individual institutions
determined their resource requirements and obtained them in the best
manner possible, regardless of the effect on the total community's
health resources. This individual approach had, at its base, hospital
goals that were not always compatible with efficient operations. A
recent study indicates that the 4 major goals of a hospital's administra-
tion are to: 1) remain solvent; 2) maintain or increase the quality
of service; 3) promote harmony within the institution; and 4) promote
growth of services and facilities.13 The research concluded, in part,
that until recently, demand and ability to pay for hospital services
were severely limited. This results in a constant struggle to keep costs
in line with income ceilings. Today, however, with a rising standard of
living and third-party-payers, hospitals can meet solvency goals and
improve their Financial positions. This in turn has allowed the adminis-
trations to concentrate on the quality, harmony, and growth goals, and
in each case to carry out actions that have enhanced the individual
hospital's position, but have contributed to the rapid rise in costs
Many health economists, politicians, and consumer groups support
some form of area-wide health planning as a solution to this problem.
Various plans have been proposed. Each plan considers the total health
resources of a community as a "pool" from which to meet total health
needs. Even the plan causing the least change from existing practices
would result in severe curtailment of the individual hospital's autonomy.
It would mean that a single hospital management would: 1) no longer
be singularly responsible for its future since all expansion plans would
require review and approval; 2) new services could not be provided
unless approved; 3) the ability to generate additional working capital
might be impaired since no new profitable service could be implemented
without demonstration of need for such service. This is an extreme
change from present practice.
At the other end of the spectrum, the individual hospital would
cease to exist as an entity. It would become part of a national health
organization. The only input the hospital would have would be to submit
an operating and capital budget to a regional director. The budget
would be considered along with all the other hospitals from the same
designated area and funded according to the manner in which that indi-
vidual hospital contributed to the overall plans for the area.
Regardless of whether either one of the 2 extreme plans or some
compromise plan is instituted, there is a growing concern that control
of rising costs and proper allocation of resources can be accomplished
only through better area-wide resource management.
Statement of Specific Problem
With a more comprehensive view of health care planning, cost
accounting and statistical information are necessary to help facilitate
decision making on a community or regional basis. Virtually all
studies completed to date, however, have concerned themselves with
the cost information needs of individual hospitals.15
While the cost accounting systems developed are useful to internal
management, several investigative committees have concluded that there
is not enough comparability among available data to make valid judg-
ments concerning the problems of effective utilization of resources
commiitted to a group of community/area hospitals. One of the earlier
studies which concluded this was the New York Governor's Committee on
Hospital Costs. That committee concluded:
...the financial and statistical reporting of
hospitals is insufficiently detailed, clear
and uniform to permit the identification of
the components of cost analysis of the causes
of rising costs, and to serve as dependable
bases for evaluation and planning.16
In 1967, the Secretary of Health, Education, and Welfare,
John W. Gardner, appointed an Advisory Committee on Hospital Effective-
ness (Barr Committee) to examine the evidence and advise him of actions
that might be taken to improve performance in 4 principal areas of
health service involving hospitals. Recommendation 7 made by the Barr
...(a) In every state there shall be a
state agency with specific responsibility
for setting up a system for accumulating,
processing, and publishing detailed infor-
mation on the operations of health care
institutions; taking into consideration
the kinds of data that will be most useful
to third-party-payers and most useful to
institutional managements in judging com-
parative performance [emphasis added]....
The Barr Committee continued by stating:
The recommendation for state and national
systems for reporting operating data from
health care institutions is based on the
conviction that pressures for improved
management performance can be produced by
making comparative data on managements
visible throughout the community [emphasis
More recently, the United States Chamber of Commerce released
its study on health care problems and made several policy proposals.
Policy proposal VI-(1) states: "All hospitals, extended care facili-
ties, and nursing home facilities [should] adopt uniform accounting
practices, financial reporting and cost-finding systems.'19 This
recommendation was supported by the comment that:
Discussions with top flight hospital
administrators revealed that there is a
real need for all community, nonprofit
hospitals to follow uniform accounting
practices and reporting techniques and
cost-finding procedures. Cost per-
patient-day varies widely among hospitals
in the same community. Many nonprofit
hospitals report sizeable net income.
At present, business, the largest single
private purchaser of health care services,
does not know what it is getting for its
money, and the only way to find out is to
get a look at the figures.20
The current criticisms of the nonavailability of necessary cost
data should not be unexpected if the environment in which the hospital
has been operating is briefly considered. Hospitals recently have been
able to secure the resources needed, due to beneficial reimbursement
arrangements. Virtually all third-party-payers have allowed hospitals
to pass all cost increases through by perpetuating rate schedules that
allowed recovery of full costs regardless of what the full costs might
be. Consequently, hospital administrations generally did not have to
review cost increases nor was there much incentive to attempt to
contain those cost increases. Only after July 1, 1966, the effective
date of the Medicare legislation, did it become necessary to try to
define costs. Controlling costs was still not necessary until mid-1972,
when Phase II economic regulations became effective.
Second, hospitals have attempted to offer, as quickly as possible,
the services which have been developed by the nation's vast health
research industry. Given the legal and social structure of the medical
care industry, the physicians generally have been able to exert major
pressure in order to install the latest techniques and equipment. As
a result, many expensive and underutilized facilities have been dupli-
cated within a community in order to placate the medical staffs of the
Even if understanding the environmental factors just mentioned
would somewhat temper the earlier criticisms, the fact remains that
the environment is changing. Along with that change comes the need to
understand cost patterns and attempts to control costs. Governmental
regulatory agencies and consumer groups are requiring more information
to allow them to review adequately and to compare hospital costs and
rates on a comm.unity-wide basis. The problem, however, stems from the
fact that no information system presently available can provide the
comparable data required.
Justification for the Study
Based upon the preceding discussion, there is a need to provide
comparable cost information for area-wide planning purposes. Addition-
ally, there is a more general problem.
The American Accounting Association's Committee on Accounting for
Not-For-Profit Organizations was critical in its recent report of the
efforts made by the accounting profession to provide meaningful guid-
ance in the adaptability of accounting practices and techniques used
in the profit-oriented sector to the not-for-profit sector.21 One of
the areas of accounting practice scrutinized by the committee was cost
accounting. More specifically regarding cost accounting techniques
the committee stated: "Cost accounting has long been recognized in
the profit-oriented environment as a useful tool in promoting efficien-
cy. This committee emphasizes that it (cost accounting) can be used
to plan future and control current operations of not-for-profit
organizations."22 In the group's summary of recommendations it stated:
"The potentials of cost accounting techniques have scarcely begun to
be realized in the not-for-profit field."23 Later in a detailed list
of recommendations the committee concluded that: "Cost accounting
systems) be designed to provide for the collecting and reporting of
costs by management responsibilities, by budget programs, and by appro-
priately determined units of service outputs. The system should permit
determination of total operational expenses for appropriate accounting
Over the years the hospital industry has generally been considered
nonprofit. Of the 7,123 hospitals in the United States, 6,265 are non-
profit institutions.25 In fact, the earlier cited committee report
recognized hospitals as a major segment of the not-for-profit sector
and devoted several paragraphs to discussing the particular problems
of hospitals. The report states: "The larger hospitals have developed
costs for determining prices for services but have seldom developed
those (costs) necessary for control by hospital management. The
emphasis has been on 'easy' or 'acceptable' methods rather than on the
best methods of cost calculations."26 This study will help resolve
this particular problem relating to hospitals, and at the same time
provide insight into the larger, more general problem of applying
proven accounting techniques of the profit-oriented sector to the not-
In summary, there are 2 major reasons for undertaking this study.
First, to resolve the problem resulting from the lack of an area-wide
cost accounting information system that can generate comparable data
for area-wide decision making, and second, to demonstrate that ac-
counting practices and techniques as developed for use in the profit-
oriented sector of the economy can be successfully adapted to the
There is an expanding body of literature concerning hospital
costs. For purposes of this study the majority of the pertinent
research studies and publications have been completed by accountants
and/or professional hospital organizations. Before reviewing the ac-
counting literature, it is necessary to differentiate between "cost
accounting" and "cost-find ng," the 2 principal methods used for col- '
electing cost information. The latter refers to a procedure used to
rearrange past financial accounting information into the desired
configuration through special studies called cost analysis or cost-
finding. The former method refers to a system which allows for the
continuous collection of accounting data in the desired configuration
as part of the financial accounting system. This method is called cost
accounting. It is the purpose of this study to develop such a system.
The understanding of the difference between the two is important in
evaluating the literature.
What accounting writers have contributed to the subject under
study is limited. Several writers have attempted to treat the entire
not-for-profit field in a single publication, and as such have been
very limited in their discussions of the special problems related to
the hospital. Tenner,27 Mikesell and Hay,28 and Kerrigan,29 follow
this pattern. The subject of hospital accounting is treated rather
superficially and the emphasis upon hospital cost accounting is negli-
gible. The few discussions of costs are relegated only to limited
mention of cost-finding and analysis.
Seawell,30 Taylor and Nelson31 and Hay32 have written exclusively
upon the subject of hospital financial management and control. Seawell
and Hay both deal primarily with cost-finding techniques, however, and
only mention the development of a cost accounting system in a general
manner. Taylor and Nelson dealt at length with the problems of devel-
oping a cost accounting system. Their work seems superior to the
others in that a system is devised that integrates the cost accounting
system with the general financial system so that "costs and operating
results are determined in an efficient manner and are reported cur-
rently when they are of value and can be readily used for management
control."33 All of these works, however, fall short of solving the
problems which prompted this study because the system they recommend
is designed for use by managers of individual institutions and do not
deal with interinstitutional comparison of cost accounting data. The
studies by Seawell and Hay have the added problem of relying on cost
analysis as a basis for their cost information. To date there have
been no standards developed defining acceptable cost analysis work.
Vatter34 has made the only known attempt to develop standards for cost
analysis in the not-for-profit sector. The system developed by Taylor
and Nelson has many of the basic elements of an integrated cost ac-
counting system but it is dated. The work was completed prior to the
enactment of Medicare legislation. As a result, their system needs to
be reviewed in light of present cost requirements.
.It can be seen that the earlier cited criticism of the American
Accounting Association's Committee on Accounting Practices of Not-For
Profit organizations is well justified. What accountants have contrib-
uted to the subject matter is not significant. In particular, those
works related to the hospital accounting problems are dated and appear
to need substantial review before they can be applied to current
problems. In fact, the systems recommended in the majority of the
accounting works are based upon the earlier work of professional organ-
izations, and especially that of the American Hospital Association.
The major portion of the work accomplished to date has been by
professional and regulatory organizations. Those organizations in-
clude the American Hospital Association, state hospital associations,
nonprofit service corporations sponsored by state hospital associ-
ations, joint state hospital associations, state Blue Cross associ-
ations, and certain state regulatory agencies.
The first efforts exclusively in the field of hospital accounting
were made by the American Hospital Association in 1922 with the publi-
cation of its first chart of accounts. Since that time the Association
has been the leader, on the national level, of developments in hospital
accounting. Their work has culminated in 3 recent publications: Chart
of Accounts for Hospitals,35 Uniform Hospital Definitions,36 and Cost
Finding and Rate Setting for Hospitals.37 These 3 works are used as
the basis for most hospital accounting today. Problems have arisen,
however, in attempting to define accounts uniformly. Also, different
responsibility structures within various hospitals have caused differ-
ing reporting patterns even though the same basic chart of accounts has
been implemented by all.
This particular weakness became apparent when the American
Hospital Association initiated a new program entitled Hospital Admin-
istrative Services.38 That particular program attempted to collect
accounting data classified as per the Association's chart of accounts.
The information collected was then measured using certain "activity
bases" and the resulting indications were used as a broad type of
standard allowing for interhospital evaluations. Each hospital's
individual changes to the basic chart of accounts has caused the
actual results to fall short of expectations.
As a mechanism for an individual hospital to use as the basis of
its accounting system, the American Hospital Association's publications
have provided basic leadership. As a tool for interhospital compari-
sons, the results have been less than successful. In addition, the
American Hospital Association has adhered to a cost analysis approach,
not a cost accounting approach, i.e., the only publication in the area
of costs has been the cost-finding manual. Hence, their work does not
extend into the cost accounting area, which is the major thrust of this
There are an increasing number of state organizations attempting
to cope with the hospital cost problem. Those states which have cost
collection systems such as Connecticut,39 New York, and Pennsylvania
have adhered to the American Hospital Association's basic chart of
accounts. Certain modifications have been made for each of the pro-
grams, but the approach has been basically the same as the national
organization's approach. Other state programs, of which Florida and
California40 are examples, have dealt with the application of indus-
trial engineering techniques to individual hospital problems. Pri-
marily, man-hours, not cost data, are generated for each subscribing
institution within the state. Often such information, as in the case
of the Florida Program, is not used for interhospital comparisons.
Finally, other programs such as the MICHA programs used by the Mental
Health Institute of Michigan and Rhode Island, deal only with indirect
cost allocation problems.41 Very little of the information regarding
these systems has been formally published. Where not referenced in the
preceding discussion, information concerning any of the state programs
can be obtained by writing to the various State Hospital Associations.
The literature of the practicing professionals has done nothing
to advance the knowledge of cost accounting techniques within the
hospital industry. While many recognize the necessity of such systems,
none have indicated a method by which one could be implemented. There
have been attempts at discussing cost accounting practices for indi-
vidual departments within hospitals, but nothing concerning an
institutional system or a system that can be applied to all hospitals
within a community.
Generally, it can be concluded that the related literature does
virtually nothing to explain how a cost accounting system can be
developed and implemented within a group of community hospitals.
This chapter had indicated that the problem of rapidly increasing
costs and decreasing availability of resources confronts the hospital
today. In an effort to more efficiently utilize the limited resources
and justify increased resources, a new system of review, the regional
management, and/or community level review, is gaining prominence. In
order to accomplish this type of review, a new cost accounting system
is necessary that can provide the required information. It was then
stated that the purpose of this study is to develop and evaluate such
a cost accounting system.
A review of the related literature indicated few hospitals have
attempted to install cost accounting systems, primarily implementing
cost-finding techniques as suggested by the American Hospital Associ-
ation and/or various state level organizations. Nothing has been done
toward establishing a community-wide cost accounting system. In ad-
dition, accountants, who have the necessary skills to provide leader-
ship in this endeavor, apparently have failed to do so.
The next chapter will compare and contrast the types of cost
accounting systems presently used by industrial concerns and by hospi-
tals. A cost accounting system will be proposed for hospitals along
the same lines as the industrial model. The balance of the research
will be divided into 2 major sections: system develo,'.'nerit and system
Chapter III will outline the system development procedure. The
procedure outlined was completed for the participating hospitals by
Health Systems Management, Inc. The researcher provided guidance in
developing the procedure and assisted in performing a substantial por-
tion of the various procedural steps. For that effort the researcher
was reimbursed by Health Systems Management, Inc. Personnel of Health
Systems Management, Inc. assisted in the activity analysis step, and
the activity definition phase of the data analysis step of the system
development procedure. The cost accounting system developed is the
property of the participating hospitals.
Chapter IV will discuss the system evaluation phase of the pro-
ject. That portion of the research project was completed entirely
by the researcher.
Finally, Chapter V will indicate conclusions reached and
recommended areas for future research.
1. Alfred M. Skolnik and Sophie R. Dales, "Social Welfare Expendi-
tures, 1929-71," Social Security Bulletin, December, 1971,
2. Ibid., p. 11.
3. Edmund K. Faltermayer, "Better Care at Less Cost Without
Miracles," Our Ailing Medical System, (New York: Harper &
Row, 1969), p. 16.
4. Dorothy P. Rice and Barbara S. Cooper, "National Health Expendi-
tures, 1969-71," Social Security Bulletin, January, 1972', p. 9.
5. U. S. Department of Commerce, Statistical Abstract of the United
States. Washington, D. C.: U. S. Government Printing Office,
6. Ibid., p. 63.
7. Richard A. Elnicki, "Effect of Phase II Price Controls on Hospital
Services," Health Services Research, Summer, 1972, pp. 106-117.
8. Ibid., p. 113.
9. Dorothy P. Rice and Barbara S. Cooper, "National Health Expendi-
tures, 1929-71," Social Security Bulletin, January, 1972, p. 7.
10. Anne R. Somers, Health Care in Transition: Directions for the
Future, (Chicago: Hospital Research and Education Trust,
19717, pp. 121-122.
11. John F. O'Leary, J. D., "Certificate of Need Legislation: The
Case For and Against," Viewpoint, 1971, pp. 1-8. This particu-
lar article gives a good overview of the certificate of need
legislation questions and a concise summary of what states have
enacted certificate of need legislation and those states with
legislative action pending.
12. Commerce Clearing House, Medicare and Medicaid Guide, H.R. 1,
Social Security Amendment of 1971, Number 42, June 1, 1971,
pp. 78-80 and pp. 302-305.
13. Rockwell I. Schulz and Jerry Rose, "Can Hospitals be Expected to
Control Costs?" Inquiry, Volume X, Number 2, June, 1973, p. 3.
14. Ibid., p. 4.
15. For recent hospital accounting information system studies and
models which deal primarily with internal management decision-
making, see: C. T. Andrews, Financial and Statistical Reports
for Administrative Decision-Making in Hospitals, Unpublished
Doctoral Dissertation, Indiana University, 1968.
M. W. Veuleman, An Inquiry Into the Adequacy of Cost Informa-
tion Systems of Selected Arkansas Hospitals, Unpublished
Doctoral Dissertation, University of Arkansas, 1971. Carnegie-
Mellon Institute and Washington University of St. Louis are
both working independently on information systems for a model
hospital. Searle, Inc., has a model information system, called
16. Report of the Governor's Committee on Hospital Costs, Marion
Folsom, Chairman (Albany, New York, Office of Public Health
Education, New York State Health Department, 1965), p. 9.
17. Secretary's Advisory Committee on Hospital Effectiveness Report,
John A. Barr, Chairman, (Washington: Government Printing
Office, 1968), p. 22.
18. Ibid., p. 23.
19. Improving Our Nation's Health Care System: Proposals for the
Seventies, (Washington: Chamber of Commerce of the United
States, 1971), p. 17.
20. Ibid., p. 18.
21. Committee on Accounting Practice of Not-For-Profit Organizations,
"Report of the Committee on Accounting Practice of Not-For-
Profit Organizations," The Accounting Review; Supplement to
Volume XLVI, 1971, pp. 80-163.
22. Ibid., p. 125.
23. Ibid., p. 92.
24. Ibid., p. 134.
25. Hospitals Guide Issue, Part II, August 1, 1971, p. 487.
26. Committee on Accounting Practice of Not-For-Profit Organizations,
"Report of the Committee on Accounting Practice of Not-For-
Profit Organizations," The Accounting Review; Supplement to
Volume XLVI, 1971, p. 130.
27. Irving Tenner, Municipal and Governmental Accounting, 3d Edition,
(Englewood Cliffs, New Jersey: Prentice-Hall, Inc.), 1955.
See especially Chapters 19 and 21.
28. R. M. Mikesell and Leon E. Hay, Governmental Accounting, 4th
Edition, (Homewood, Illinois: Richard D. Irwin, Inc.), 1969.
See especially Chapters 20 and 21.
29. Harry D. Kerrigan, Fund Accounting, (New York: McGraw-Hill),
1969. See especially Chapter 20.
30. L. Vann Seawell, Hospital Accounting and Financial Management,
(Berwyn, Illinois: Physicians' Record Company), 1964.
31. Philip Taylor and Benjamin 0. Nelson, Management Accounting for
Hospitals, (Philadelphia: W. B. Saunders Company), 1964.
32. Leon E. Hay, Budgeting and Cost Analysis for Hospital Management,
2d Edition, (Bloomington, Indiana: Pressler Publications),
33. Taylor and Nelson, op. cit., p. 30.
34. William J. Vatter, "Excerpts from Standards for Cost Analysis,"
Federal Accountant, September, 1970, pp. 64-87.
35. American Hospital Association, Chart of Accounts for Hospitals,
36. American Hospital Association, Uniform Hospital Definitions,
37. American Hospital Association, Cost Finding and Rate Setting for
38. American Hospital Association, Hospital Administrative Service
(HAS), Guide for Uniform Reporting, Chicago, July, 1972.
39. Connecticut Hospital Association, Connecticut Hospital Association
Accounting Manual, (New Haven, Connecticut: Connecticut
Hospital Association), 1970.
40. California Hospital Association Commission for Administrative
Services in Hospitals (CASH), Management Leadership in an
Age of Change, Sacramento, California.
41. For details concerning MICHA, see Andrew McCosh, "Computerized
Cost Finding Systems," Hospital Financial Management, 'ov-LbeO'r,
1969, pp. 18-21, or send inquiry to MICHA, Incorporated,
Ann Arbor, Michigan.
THE COST ACCOUNTING SYSTEM
According to the comments of one of the American Accounting
Association's Committees, "cost accounting, coupled with performance
standards, has made much of modern management possible."l Initially
used to accomplish only the function of product costing for inventory
valuation and income determination, cost accounting today encompasses
the more general aspects of management control and has been titled
managerial accounting. Product costing is only one of many uses of
cost accounting information today. Benninger2 indicates the level of
sophistication of current cost accounting when he enumerated the uses
to which cost data are put. They include: 1) planning and budgeting;
2) cost control; 3)) employee motivation; 4) financial statements
preparation 5) management motivation; 6) product pricing; 7) special
decisions; and 8) uniform industry pricing.3 Additionally, the cost
accounting systems have been fully integrated into the financial
While industry has been developing and refining such accounting
systems, the nonprofit sector has lagged far behind. The health care
industry has a need for cost data as the previous chapter indicated.
It has probably done more than most segments of the nonprofit sector
to provide some such cost information through the efforts of the
American Hospital Association. Those efforts have been cost-finding,
however, not cost accounting. As a result, cost data are collected and
analyzed, usually only annually, after the year has been completed.
There has been no effort to integrate existing cost systems with finan-
cial accounting systems. The Committee on Accounting Practices of the
Not-For-Profit Organizations recommended:
1. Each NFP organization incorporates into its
information system appropriate cost accounting
records, techniques, and accounts so that
information useful to management and external
users will be produced and reported on a timely
2. The cost-accounting systems be designed to
provide for the collecting and reporting
of costs by management responsibilities,
by budget programs and by appropriately
defined units of service outputs.
3. The cost-accounting system be integrated
into the over-all accounting system and
employed on a continuing basis....4
It has been noted that a major problem in developing cost ac-
counting systems for nonprofit institutions has been the inability to
identify output. One research group has indicated that "the problem
is one of identifying meaningful concepts of cost association and
allocation so that assignments of administrative costs become something
more than an exercise in arbitrary calculations."5 Horngren calls this
the identification of a "cost object" and states: "He (the manager)
needs the cost of something. It may be a product, a group of products,
a plant, a territory, a machine-hour, a labor-hour, an operating
division, a customer, an order, or a project."5 These are easier to
define for prcduct-oriented concerns. It is somewhat more difficult
for service-oriented agencies but it can be accomplished. Since non-
profit organizations deal with both products and services, the
principles as established in the profit-oriented sector of the economy
should be applicable to the not-for-profit units as well.
The foregoing discussion indicated the organization of this
chapter. First, the general cost accounting system as presently used
by industry will be reviewed. Second, the current cost-finding system
employed in the hospital industry will be discussed. Finally, a cost
accounting system model will be developed for the hospital industry
that is similar in nature to the one presently employed by industrial
firms. Before turning to the cost accounting system discussion, terms
frequently employed throughout this study will be defined.
Definition of Terms
The following terms will have the indicated meaning when used
throughout this study.
A cost center is defined as the smallest segment of activity or
area of responsibility for which costs are accumulated.7 Since the
cost center is the basis of the system developed, some concepts which
are useful in understanding the full implication of the cost center
approach, are listed below.
First, physical size of area has nothing to do with the establish-
ment of cost centers, i.e., one supervisor might be responsible for a
large area of space and numerous employees while another supervisor is
only responsible for a small space and a few employees. An example
might be the comparison of the Housekeeping Department cost center
responsible for cleaning all floors, and the Laundry and Linen Depart-
ment cost center responsible for mending torn linen. The former would
have a large number of personnel working in a large area while the
latter would require only a small room and 2 or 3 employees. Both,
however, would be considered cost centers.
Second, a cost center is not identical with a department. In some
cases it may be, but in others the department may be so large and com-
plex that it would be divided into several cost centers, Nursing
Services Department would be an example. It is divided into smaller
organizational groups such as Nursing Services-Medical, Nursing
Services-Surgical, Nursing Services-Pediatrics, and Nursing Servic;s-
Third, cost centers should not overlap. There should be no
function jointly managed by 2 different supervisors.
Fourth, different cost centers may or may not include similar
operations. If an organization is so large that one function is accom-
plished by 2 identical groups, each group under a different supervisor,
then there are 2 cost centers.
Finally, cost centers are not strictly distinguished according to
the supervising individual, but according to the supervisory occupation.
An emergency room is a single cost center, yet it may be supervised by
a different individual on each shift.8
This term indicates the unit of measure for the level of activity
that takes place within a cost center. The activity base relates to
and approximates resource utilization within a cost center based upon
the output of that particular cost center. Examples are laboratory
tests for clinical laboratory cost centers, hours of housekeeping ser-
vice provided for housekeeping cost centers, and patient days for
nursing cost centers.
Patient Service Cost Centers
This term defines those cost centers that provide services di-
rectly to the patient. There are 2 types of direct patient service
Patient location cost center. Those cost centers where the pa-
tient is physically located for the receipt of services. This includes
nursing areas, outpatient clinics, emergency rooms, and operating rooms.
Primary service cost centers. Those cost centers that provide
professional support services to the patient location cost centers.
They include such cost centers as clinical laboratory, radiology, inha-
lation therapy, and physical therapy. These cost centers represent
those activities that distinguish a hospital from a nursing home or
other such types of "maintenance" institutions.
Support Service Cost Center
Those cost centers that provide supportive services to the patient
services cost centers. There are 2 types of support service cost
Professional support service cost center. Those cost centers
that provide support to the professionals delivering health care at the
patient location cost centers. These include such cost centers as
medical records, admitting, and nursing supervision.
Hotel support service cost center. Those cost centers that pro-
vide institutional services. These include such cost centers as house-
keeping, dietary, maintenance, and administration. 9
Costs of the support service cost centers within the hospital
must be distributed to the direct patient services cost centers if an
approximate full unit cost of the patient service is to be determined.
In order to accomplish the reapportionment of costs from the support
service to the patient location cost centers, some factor common to
both the amount of service used by the patient location cost center,
and to fluctuations in support service cost center costs, should be
selected as a basis for the distribution.10 Each direct patient ser-
vice cost center should absorb its share of the support service cost
center costs, based upon the amount of services it used. In the case
of housekeeping, the direct patient service cost center would be
charged based upon the number of hours of housekeeping services re-
quired to clean the direct patient service cost center.
With these basic terms defined, it will now be possible to turn
to a discussion of the cost accounting system to be developed during
the course of the research.
Current Industry Cost Accounting System Model
In its simplest form, manufacturing firms today generally employ
some version of the model represented by the schematic in Figure i.
Stage I is an acquisition process. Raw materials needed to make
the product are purchased. At Stage II those raw materials are con-
verted into a product as a result of operations performed by laborers
working directly with the raw materials. Assisting the direct laborers
are various employees performing indirect activities. These indirect
activities are commonly referred to as overhead.
The simplified model infers that there is only one type of material
converted into a single product by direct laborers performing only one
operation, aided by one indirect service. In reality, the process is
much more complicated. Various products may be manufactured by using
Fig. l.--Simplified manufacturing cost accounting system model.
many different materials and performing numerous operations upon the
materials. An expanded schematic might appear as follows in Figure 2.
Stage I Raw Materials < Purchase
S 1. Machinists
Stage II Work-in-Process 2. Assembly Purchase
3. Painters of Goods &
Stage III Finished Goods
Fig. 2.--Expanded manufacturing cost accounting system model.
In the expanded model, the multiple lines from raw materials to
work-in-process indicate many types of materials being moved into pro-
duction. At Stage II, the purchases of labor services are indicated
for the various types of labor services required to convert the materi-
als into products. Finally, the multiple lines from work-in-process
to finished goods represent a diverse number of final products manu-
factured. In the expanded model, all indirect services used to support
the conversion process are lumped together.
The identification of the various indirect services and the addi-
tion of than to the expanded cost accounting system model transform the
expanded model into the complete model. It might appear as Figure 3.
Fig. 3.--Complete manufacturing cost accounting system model.
The evolution of managerial accounting from cost accounting can
be traced through the 3 models. The simplified version allowed for
only the costing of product at a gross level. The expanded model pro-
duced information that could be used to plan, control and evaluate,
in detail, the direct or prime costs involved in the manufacture of
various products. A better product costing method also was achieved.
Finally, with the addition of detailed information concerning the
indirect services, full product costing was achieved. More importantly,
the model now provided data that could measurably aid management
planning, control, and evaluation. Since each of the labor operations
and indirect services is normally supervised by a different individual,
a responsibility accounting system evolved. By being able to collect
costs in a detailed fashion, planning and control functions are placed
upon a responsible individual who is later evaluated based upon adher-
ence to the plan. At the same time, by aggregating data, product
costing is achieved.
Being able to define the responsibility centers within an organi-
zation, those individuals who supervise them, and the costs of operating
each has made modern cost accounting an executive control device.
Current Hospital Cost Accounting Model
Presently various types of cost data are required by external
parties. Usually that information is required annually. Consequently,
hospitals generally have tended to wait until year-end, then rearrange
the financial accounting data by means of cost analysis to accommodate
the cost requesting agencies. The result of this annual cost-finding
exercise is the assignment of all costs to one of several programs.
While there may be many ways to classify the various programs, Berman
and Weeks11 have developed a programatic format that seems to be all
inclusive and which will be used as the basis for this discussion.
Accordingly, the activities of a hospital are divided into 4 major
programs which are listed below.
Basic production. This program component includes all direct and
indirect costs of producing a service. This includes labor, materials,
depreciation, and the appropriate portion of support service cost
center costs. The cost of providing a service may be calculated de-
partmentally or on a per diem basis such as daily room charges. The
sum of all such service production costs represent "Basic Production
Nonproduction. This program component includes all direct and
indirect costs associated with providing activities not related to
service production. This includes labor, materials, depreciation, and
the appropriate portion of support service cost center costs which are
required to support such activities as community health programs,
education programs, and research programs.
Capital needs. This program component includes interest paid for
monies required to provide either working or plant capital. Also
included are those expenses which are necessary to complete the fi-
nancing transactions such as legal fees and other debt service charges.
Revenue reduction. This program component includes all bad debts
written off, discounts allowed, and all direct and indirect costs of
free services provided.
For this research, the Basic Production program is divided into
2 programs. One is called Routine Service and consists of those direct
and indirect costs associated with providing room, board, and nursing
services. The second component is the Professional Support Service
which is required to provide patient care.
When the various program components are summed, the following is
+Professional Support Service
Basic Production Cost
The programs have been defined as outlined above for a reason.
Under most cost reimbursement schemes, all of the Basic Production
costs are reimbursable. Only a limited amount of the Nonproduction
and Capital costs are al able, however. Research costs can only be
recovered to the extent that they relate directly to patient care.
Many educational programs such as resident and intern instruction are
reviewed closely before any reimbursements are allowed. Interest
expense can only be recovered to the extent that it exceeds interest
earned on monies invested. Finally, the items appearing in the
Revenue Reduction component are entirely nonallowable.
A schematic of the programatic model just outlined might appear
as Figure 4 below.
Moving from left to right, the program costs become less allowable
or subject to closer scrutiny under the various reimbursement schemes,
until the final module, Revenue Reductions, is entirely nonallowable.
In practice, then, it is the object to include as many costs as possi-
ble in the Basic Production component.
Direct & Indirect
Costs of Providing
Room, Board, and
Direct & Indirect
Cost of Providing
Working & Plant
Fig. 4.-- Programatic cost accounting model. Current hospital cost accounting model.
-- --- -~--
At this point, one exception should be noted. Usually those items
representing Revenue Reductions are not considered expenses or expired
costs of the current period. This model, however, implies that the
costs of operation must be recovered. If some are not so recovered
due to a bad account or a courtesy discount, it is incumbent upon the
management to raise the necessary resources in some other fashion.
Consequently, the model includes a component which recognizes the
necessity to recoup the resources which are consumed but for which no
reimbursement is received, and calls the model a Full Cost model.
j While this method of cost analysis allows for an evaluation of
program costs which can be used for rate setting and reimbursement
purposes, it fails to achieve the significance of the cost accounting
system model which was outlined in the previous section. First, it is
an historic evaluation of the operations. Often it is too late to take
Corrective action once the year has ended. Second, it does not allow
for product costing on a current basis. To know what Basic Production
component costs are after a year's operation is of little use in
helping determine what rates should have been charged during that
period of time. Also, unless the historical program costs are manipu-
lated to reflect expected events, there is little evidence to indicate
that they can be useful planning tools for future rate setting policies.
Third, since the structure is one of a programatic nature, the responsi-
bility lines often are blurred and what information is presented is
lacking in its ability to provide for the control and evaluation
aspects found in the industry model. Finally, this approach is only
significant when it is assumed that ultimately total allowable costs
will be recouped, as in the case of the year-end Medicare adjustment.
This approach, however, is being challenged by those who propose
prospective rating, a plan whereby hospitals would be reimbursed by
third-party-payers based upon budgeted or anticipated expenses.
As previously indicated, the major difficulty of establishing the
profit-sector model in the not-for-profit sector has been the problem
of output or product identification. Berki12 explains the various
attempts that have been made to resolve this problem in the hospital
industry. Of the 6 different approaches outlined, one relates to the
identification and weighting of service outputs. Service outputs are
defined in 2 ways. An all inclusive output index is used such as a
patient-day, weighted by whether it is an adult, pediatric, or nursery
type of day. At the other extreme is the identification of the
service or output of each hospital department. In this scheme the
weighting is implicit since for the medical departments the units of
suggested service is either in terms of the numbers of operations,
treatments, or procedures, or the time dimension of service. It is
the latter concept that was used in this research to develop the cost
Uniform Cost Accounting System
Any uniform cost accounting system needs to allow for the cost
data to be displayed several different ways. The current hospital
cost accounting model indicates that program costs are needed. To
reap the more general benefits of planning and control, the data must
be capable of being displayed along organizational lines in order to
allow for responsibility accounting. Finally, the same data must also
be able to provide information for product costing purposes. Figure 5
is a diagram of the relationships of the basic cost data to the ulti-
mate purposes to which it is put.
BASIC DETAILED COST DATA
SERVICE CENTERS RESPONSIBILITY CENTERS
-- ^---- ,--------
Cost Reimbursement Planning
Rate Justification Control
Fig. 5.--Cost accounting data uses.
A slightly modified version of the profit-sector cost accounting
system model is outlined below in Figure 6. That particular model was
used as the basis for the cost accounting system designed during the
course of this research.
-Figure 6 differs from Figure 3 in 2 respects. First, the assign-
ment of total overhead is accomplished differently in each model. The
hospital model applies overhead on a more detailed basis than the
industry model. The latter generally uses 1 rate to apply overhead
to products. The former, by virtue of having a separate cost center
\, for each overhead item, charges overhead to the various products based
Supon each supportive service's unit rate times the amount of that
Second, there are no clearly defined stages of production in the
hospital model as there is in the industry model. Each hospital cost
center primarily provides services, either supportive in nature and to
Fig. 6.--Proposed hospital cost accounting system model.
Support Service Support Service
Cost Centers Cost Centers
both patient location and other support service cost centers, or
directly to patients in patient location cost centers. If a comparison
were to be made, Stage I might be equivalent to the purchase of indi-
rect labor and materials by the Support Service Cost Centers. Stage II
might be compared to the production of service by the Patient Service
Cost Centers. This service production, however, is made with the aid
of the outputs of the various Support Service Cost Centers and the addi-
tion of more direct labor and materials. Stage III might be the same
as the provision of the services to the patient or physician. The
direct parallel between the two is not easily seen, however.
In this chapter, the types of cost accounting systems found in the
industrial, profit-oriented sector were compared to the cost accounting
system currently used by the hospital industry. The weaknesses of the
current hospital cost accounting system were indicated. Finally a cost
accounting system for hospitals similar to the current profit sector
cost accounting system was outlined. It will be the purpose of the
remainder of this research to develop and evaluate such a system as it
applies to the hospital industry. Chapter III will discuss the system
development phase of the research. Chapter IV will discuss the system
evaluation phase of the research. Both will begin with statements
about the methods used to develop the system and evaluate the system,
respectively. The latter portion of each chapter will discuss the
results of applying the particular method.
1. Committee on Accounting Practices of Not-For-Profit Organizations,
The Accounting Review, Supplement to Volume XLVI, 1971, p. 133.
2. L. J. Benninger, "Utilization of Multi-Standards in the Expansion
of an Organization's Information System," Cost and Management,
January-February, 1971, pp. 23-28.
3. Ibid., p. 25.
4. Committee on Accounting Practices of Not-For-Profit Organizations,
The Accounting Review, p. 134.
5. Committee on Concepts of Accounting Applicable to the Public
Sector, 1970-71, "Report of the Committee on Conepts of
Accounting Applicable to the Public Sector 1970-71," The
Accounting Review, Supplement to Volume XLVII, 1972, p. 99.
6. Charles T. Horngren, Cost Accounting: A Managerial Emphasis, 3d
Edition (Englewood Cliffs, New Jersey: Prentice-Hall, Inc.,
1972), p. 22.
7. Ibid., p. 691.
8. Stanley B. Henrici, Standard Costs for Manufacturing, 3d Edition
(New York: McGraw-Hill, 1960), Chapters 1 and 2.
9. Richard Elnicki, "Hospital Productivity Measures," paper delivered
to Committee on Health Services Industry, Economic Stabiliza-
tion Program, Phase II, Washington, D. C., May 15, 1972.
10. Horngren, Cost Accounting: A Managerial Emphasis, pp. 395-399.
11. Howard J. Berman and Lewis E. Weeks, The Financial Management of
Hospitals, (Ann Arbor, Michigan: Bureau of Hospital Admini-
stration, School of Public Health, University of Michigan,
1971), pp. 148-167.
12. Sylvester E. Berki, Hospital Economics, (Lexington, Massachusetts:
Lexington Books, 1972), pp. 31-48.
DEVELOPMENT OF THE UNIFORM COST ACCOUNTING SYSTEM
The preceding chapter included a discussion of the types of cost
accounting systems that are currently used by: 1) industries in the
profit-oriented sector of the economy; and 2) by the hospital industry.
A new cost accounting system, to be used by hospitals, was developed.
The recommended cost accounting system was based upon the industry
version. Figure 6, Chapter II, represents the proposed cost accounting
It will be the purpose of this chapter to indicate how the pro-
posed cost accounting system was transformed from the conceptualized
model into an operating cost accounting system. The first part of this
chapter will explain in detail each step of the method used to develop
the cost accounting system. The latter part of the chapter will dis-
cuss the results of using the method selected.
Method Used to Develop the Uniform Cost
A review of Figure 6, Chapter II, shows that at the base of the
proposed cost accounting system is the requirement that it be possible
to determine costs for each patient service and support service cost
center. The locus of cost planning, cost accumulation, and cost
control is the cost center. In order to develop a cost accounting
system that would accommodate the required data collection and manipu-
lation at the cost center level, several steps were required. They
were: 1) identify cost centers; 2) develop a questionnaire to be
used in completing an activity analysis; 3) test the questionnaire;
4) perform an activity analysis; 5) use the activity analysis to
develop a system framework, uniform cost distribution methods, and
uniform activity bases; and 6) develop report formats. Each step
will be discussed in detail below.
Identify Cost Centers
At the core of any accounting system is the framework which allows
for the systematic accumulation of the data which are to be analyzed.
That framework usually follows organizational lines. The same was true
for this study, except it was necessary to divide the hospital organi-
zation into extremely small parts. Those small segments have been
defined as cost centers.
The first step of the procedure, then, was to identify all the
possible cost centers that might be found within a hospital. The
recommended charts of accounts of the American Hospital Association
and the Connecticut Hospital Association were initially reviewed for
guidance in completing this task. Additionally, departmental handbooks
published by the American Hospital Association's Hospital Administra-
tive Services Program were reviewed.
Identifying what cost centers might be found within a hospital
was just the beginning. It also had to be determined that a hospital
had one of the identified cost centers. If so, then it had to be estab-
lished that the same activities were being performed within the same
cost centers of the various hospitals to insure that the cost data
collected would be comparable. The accomplishment of this required a
survey of the tasks performed in each cost center. This survey was
called an activity analysis. The activity analysis was accomplished
by conducting a structured interview with each cost center supervisor.
A questionnaire was to be used as the guide for the interview.
An exhaustive search of the literature revealed that nothing had
been published which described such an activity analysis, and that no
questionnaire had been developed that could serve as a guide in devel-
oping the type of questionnaire needed for this research. The next
step, then, was to develop such a questionnaire.
Since no data gathering instrument was available, one was devel-
oped. The Graduate Program in Health and Hospital Administration at
the University of Florida was engaged in a research project for which
such a questionnaire would also be useful. As a result, John M.
Champion, Chairman of the Graduate Program in Health and Hospital
Administration, the faculty, and selected graduate students provided
direction and assistance in developing a set of questions for each
identified cost center. The questions were divided into 2 groups.
The first group contained questions aimed at determining general infor-
mation about each cost center. The questions were used to determine
such information as staffing patterns, work hours, reporting practices,
and reporting frequencies. This group of questions was placed on one
questionnaire and titled "General Functional Questionnaire." Every
cost center supervisor was required to respond to the general questions.
The second group of questions was aimed at determining what
specific activities were being carried out within individual cost
centers. A separate set of questions was developed for each cost
center. This second part of the questionnaire was titled "Specific
Source materials for this phase of the research included
McGibbony's Principles of Hospital Administration.1 United States
Department of Labor's Job Descriptions and Organizational Analysis for
Hospitals and Related Health Services,2 Goldstein and Horowitz's
Restructuring Paramedical Occupations: A Case Study,3 Brown's
Hospitals Visualized,4 and various American Hospital Association
publications regarding selected departmental activity.5
The purpose of developing the questionnaire was to use it as a
guide for interviews with the supervisors of each cost center. The
interviewing would take place in several hospitals. In order to com-
plete the activity analysis within the time frame of this project, a
team of 4 interviewers was selected. Prior to sending the 4 inter-
viewers into community hospitals to collect the information, some
training of those individuals was desirable. Additionally, since the
questionnaire used as the interview guide was new, some testing of it
was necessary. Consequently, there were 2 reasons for conducting the
test. First, it was necessary for the interviewers to become better
acquainted with hospital organizations, personnel, and procedures.
The test period enabled the interviewers to attain some degree of pro-
ficiency in those skills required to question hospital supervisors
prior to the actual interviewing that would be required as part of the
research. Second, even though an extensive effort had gone into the
development of the questionnaire, there was the possibility that a
cost center might have been omitted or improperly identified. The test
would indicate such problems.
The test was conducted at the Shands Teaching Hospital and
Clinics, J. Hillis Miller Health Center, University of Florida. Shands
was selected because its teaching capabilities require a most complex
and up-to-date array of services. All cost centers identified in the
initial step of this procedure were found at Shands Teaching Hospital
and Clinics. The supervisors of those cost centers, by nature of the
complex teaching situation, had to remain abreast of current trends
in their particular field, and as such were able to indicate potential
problems in the construction of the questionnaire.
Perform Activity Analysis
After testing the questionnaire and making minor adjustments, the
next step was to perform the activity analysis. The Jacksonville
Hospital Council, Jacksonville, Florida, which consists of the Adminis-
trators of the 9 Jacksonville hospitals, initially volunteered their
institutions for the research. The 9 hospitals represented a range of
sizes from 66 beds to over 445 beds, and a variety of ownership
patterns: 2 were city-county owned, 4 were privately owned, and 3
were affiliated with religious organizations. Of the latter 3, 2 were
Protestant and 1 was Catholic. All 9 were nonprofit institutions.
After extensive meetings with the administrators of the various
hospitals and their respective boards of directors, 4 hospitals decided
not to participate. Those withdrawing were the 66-bed city-county
hospital and 3 of the privately-owned hospitals. Of the private
institutions withdrawing, one was a small 160-bed unit, one a medium-
sized 325-bed unit, and one a 72-bed specialty (pediatric) hospital.
Appendix K lists those five hospitals participating along with selected
volume indicators concerning each.
Even though the hospitals remaining numbered 5, they accounted for
72 percent of all beds and 74 percent of all admissions for the city
of Jacksonville. The size of this volume coupled with the variety of
sizes and ownership patterns represented were felt to be significant
enough to make the results meaningful. A system that could meet the
requirement of providing comparable data for decision-making purposes
among the members of this heterogeneous group should be able to accom-
modate any mix of hospitals.
The administration of the questionnaires by means of structured
interviews was completed over a 3-month time period. During that time,
the supervisor of each defined cost center was interviewed by one of the
four members of the interview team.
The information gathered via the activity analysis was studied to
aid in the definition of each cost center's activities. The defini-
tions for the cost centers which resulted from the data analysis became
the basis for the system framework (chart of accounts), uniform activ-
ity bases, and uniform distribution methods. The activity bases were
determined after reviewing both the activity analysis and current meas-
urement practices as recommended by the American Hospital Association in
Uniform Hospital Definitions6 and the Connecticut Hospital Association
Accounting Manual.7 The chart of accounts, distribution methods, and
activity bases will be discussed later in this chapter.
Design Cost Reporting Format
The final step of the system development portion of the research
project was to design the forms to be used for collecting the cost and
statistical data, and reporting the results. Examples of the forms
will be presented and discussed when the results of the method appli-
cation are reviewed later in this chapter.
All 6 of the steps that were completed to move from the conceptual
cost accounting system model to the operating cost accounting system
have been outlined in some detail above. The next section discusses
the results of completing each step of the procedure.
Evaluation and Results of the System
Since each of the 6 steps was discussed separately in the pre-
ceding section, each will be evaluated separately in the following
Identify Cost Centers
Appendix A is a preliminary list of the cost centers identified.
Initially, approximately 250 cost centers were identified, but they
were consolidated into the 107 shown on the preliminary list. The
consolidations were based upon the level and nature of the activity
within the cost centers. It was estimated that the cost to collect
information for all 250 cost centers would exceed the value of gaining
the information, particularly since some of the 250 cost centers were
small in terms of the expected number of employees and dollar expendi-
tures. The criteria for consolidating were to have a separate cost
center if: 1) the expected number of employees in a cost center
numbered more than 2; and 2) the expected dollar expenditures were
more than $100. There were some exceptions to these guidelines, but
the criteria were adhered to generally.
The analysis of which cost centers should or might be found
within a hospital was developed a priori. It would be the purpose of
a later step, the activity analysis, to substantiate or refute such
an assumption. Having completed the preliminary list of cost centers,
the questionnaire development step was next.
Appendix B contains a copy of the General Functional Questionnaire
that was used in the interviews with each cost center supervisor. The
same appendix also contains copies of several of the Specific Func-
tional Questionnaires. Those Specific Functional Questionnaries
presented are meant to be representative of the type of questions
developed and used for gathering information from specific cost
centers. The complete set of questionnaires is located in the offices
of the Graduate Program in Health and Hospital Administration, Univer-
sity of Florida.
The results of the testing of the questionnaires at Shands
Teaching Hospital and Clinics were encouraging. Only one new cost
center was added, Cardiac Catherization Laboratory. All other re-
mained essentially unchanged. The 4 interviewers gained experience
&nd were prepared to complete the activity analysis.
The 4 interviewers required approximately 5 working days each to
complete the activity analysis in each hospital. By contacting each
cost center supervisor a great amount of detail was generated. A
repeat of this research might be more efficient, and yield substan-
tially the same results, if the number of interviews were reduced.
The activity analysis of all cost centers was important for this ini-
tial project, but for future research, it would probably be more
important to know the activity for those cost centers which provide
unique services, i.e., Central Sterile, Patient Accounting, and Admin-
istration are fairly standard. Consequently, using the cost centers
defined during this research as a base, the Administrator, Assistant-
Administrator, and Department Managers might be able to indicate for
which cost centers an activity analysis might not be necessary. As
such, a substantial amount cf time could be saved during this phase
of the research.
It was during this step of the system development procedure that
the elements required for the operation of the system were developed.
The elements were 1) a system framework (chart of accounts);
2) activity bases; and 3) distribution methods. The development of
cach will be discussed below, but, first, the effect of the activity
analysis upon the number of and definition of cost centers will be
As previously indicated, Appendix A represented the preliminary
of 107 cost centers that were expected to be found within the
hospitals. The test at Shands Teaching Hospital and Clinics resulted
in the addition of one more cost center. By the time the interviews
were completed in all 5 hospitals the changes were of a greater mag-
V nitude. Appendix C is a partial list of the cost centers identified
during the activity analysis which needed to be defined and accounted
for separately in the cost accounting system. A comparison of the
total final list with the preliminary list in Appendix A indicates sub-
Sstantial change. The total number of cost centers ultimately identified
increased to 252. This was primarily the result of expanding the number
of cost centers recognized within the Nursing Service., the Clinical
Laboratory Department, and the Housekeeping Department. These increases
were offset somewhat by eliminating a few of the original cost centers
and consolidating others. The net effect, however, was the increase
cited. The final result of studying the information obtained during
the activity analysis was the identification of 252 activities con-
sidered significant enough to require separate definition. Each activi-
ty so defined became a cost center. After determining and defining the
cost centers, the balance of the analysis phase was used to develop the
3 elements of the cost system. The development of each will now be
System framework. Every accounting system must have a framework
which allows the data collected to be logically organized. That frame-
work is a chart of accounts. Every hospital participating in this
research had a chart of accounts, and all of the hospital controllers
indicated that their charts were in conformance with the American
Hospital Association's Recommended Chart of Accounts. As a result,
it was first planned to use that particular chart as the basis for the
collection framework required by this research. A thorough review of
each of the hospitals' charts, however, indicated such an action would
be impossible. First, the chart recommended by the American Hospital
Association allows individual hospitals considerable latitude in the
interpretation and adoption of the chart. This resulted in the hospi-
tals assigning the same numbers to different activities, and, con-
versely, different numbers to the same activity. Appendix D is a
partial copy of the analysis of the hospitals' charts which indicates
the extent of the problem. If the only difficulty had been the latter
one, an easy solution could have been reached. The former difficulty,
however, rendered the use of that particular chart hazardous at best,
since accounting data were being collected for heterogeneous activities
in the same account.
Second, some activities of major proportion were not indicated in
the charts of some of the hospitals. For example, a major expense is
involved as a result of admitting people to the hospital for care.
However, 2 of the hospitals were not collecting costs for that partic-
Finally, the charts which were being used did not provide for the
collection of detailed enough information to allow for costing at the
level of activity indicated. This shortcoming was two-fold. First,
there was not enough flexibility to permit an account for each cost
center. Second, the amount of data which could be collected concerning
each cost center (activity) was severely limited.
For the 3 reasons indicated above, it was determined that a new
chart of accounts should be developed. The new chart followed the
general numbering scheme of the one recommended by the American Hospi-
tal Association, but it allowed for the necessary detail. Further, by
explicitly defining each activity, the collection of information for
heterogeneous activities in the same account was significantly reduced.
Each cost center identified through the activity analysis was assigned
a primary account number. There are 252 indicated primary account:,
with the flexibility to increase that number to 400 if other activities
should be identified for which it is deemed necessary to collect cost
The chart of accounts constructed here uses a 6-digit number to
identify each account and type of expenditure. The first 3 digits are
the primary account numbers. They are organized by department and
activity within the department. Each identified cost center has been
assigned a primary account number from one of the following groups.
600-699 Nursing Services
700-799 Other Professional Services
800-899 General Services
900-949 Fiscal Services
The fourth digit identifies primary subclassifications. They are:
0 Salaries and Wages
1 Employee Benefits
6-7 Purchased Services
The fifth and sixth digits identify secondary subclassifications.
.001-.099 Job Categories
.100-.199 Type of Employee Benefit
.200-.299 Type of Fee
.300-.599 Type of Supply
.600-.799 Type of Service Purchased
.800-.999 Other Subclassifications
Appendix E contains illustrative material from the recommended
chart of accounts. The format of each account description is standard-
ized and included 6 major items of information. Those items are:
1. Account number and title. Each cost center has been assigned
an account number and title.
2. Function. This indicates the activity and/or activities to
be accounted for in the particular account.
3. Expenses. This indicates those expenses that should be
accumulated in the particular account.
4. Activity Base. This indicates the statistics used to measure
the level of activity within the particular account.
5. Distribution. This indicates the method to be used to
distribute costs from the support service cost center accounts
to the patient service cost center accounts.
6. Sub-Account. This indicates what account number should be
used if a more detailed collection of cost information is
It can now be demonstrated how the chart of accounts is used to
classify cost accounting data. A head nurse who works in a Nursing
Service-Medical cost center would have her salary recorded to account
number 610.010. The 610 represents the Medical Nursing Service cost
center (primary account) and the .010 indicates a head nurse's salary.
Group life insurance paid by the hospital for this particular head
nurse would be charged to account number 610.110. Any medical supplies
used on this head nurse's floor would be charged to account number
610.300. Consequently, the total direct cost of the Nursing Service-
Medical cost center would be accumulated in account number 610. The
various subclassifications indicate the type of expense.
Activity base. A common denominator is required in order to
measure the level of activity within an account and to provide compara-
bilit.y of the activity levels for 2 or more hospitals. That common
denominator is the activity base. As defined earlier, it is important
that it reflect the output of a cost center and fluctuate as that out-
put fluctuates. The latter fact becomes important for cost distribu-
While the activity analysis was helpful for developing the
activity bases, most activity bases selected tend to conform to current
American Hospital Association and Medicare guidelines. The base which
was selected in some instances, however, represents a statistic that
is not currently being collected. For example, the recommended activ-
ity base for the laboratory cost centers relative unit values of the
laboratory tests performed is a case in point. At present, few
hospitals collect this information. Instead, the number of unweighted
laboratory tests are summarized without considering the complexity of
the various tests or whether those tests were completed manually or
The bases selected, when applied consistently and uniformly to
the corresponding cost centers, represent a measure of the level of
activity which allows for comparative analysis. It also provides a
means of internal control for managers. An activity base has been
indicated for each cost center. The activity bases for those cost
centers (accounts) displayed as part of the standardized chart of
accounts format can be seen in Appendix E.
Distribution method. If the full-cost of services rendered is to
be calculated it is necessary to distribute the costs incurred by the
support service cost centers to the benefiting patient service cost
centers. In order to accomplish this it is necessary, first, to iden-
tify those cost centers that are support service cost centers, and
then to distribute costs from them to the benefiting patient service
cost centers. Appendix F is a partial listing of cost centers by cate-
gory which identifies all cost centers by type of service provided.
With few exceptions the method of distribution is a ratio devel-
oped from the activity base. For example, the Social Service cost
center, Account 752, has as an activity base the "number of consulta-
tions" held with patients ard patients' families. The distribution
method is to spread Social Service costs to patient service cost centers
base upon the ratio of consultations held with patients and patients'
families of each patient service cost center, to total consultations.
The costs of generating that output are distributed to the patient
service cost centers that supposedly benefit from such activities.
The distribution method for each support service cost center follows
this pattern with the exception of Medical Records-Research (Account
788), and all Data Processing cost centers (Accounts 936-938). Those
4 accounts require a special analysis in order to accomplish the dis-
Defining a distribution method for each account does not resolve
which of the recognized accounting procedures will be used to allocate
costs. There are a variety of ways in which this can be accomplished.
The American Hospital Association8 recognizes 4 major procedures.
First, there is the direct procedure which closes costs of the support
service cost centers directly and exclusively to the patient service
cost centers. This entirely overlooks the fact that one support
service cost center can provide service to another support service
cost center. Second, the step-down procedure provides for the
recognition of the relationships resulting when one support service
cost center provides service to another support service cost center.
Those cost centers providing service to the greatest number of other
centers are closed first. Once a cost center is closed, nothing more
can be distributed to it. Consequently, a cost center being closed
subsequent to one of the larger cost centers would not be permitted
to allocate any costs to the larger cost center, even if it had pro-
vided services to that cost center. Third, the double-distribution
procedure allows for one cost center to allocate its costs to any
other benefiting cost center on the first distribution. On the second
distribution the balances remaining in the support service cost centers
are closed directly to the patient service cost centers. This method
takes into account the interrelationships between cost centers.
Further, it can be accomplished by means of an iterative process that
allows numerous distributions, finally allocating directly to patient
service cost centers when the balance in the support service cost
centers reach some small, predetermined amount. The fourth, and last
procedure requires the development of a set of simultaneous equations
which represent the complex interactions among all cost centers. Once
the equations are defined, the solution can be calculated, usually with
the assistance of a computer.
Horngren9 explores rather extensively the direct, step-down, and
simultaneous equation method, and indicates that "little is known
empirically about the effects on decisions of alternative cost-alloca-
tion bases (procedures)."10 Implied is the inability to determine what
method might be the most accurate, most accurate being defined as the
distribution of costs to the area benefiting most. Horngren further
states: "The use of linear algebra (simultaneous equation method) may
make a difference in decisions upon occasion,"11 inferring that the
great effort required to develop the simultaneous equations might not
be worth the additional expense.
It is not the purpose of this research to indicate the one best
procedure for cost distribution. In fact, that would require a separate
project. What this brief discussion has done is indicate the various
acceptable distribution procedures in order to place in its proper
perspective the one chosen for this research the step-down procedure.
First, it does, to some extent, rectify the intercost-center relation-
ships problem. Second, while a double-distribution or algebraic method
might afford a more precise answer, the additional time required to
achieve a result using that method was deemed impractical for this
research, particularly when the "more accurate" assertion was neither
a fact, as the brief preceding discussion indicated, nor was it to be
tested within the scope of this research.
The distribution method for those support service cost centers
displayed as part of the standardized chart of accounts format can be
seen in Appendix E.
Design Data Collection and Report Formats
The last step of the procedure was to design the forms required
to collect the cost and statistical information, and the reporting
formats. Several different forms are necessary for the collection of
the cost and statistical data. Examples of each have been placed in
Appendix G. The purpose of each will be discussed below.
The first form titled "Data Collection Form," is used to collect
the basic cost and selected statistical information for each cost
center. One set of forms must be completed for each cost center. The
data on this form provides the basic input into the cost system. The
Data Collection Form, along with the instruction page provided is
self-explanatory. A significant amount of detailed cost information
is collected concerning the elements which make up each cost center's
The next 3 forms in Appendix G are titled "Activity Measurement
Statistics," "Activity Measurement and Cost Distribution Statistics -
All Cost Centers," and "Activity Measurement and Cost Distribution
Statistics Patient Service Cost Centers." Data entered upon these
forms become the activity bases used for measurement and distribution
There are 3 separate groups of statistics required at this point
as indicated by the 3 different collection forms. This requirement
exists because of the various types of cost centers identified:
support service and patient service. Of the 2 types of support serv-
ice cost centers, professional and hotel, the hotel support service
cost centers provide service to other cost centers within the hospital.
For example, housekeeping and maintenance perform services for all
other hospital cost centers. Consequently, the statistics collected
on the "Activity Measurement and Cost Distribution Statistics All
Cost Centers" form are used as the activity base within the hotel
support service areas. Additionally, they also provide the means for
distributing the costs of providing such services to all areas within
the hospital that benefit from such services.
The professional support services, however, provide services to
the patient location areas only. To collect statistics which will be
the activity base for this group of cost centers, the form titled
"Activity Measurement and Cost Distribution Statistics Patient Loca-
tion Cost Centers" has been developed. The information collected
thereon will also serve as a basic input into the distribution method
for professional support service cost centers.
Finally, since it is the ultimate purpose to determine the full
cost of the patient service cost centers, both primary and patient
location, the distribution of costs stops at that point. No costs
will be distributed from patient service cost centers. As a result
the statistics collected from each of these cost centers will be used
only as an activity base. To collect the data required to accomplish
this, the form titled "Activity Measurement Statistics" has been
Finally, the report formats were designed. Based upon the type
of data that were collected and the manner in which it is processed
through the system, 4 reports were developed. Of these, 2 represent
detailed cost information which reflects the costs by element within
each cost center. Additionally, the summary reports reflect total
cost center costs at 3 different points within the model: 1) at
initial entry point; 2) after adjusting for depreciation, interest,
start-up, and insurance costs; and 3) after all distributions, or
at "full-cost." Appendix I contains completed copies of each report
which indicate the reporting format. A detailed discussion of each
is presented below.
Detailed reports. The 2 detailed cost reports are titled
"Hospital Cost Report" and "Comparative Hospital Cost Report." The
first of the 2 is designed to display detailed information concerning
the elements of cost of each cost center. Displayed are: 1) the
dollar cost of each element, 2) the percentage each element of expense
is to total cost center expense, 3) the expense per patient day of
each element of expense within the cost center, and 4) the expense
per activity base for each element of expense within the cost center.
A significant amount of detail is displayed for each cost center.
The "Comparative Hospital Cost Report" contains the same informa-
tion as the "Hospital Cost Report" except it is displayed on a compar-
ative basis. This allows for the comparison of cost elements within
the cost center, by hospital.
Both of the detailed reports display the cost information as
collected at the initial point of entry into the system, and prior to
any adjustments or allocations.
Summary reports. The 2 summary reports are titled "Hospital Cost
Summary Report" and "Comparative Hospital Cost Summary Report." The
first of these reflects total cost center costs for each cost center
within a hospital. The same 4 items, dollars of expense, percentage
of hospital total, cost per patient day, and cost per activity base,
are displayed on this report as they were on the detailed reports.
Additionally, this information is shown at 3 different points within
the model. First, the expenses as initially recorded are displayed.
This section is called the "Direct Expenses" section, and presents the
total cost center costs as displayed on the detailed reports. Second,
the direct expenses of each cost center are adjusted for depreciation,
interest, start-up, and insurance. This produces the "Adjusted Direct
Expenses," and this information is displayed in the same fashion as the
"Direct Expenses." Finally, after the costs of all support service
cost centers have been distributed, the "Full-Cost" portion of the
report is prepared.
The "Comparative Hospital Cost Summary Report" displays the infor-
mation from the "Hospital Cost Summary Report" on a comparative basis
for all hospitals.
The 4 reports called for as output of this cost accounting system
enable detailed information for a single hospital or a group of hospi-
tals to be evaluated, even for the smallest element of costs for any
of the cost centers. At the other extreme, comparative summary cost
accounting data are made available at 3 different points of processing
within the model.
This chapter has been concerned with identifying the steps of the
procedure which were required to develop the cost accounting system
recommended in Chapter II. Next, the results of applying that method
were discussed. Finally, the elements of the system were described and
provided in the appendices, along with the necessary forms and report-
ing formats. In essence, the elements required to move from the con-
ceptual cost accounting system model to an operating cost accounting
system were developed. At this point, it is assumed that the cost ac-
counting system developed will produce the desired comparable cost data.
It will be the purpose of the next chapter to test that assumption and
determine if that conclusion is warranted.
1. John R. McGibbony, M. D., Principles of Hospital Administration,
2d. edition, (New York: G. P. Putnam's Sons, 1969). Chapters
9-29 are detailed explanations of the responsibilities and
activities of a hospital's departments.
2. United States Department of Labor, Manpower Administration, Job
Descriptions and Organizational Analysis for Hospitals and
Related Health Services, (Washington, D. C.: Government
Printing Office, 1971).
3. Harold M. Goldstein and Morris A. Horowitz, Restructuring Para-
medical Occupations: A Case Study, (Boston: Department of
Economics, Northeastern University, 1972).
4. Ray E. Brown and Richard L. Johnson, Hospitals Visualized, 2d
edition, (Chicago: American College of Hospital Administra-
5. Hospital Administrative Services, Departmental Handbook-House-
keeping, Departmental Handbook-Nursing Services: Operating
and Recovery Rooms, Departmental Handbook-Dietary, Depart-
mental Handbook-Laundry and Linen, Departmental Handbook-
Nursing Services: Obstetrical Nursery, Delivery and Labor
Rooms, Departmental Handbook-Plant Engineering, (Chicago:
American Hospital Association, 1966), and American Hospital
Association, Management Review Program-Food Services Depart-
mnent, and Management Review Program-Nursery Service. (Chicago:
American Hospital Association).
6. American Hospital Association, Uniform Hospital Definition,
(Chicago: American Hospital Association, 1960).
7. Connecticut Hospital Association, Connecticut Hospital Asso-
ciation Accounting Manual, (New Haven, Connecticut:
Connecticut Hospital Association, 1970).
8. Cost Finding and Rate Setting for Hospitals, American Hospital
Association, 1968, pp. 31-34.
9. Horngren, Cost Accounting- A Managerial Emphasis, pp. 417-428.
10. Ibi_d., p. 426.
11. Ibid., p. 424.
COST ACCOUNTING SYSTEM EVALUATION
The cost accounting system developed in the preceding chapter was
assumed capable of producing cost accounting information for use by
internal and external decision makers. It will be the purpose of this
chapter to indicate how that assumption was tested. Each step of the
method used to evaluate the cost accounting system will be detailed.
At the same time, a discussion of the results of completing each of
those steps will be included.
The method used to evaluate the cost accounting system consisted
of 3 major sections. First, actual cost data were collected from each
participating hospital and processed in accordance with the instruc-
tions and guidelines developed in Chapter III. This represented a
test of the procedural aspects of the system. Second, an evaluation
of the cost output was conducted to determine if the information was
capable of providing assistance to internal and external decision
makers. This second section of the method, the output evaluation
section, was completed by having the administrators and the financial
and/or accounting managers of selected hospitals review and comment
upon the cost accounting system's final product--the 4 cost reports
described in Chapter III. The last phase of the evaluation was to
determine the reporting requirements of external cost information
users, and to evaluate the cost accounting system's output against
The remainder of this chapter will be a detailed discussion of
the major parts of the method which were outlined briefly above.
Method Related to Procedural Aspects
and Discussion of Results
It was the aim of this particular portion of the research to de-
velop the group of reports called for as the output of the cost as-
counting system. As such, the reports were developed from each
hospital's actual cost information and are intended to be represen-
tative or typical of the reports which can be prepared on a continuing
basis to assist in both internal and external reporting situations.
There were 3 operations performed to arrive at the final output:
1) data collection, 2) data manipulation, and 3) report preparation.
Each operation will be discussed in greater detail below.
The 5 Jacksonville hospitals participating in the project were
asked to provide the cost data for each activity defined in the Chart
of Accounts, which was being performed within that particular
hospital. Additionally, the statistics necessary to measure out-
put and distribute indirect costs were to be provided for each
activity. The forms displayed in Appendix G were used for that pur-
pose. The data were to cover a 1-month time period. The month was
to be a "normal" month, with "normal" defined as a month in which
there were no major renovations causing areas of the hospital to be
closed, no extremely high or low census as compared with the average
for the past 12-month period, and no other extenuating circumstances
which might cause operations to be out of the ordinary such as labor
disputes. Each administrator determined the "normal" month for his
hospital given the preceding guidelines. Three selected January,
1973, and two selected March, 1973.
Having selected the time period, the accounting personnel within
each hospital collected all necessary information by following the
activity definitions as per the Chart of Accounts. The personnel
collecting the data were to contact the researcher only if and when
problems were encountered with the activity definitions. It was
imperative that the integrity of the definitions be maintained so
that cost information, when completed, would be for identical activi-
ties. Other than that one exception, the hospital personnel were to ac-
complish the data collection using only the guidelines provided by the
Chart of Accounts. This served two purposes: first, to determine how
closely the definitions explained the activities within the various de-
partments of the hospitals, and second, to establish how much effort
was required to develop the data in the required detail.
The current accounting systems employed by the participating
hospitals represented varying degrees of sophistication. As a result,
it took only a short period of data collection to determine that only
one of the hospitals was presently collecting information approaching
enough detail to satisfy the reporting requirements as per the pro-
posed system. An investigation indicated that a major difficulty was
that the existing reports were prepared at a summary level. A vivid
example was found in the nursing service areas. All medical and
surgical units were summed together and reported as Medical-Surgical.
The proposed cost accounting system called for each medical and surg-
ical nursing unit to be identified separately. In order to separate
the various nursing units, both cost and statistical information had
to be reported for each unit individually. An examination of the hos-
pitals' cost records indicated that the detailed cost information was
available, and it was used at the detailed level for this project. A
more serious problem, and the main reason why the existing cost re-
ports were used in summary form, was that the statistical data were
either not collected, or not collected below the summary level. The
latter difficulty required that the accounting personnel collecting
the data for this research perform special analyses in order to obtain
the necessary information.
The special analyses resolved all statistical data problems ex-
cept two. First, for Central Sterile, only 2 hospitals maintained a
count of requisitions. Second, with one exception, none of the hospi-
tals could provide relative unit values where such were required.
Only 2 hospitals were able to do so for the laboratory, and that
measure was used for those 2 as a laboratory indicator. For all other
relative unit values, unweighted units were substituted, i.e., number
of x-ray exams instead of relative unit values of x-rays, and number
of cardiac catherization procedures instead of relative unit values of
Because of the time required to perform the special studies in
order to collect the statistical information, the data collection it-
self took longer than had been anticipated. It required an average of
approximately 4 weeks in each hospital. This operation was begun
April 1, 1973, and completed May 31, 1973. The next operation was to
process the data.
The information collected was processed through the cost account-
ing system model represented by Figure 6, Chapter II. The amounts
distributed from one cost center to another were calculated as per the
instructions in the "Distribution" section of the Chart of Accounts,
Appendix E. For the reasons indicated in Chapter III, the step-down
procedure was used to distribute costs in accordance with the instruc-
tions in the Chart of Accounts. The sequence for closing accounts as
outlined in Chapter III was followed. That called for 1) the distri-
bution of depreciation, amortization of start-up costs, insurance ex-
pense, and interest expense to all cost centers; 2) the closing of
hotel support service cost centers; and 3) the closing of the pro-
fessional support service cost centers. Figure 7 is an example of how
the step-down method works and is extracted from one of the calcula-
tions. It is used here for illustrative purpose only. Appendix II con-
tains the entire step-down calculations for closing one hospital's
professional support service cost centers to the patient service cost
The entire cost allocation process for this project was completed
manually. It was determined that it would take several months to de-
volop and to write a computer program to accomplish such an alloca-
tion. Consequently, that would have extended the time frame for
completing this research. It would be advisable, however, to use a
computer for such a routine, repetitive function as this one should
TO CLOSE PROFESSIONAL SUPPORT SERVICE COST CENTERS
Cost Bal. from Total
Center Work. A. 601 602 690 758 765 775 920 921 Cost
601 7189 7189
602 9114 188 9302
675 36987 126 167 94 37374
690 5132 50 65 5247
758 11522 11522
765 3103 3103
775 17731 17731
920 17023 17023
921-678 15120 117 157 89 15483
702 11738 11738
706 53837 58837
714 13599 13599
716 14064 14064
718 5469 5469
721 49289 49289
728 7347 7347
731 35933 35933
735 6791 14 19 10 6834
737 18946 18946
739 2685 2685
741 7647 7647
757 22416 308 408 232 23364
660 53532 643 854 484 3103 58616
Fig. 7.--Example of step-dcwn cost allocation procedure.
the cost system be implemented. The time required to complete this
operation manually was an average of 10 days for each hospital.
At the completion of the cost distribution calculations, it was
necessary to develop a format for displaying the results of those cal-
culations in a logical fashion. For that purpose, 4 were developed in
Chapter III: 1) Hospital Cost Report, 2) Comparative Hospital Cost
Report, 3) Hospital Cost Summary, and 4) Comparative Hospital Cost
Summary. This portion of the method discussion will present the com-
pleted formats. The text will include examples of completed, actual
reports and some tables containing extracts of the other reports.
Completed copies of all 4 reports are presented in Appendix I. This
serves 2 purposes. First, it demonstrates the reports that are gen-
erated by the cost accounting system. Second, it is a copy of the in-
formation provided to those who evaluated the cost accounting system.
Figure 8 is a copy of one completed Hospital Cost Report. The in-
formation for this report came directly from the Data Collection Form.
The Hospital Cost Report displays significant detail concerning the di-
rect expenses of each cost center. Information concerning each ele-
ment of the direct expenses of each cost center is displayed 4
different ways. Under the "Dollars" column, the dollars expended on
that element are shown. Under the "Percent of Total" column, the per-
centage each element of direct expense is to the total cost center's
expense is shown. Under the "Patient Day" column, the result of di-
viding each element of the direct expense by patient days is shown.
Finally, under the "Activity" column, the result of dividing each
HOSPITAL COST REPORT
PAGE 1 OF 3
ACCOUNT NUMBER: 610 ACTIVITY BASE: Hours of Care
DATE: One month
cc--A '-nrt Ti----j'l I of Tcal tient Di' Actliv L Do,! J.rs
SAEARTA'TrT.AucS-----I-T- -Alp_-----_ -
Nursing Super./Super. I .8
Head Nurse/Professional 1 4.40 1.27 .18 924_
_Chare _lurse -!
Staff Nurse | 26.17 7.4 .03 i 555
Pract. Nurse/Semi-Pro. | 15.29 4.40 .53 3192
using Assist./Student 19.72 5,68 .82 4117
Unit Admin./Clerical I
Clors/TyJs ts. 8.12 2.34 .34 ?9-
TechnjLc i /Technici rn
Phys ici n sPhys ici ns I
.[ntterns & Residents
General l/Gen era 1
TOTAL SAL., KAGES, HRS. /." Hr73 3.05 ib, -
_Social Security (FICA) 4.3 10.24 ... .0
_Grou_ Life Insurnce 1.38 .54 .08 393
GrJQ.IP i Heath insurance
Retire. Plan Contribtion 63 .18 .X3 132
_J1 .Tn's CoLoensation .34 .10 .0 71
StJte Unem y. Tax .66 .19 .03 1
FJed. Upel oy. Tax _____
1n_____ ___ _.72 .21 .03 151
health Service .06 .02
TLZ.BEE..T ___......... ..
_leoal ____.....________ ___.____ _______
__lcin ae____ _____ __ _e
Consulting __ ____
Med. Spec. Admin.
Med. Spec. -Phys.Serv. _____ _
Medical & Surgical .34 38 .06 ___ 9__
Inven. Cout Adi u st
__J.'ear-iing.. A.r,] (ex Ulni .) --
.__I-.om Ls,,______ _a.._____ I -
Fig. 8.--xaple of a completed Hospital Cost Report.--- -
Fig.' 8.--Examiple of a completed Hospital Cost Report.
HOSPITAL COST REPORT
ACCOUNT NUMBER: 610 ACTIVITY BASE: Hours of Care
PAGE 2 OF 3
DATE: One month
__ Account Title % of Total Patient Day Actvity Dollars
Films and Chemicals ____
Pub. jBooks & Periodicals
Beverages & Nourishments
LRe&ir_ L& jinjtenanj ce_
Di shes, G ass]w re. Silver. ___ _____
Disposable Eating Uten.
Food-Meat, Fi sh, Poul tryv__
House. Paper Products _____
House. Sanitary Products
Miscellaneous .18 .0 .01 37
"--TOTAL SUPPLIES 1.56 .44 .u/ "
-PURCHASED SERVICE ... .
Purchas. Main Contract
_Purchas. Main Other_
Utilities Electricity ____ __
Utilities Water & Sewer
Garbage Collection ___ __
Telephone & Teleraprah .47 .14 .02
Insurance & Bonding 1.22 .35 5 ___ Z5
Duees ard j erb r-ships-
_ P:r f.A..._AnJ J^i-t, _Stu..d, .....
_ .I --Lje- 1-
Travel 0- Other
_Euipment Leasesi- .72 .21 .03 150
FPig.h &.--Cntinu ment
HOSPITAL COST REPORT
PAQE 3 OF 3
ACCOUNT NUMBER: 610
ACTIVITY BASE: Hours of Care
DATE: One month
AccmirLTtl0e % of Total Patient Day Activity_ DTo rs
non-Hos pital Lab.
Serv. From Other Hosp. ____
O outside oni_ orin
Pr itin_____ _______ _______ ______ ____
Inter1ov. Aen. (Univer.)
TOTAL PURCHASED SERVE. 2.41 .70 .IO 02
pri._-JigFJquY n1.4u .40 .06 --
__QIaC-_i- F_ ,L1_ oi-_ .17 .05 .1 35
__Dnprec Building 2.75 .79 .T1l 57
._De'prec- Building Sery. 3.41 .98 .14 711
)Derec. Land Imorovement .36 .10 .01 75
Amort. of Start-Up Cost__
Interest Short Tenn Loan .08 .2 17
_Interest Mortgages 3.94 1.14 .1 823
Interest Bonds 1.62 .47 .01 338
Interest Other _
Loss on Dis. of Assets
Loss on Dis. Stocks & Bonds
Credits to Expense ___
Credits to Exp. Research _
Credits to Exp. Grants
Cre. to Exp. Cen. St. Sup ___
Credits to Exp. Pharmacy _____
Cre. to Lxp.- Rep. A& Main.
Crc. to Ep. Other
TOTAL OTHER EXPENSES 13.73 3.95 .56 2864
G RANiD TOTAL 100.09 28.80 4.14 20881
OTHER DATA: _
'---1 -t--- *-1*~---- I- -
element of direct expense by that certain cost center's activity base
as defined in the "Activity" section of the Chart of Accounts is shown.
The cost accounting system calls for one such report to be prepared for
each cost center within each hospital.
Figure 9 is a copy of one completed Comparative Hospital Cost Re-
port. The comparative report displays the same information as the
Hospital Cost Report, except it displays cost on a comparative basis
so that each hospital's direct expenses may be evaluated in comparison
with others in the community performing the same activity. That com-
parison may even be carried down to each element of direct expense, if
Both of the detailed reports just discussed represent the col-
lection of cost information before any cost distribution procedures.
In order to establish cost in accordance with the cost accounting
system model presented in Figure 6, Chapter II, it is necessary to
begin to recognize certain indirect expenses and distribute those ex-
penses to the benefiting cost centers. Initially, the direct expenses
of all cost centers were adjusted to recognize the amount of depre-
ciation, amortization of start-up costs, general insurance expense,
and interest expense that should be borne by each. This new cost
center expense was titled "Adjusted Direct Expense." At this point in
the processing, if the amounts reflected in those accounts for all
cost centers designated Hotel Support Service Cost Centers and Pro-
fessional Support Service Cost Centers were summed, the total would
represent the costs of production through Stage I of the cost account-
ing system model depicted in Figure 6, Chapter II.
COMPARATIVE COST REPORT
DATE: ACTIVITY EASE: PAGE 1 OF 4
Acct. Cost s % of T tal Cost r r Patlert Day :ost Per Activity Base
S2 3 4 5 1 2 3 4 5 2 3 4 5
~ 3AL ES-AND = AGE-S ----
001 Nursin_ Super. L uer. .,66 1,17 _
C .010 Head Nurse/Professional 4,.0 16.22 1.27 3.35 ,18 .72.
.011 Charge Nurse__ ___
.012 Staff Nurse 6_.17 7__4 1,08
.020 Pract. Nurse/Semi-Pro. 15.29 22,00 4.40 4.5A .63 98
.030 Nursing Assist./Student 19.72 5.68 ,__
.040 Unit Admin./Clerical __67 .5 12
.041 Clerks/Typists 8.12 2.34 .34 _
.061 Interns & Residents
070 General/General _24,8 5.13 10
TOTAL SAL., WAGES, HRS. 73.70 63.40 71.41 71.25 21.23 14.47 14.74 _8. _3_ 3.05 2.96 3.17 3,05
10 Scial Security (FICA) 4.31 3.74 3.36 4.17 1,24 ,85 ,69 1,07 .18 .17 .15 .18
.110 Group a ife Insurance 1,88 .85 .54 .22 .0 04
ll Grmip Hpalth Iinr ranpc 3.29 1.10 .86 .75 ,23 .22 ,15 .05 .04
.112 Group Disability Insur. 3.58 92 .15
.120 Retire. Plan Contribu. .63 3.78 .96 .18 .86 .20 .03 .18 .04
.130 W Comen's Cmpensation .34 .23 .10 .05 .01 .01
.140 Stte Une mloy, Tax .66 .24 .19 .05 .03 .01
,M1 Fed, Unemploy, Tax
.15 Uniforms .72 .21 .03
.160 ieals .37 .08 .02
170 .06 02 -
TOTAL FRINGE BENEFITS 8.60 10.81 6.26 9.46 2.48 2.46 1.30 2.43 .36 .50 .28 .41
.220 Collection Agencies
.23 Cniultirg _____ ______
F.24-0x P a n_______ _c______teo_______ n pt H I tl_______ ______-s
..24 MPd Spac.-Ad in.
S- e,-Phys -Serv,_____ I ____ -
Fig. 9.--Example of a completed Comparative Hospital Cost Report.
COMPARATIVE COST REPORT
PAGE 2 OF 4
Act. Cost s % of Ttal Cost P r Patie t Day ost Per ctiviy Base
1 2 3 4 5 1 2 3 4 5 1 2 3 4 5
.30C Mpdical & Surgical 1.34 2.14 .14 .23 ,38 .49 .03 .06 .r, .10. ()
,301 Inven. Count Ad2ust.
.__310, Drugs .03 01
320_ Intravenous Solut ons. 01
.3-0T Wear. Apparel (ex. Un. __
3401 General peratin .95 20_
.350 Oxvcen and Gase_____
S_36C0 Films and Chemicals ,
___________r___ ____ __ ___I 2.14 .14 .23 3_ ___..... _......... ___. ........DL...
.364 __ _____ .03_ _______"-_ .03.01____ ______________
__30________ Fu e
.390 P;b. fBooks & Period.) .
.400 Bov-ages o -ourish.
.410 Reir MaIrtenance-
.420 Dishes. _Glass.. Silver._
42 Disposable Eat. Uten.
.441 Fnnd-Mept, Fish, Paul
.443 Fod-FresIh Prodruce
_444 Food-All Other_ _____ __ __
.4Pa aIboratory _
.._,_4.AC Housekee Pinor....
461 House.-Paper Products i
4 nSne.-Rpitary Prndut -
4 Print___ _____ _
.500 Miscellaneousd .18 ,2f 1 .0. .- -.1 0__ ___ n I --
COMPARATIVE COST REPORT
PAGF 3 OF 4
Acct. Costt al ost Pr Patiet Day Cost Per Activiy Base
No. Title 2 3 4 5 1
o. T1e 1 2 3 4 5 1 2 3 4 2 3 4 5
TOTAL SUPPLIES 1.5 2.14 1.51 23 .44 .49 .31 .06 -07 .in .07 .01
.600 Purchased Maintenanc
6__ 01 Purchas. Main-Contrat
. l2? Purchase. M!i,-[ther
.613 Utilities-Water & Sewer
.620 Garbage Collection
.630 Telephone & Telegraph _7 .14 ,?
.640 Insurance & Bonding 10.10 1,22 2,47 ,20 1.45 3.76 .5 6 .- 4 __ .05 I .n .-ni 0
.650 Dues and Memberships
.651 Prof. Activity Study
,661 Travel -ducation
.662 Trav l-Oth-r
,670. Equipment Rentn1s
-.71 EDquipment leases .72 .21 ,
S .672 Photocopy Equipmient
.700 tNon-Hoopital -ab,
701 Se From Other sp
.710 Outside Monitorino
.722 Housekeeping ____ _______ ____ ______
.723 Dietary _____ ______ ____ ______ ______
.725 Data Processing__ _
.730 Interao. Aen. (Univer
i .740 Other. .4 10 -02
COMPARATIVE COST REPORT
DATE: Av IV IT t L: PAGE 4 OF 4
Acct. Cost s of Ttal Cost Pir Patient Day :ost Per Activiy Base
STte 1 2 3 4 5 1 2 3 4 5 1 2 3 4 5
TOTAL PURCHAFSD SERV. 10.10 2.41 2.47 .69 1.45 3.76 .70 56 .14 .37 .10 .12 .03 .06
.800 Depreciation _
,801 Deprec,-Maj. May. Equip 1.40 4.91 1.24 2.53 .40 1.12 .26 .65 .06 .23 .05 .11
p802 epre-Fixed Equin .17 I .04 .05 .01 .Oi -
.803 Dprc -Buildig 33888 2.75 8.80 13.08 10.11 14.47 .79 2.01 2.70 2.60 .11 .41 .58 .43
.804 Deprec.-Building Sery... 3.41 -98 14
.805 nere.-Land Im'rmvp.t 6 05 _07 i___ .01 .01 __01 -
To10 Arnrt- nf .Sart:-tp r.n;t __7 .01
.qS) Tntprpt _____ _____
.821 Interest-Short Trm Loan ,08 .02
.822 Interest-MAortgages 51.02 3.94 7.13 .30 18.98 1.14 1.E3 .19 .16 .33 .04
.8231 Interest-Bonds 1.62 4.80 4.97 .47 .99 1.28 .07 .21 .21
.830 Losson .Dis, of Assets
S.840 Loss Dis. Stocks.&__ ___ __
.85 Credits to Exense
.851 Credits to Exp.-esear.
.851 Credits to Exp.-Resear.
.853 Cre. to Exp.-Cen.St.Sup_
.854 Credits to Exp-Pharmacy
'___5i Cre. to E-p-Rep.&Ma'n.-
.856 Cre. to Exp.-Other
TOTAl OTHER FXPENSFS 85.90 13.73 21.18 20.13 17.61 33,45 3.95 4,84 4.16 4.53 .56 .98 .89 .75
.GRAND TOTAL 100, 110,0 00.00, 100.00 100.00 37.21 28.80 22.82 20.64 25.69 4.14 4.68 4.43 4.28
Full Time Eauqy. Emylov
Moving from the adjusted direct expenses of all cost centers to
the full cost of the patient service cost centers required the step-
down operations previously discussed. The report that reflects the
distribution of costs from support to patient service cost centers so
that full costs may be calculated is the Hospital Cost Summary. The
basic input to this report was each cost center's total direct expense
as reflected on the Hospital Cost Report. The summary report displays
the same types of information as the detail report, i.e., dollars cost,
cost as a percentage of total, cost per patient day, and cost per ac-
tivity base. The information, however, is provided at 3 different
stages of the cost accounting system: Direct Expenses, Adjusted Di-
rect Expenses, and Full Costs.
Figure 10 is a partial copy of the Hospital Cost Summary Report.
It is meant to serve as an illustration of the manner in which the cost
inFormation is displayed. A complete copy of the Hospital Cost Sum-
mary Report for one hospital is displayed in Appendix I.
The final report prepared was the Comparative Hospital Cost Sum-
mary Report. This report summarizes the information found on each
Hospital Cost Summary Report. A comparative display of the information
allows the management of each hospital to evaluate its cost of provid-
ing specific services with other hospitals providing the same service.
Further, the comparison can be made for the 3 stages of costs. The
following tables reflect, in summary form, highlights of the compara-
tive analyses. The complete Comparative Hospital Cost Summary Report
is presented in Appendix I.
The information reflected in Table 1 is the same as that shown in
Figure 9, the Comparative Hospital Cost Report.
HOSPITAL COST REPORT
OIRFCT EXPENSE A3JU)STEO DIRECT EXPENSE FULL COST
COST CTE rST CENTER R ,OST EAL, TR i6i- Ett- PR- T CH COST -- Firt NT i ACTIVITY 'r T ACH COST PEr FATiMNI PER AUIVTY
WBR" TITLE J CENTER CENTER CF TCTAL DAY 8ASE CENTER CENTER OF TOTAL DAY SE CE CETETP OF TOTAl PAY PASr
U.S. Surg. Ortto
N.S. ICU Cornary
N.S. Rec. Roo
N.S. DlI. 4 Labor
Pharnacy repackk & Ois.
Interns and Residents
Operation of Plant
Laundry Coll. & Dist.
15. 64 1.84
11,738 1 29
Fig. 10.--A partial copy of the Hospital Cost Summary Report.
Table 1: Direct Expense Comparison
Selected Cost Centers as they appear on
the Comparative Hospital Cost Summary Report
910 Patient Acctg.
.Percent of Total
910 Patient Acctg.
Cost Per Patient Day
910 Patient Acctg.
Cost Per Activity Base
910 Patient Acctg.
$ 897 $
$ 23,988 $
Table 2 reflects the adjusted direct expenses for selected cost
centers. This cost information represents the direct expenses ad-
justed for depreciation, insurance, amortization of start-up costs,
and interest expense. The effects of adding those 4 major categories
of indirect expenses to the direct expense can be easily traced by
comparing the data in Table 1 with the data in Table 2.
Table 3 indicates the effect of distributing the costs of support
service cost centers to patient service cost centers. It should be
noted that the support service cost centers show no "full cost." They
have been closed to the patient service cost centers. Those cost
centers which still remain open and for which a full cost is displayed
are those cost centers selling a service/product to the patient/phy-
sician. The price or charge of the service offered by the cost
centers should be equal to the full cost if each cost center is to
"break even," i.e., to operate at neither an accounting profit nor ac-
The foregoing discussion attempted to explain the procedural por-
tion of the evaluation method. The discussion centered around the de-
tails of collecting, processing, and reporting the cost data which
were later evaluated. As such, copies of, or extracts of, infor-
mation from all reports were provided in the text of this chapter.
All reports are shown in Appendix I. The only problem related to
these 3 steps was encountered during the data collection operation.
The manner in which the problem was alleviated was discussed. In all
cases, the procedures called for in the cost accounting system de-
velopment discussion in Chapter III were followed. This section has
demonstrated that by carrying out the instructions included in the
Table 2: Adjusted Direct Expense Comparison
Selected Cost Centers as they appear on
the Comparative Hospital Cost Summary Report
910 Patient Acctg.
Percent of Total
910 Patient Acctg.
Cost Per Patient Day
910 Patient Acctg.
Cost Per Activity Base
910 Patient Acctg.
$ 31,418 $
Table 3: Full Cost Comparison
Selected Cost Centers as reflected
on the Comparative Hospital Cost Summary
910 Patient Acctg.
Percent of Total
910 Patient Acctg.
Cost Per Patient Day
910 Patient Acctg.
Cost Per Activity Base
910 Patient Acctg.
$ 6,159 42,739
cost accounting system development discussion, the reports called for
can be prepared. It will be the subject matter of the following
section of this chapter to evaluate that output.
Method Related to Output Evaluation
and Discussion of Results
After generating the required cost information, the next step was
to determine whether that output was the type of information antici-
pated. There were 2 aspects to the test required to determine this.
First, did the reports help internal managers in their decision making,
by providing measures of 1) the activities within their hospital, and
2) the comparable activity within other hospitals in order to compare
operations? The answers to these questions were determined by provid-
ing a group of hospital managers with the cost reports and then so-
liciting their response to several questions concerning the reports.
Second, the question of the reports' being able to provide comparable
data for external parties remained. This problem was resolved by de-
termining the reporting requirements of the identified external users
and comparing the system output with those requirements.
Evaluation by Hospital Managers
Copies of selected reports were presented to a panel of 13 eval-
uators. The evaluators were the administrators, assistant adminis-
trators for finance, financial directors, and chief accountants of the
5 Jacksonville, Florida hospitals participating in the research. Ap-
pendix K lists the evaluators by name, position, and hospital repre-
sented. The evaluation was accomplished by holding interviews with
each hospital's personnel separately. The interview procedure is
I. Distribute Reports to Managers. Copies of the following reports
were given each manager.
A. Hospital Cost Report. Due to the detailed nature of this
report, copies were provided for only 6 cost centers.
Those cost centers were:
610 Nursing Service-Medical
660 Nursing Service-Operating Room
706 Laboratory-Clinical Pathology
757 Emergency Room-Nursing
910 Patient Accounting
This group of reports was selected because it contained at
least one of each type of cost center.
B. Comparative Hospital Cost Report. Copies of this report for
the same 6 cost centers listed in A. above were provided.
C. Hospital Cost Summary.
D. Comparative Hospital Cost Summary.
II. Discuss Reports. During this period of time the researcher dis-
cussed each report and its purpose. Questions from hospital
managers concerning the method used to prepare the reports, and
the interpretation of the reports, were answered during the
III. Managers' Evaluation. At the conclusion of the discussion, the
hospital personnel were asked to respond to several questions.
Appendix J contains the list of questions used for this purpose
and a recap of the responses. Additionally, each manager was
asked for comments regarding the output of the cost system in
relation to his needs.
The questions asked of the hospital managers were designed to de-
termine 4 types of information. First, questions 1 and 2 were directed
at determining the general cost accounting system's effectiveness.
Second, questions 3 through 6 were directed toward evaluating the
various elements of the cost accounting system. Third, questions 7
through 12 were directed toward determining the uses of cost ac-
counting system's output. Finally, the last question was directed
toward possible implementation of the cost accounting system. The re-
sponses to the questions will be grouped below by the 4 major topics
General System Effectiveness
The 2 questions relating to the overall effectiveness asked if
the cost accounting system could produce costs by program and by prod-
uct. "Program" in this case referred to the various programs identi-
fied in the current hospital cost accounting system model as depicted
by Figure 5, Chapter II. "Products," on the other hand, referred to
the outputs of the cost centers which are part of the proposed hospi-
tal cost accounting system model as depicted by Figure 6, Chapter II.
All evaluators indicated that the system provided both program and
product costs, but one evaluator (an administrator) did indicate that
there should be an additional calculation for the purpose of review-
ing costs of activities that provide a substantial amount of service
for outpatient clinics and emergency rooms. In essence, this would
result in a more finely defined product cost.
System Element Evaluation
The proposed cost accounting system has as its base proper ac-
tivity definitions, with a cost center designated for each activity.
Additionally, the activity measures must represent the output of each
cost center for the cost accounting system to be of value. Questions
3 through 6 were directed at determining whether the elements of the
cost accounting system did what they purported to do.
All evaluators responded that the activities were defined such
that they represented accurately the activities being performed within
their respective hospitals. Additionally, all of the evaluators were
in agreement with the activity bases that had been selected to measure
the level of activity within each cost center. There was one exception:
2 evaluators (one administrator and one chief accountant) indicated that
the activity base of "hours of care provided" used for the nursing
services cost centers might be a more meaningful activity base if it
were weighted by patient days of care provided. No recommendations
were made regarding a preferred weighting scheme.
The need to define so many activities, however, was not as unan-
imously endorsed. Of the 13 evaluators, 4 felt that too much cost
detail was presented, while 9 indicated that the amount of cost detail
was right. Yet, when asked if the number of activities defined was
too few, too many, or about right, only 2 felt that too many activities
had been defined. The other 11 felt that the number of activities de-
fined was correct. This seemed to point to a minor conflict. Some of
the evaluators felt the cost accounting system was too detailed, yet
when confronted with reducing the number of activities for which costs
would be collected, they indicated that the number of activities was
In general, the majority of the responses indicated that the cost
accounting.system was producing the right amount of information and
for the right number of activities. More important was the unanimous
response that the activities had been defined accurately and, with the
noted exception, the activity bases properly reflected the outputs of
the various cost centers.
Uses of System Outputs
The next 6 questions were asked in order to determine how the cost
data would be used. The first question of this series asked to what
groups of external users had the hospital managements been required to
provide cost data? The following is a summary of the responses re-
garding the 5 hospitals. Listed first is the requesting agency, fol-
lowed by the number of hospitals sending reports to that group within
the past 6 months.
Annual Price Commission Reports 2 hospitals
Price Exception Request 2 hospitals
Annual Medicare Report 5 hospitals
Special Reports to Public Groups
or persons 2 hospitals
Special Reports to Third-Party-Payers 1 hospital
The next question asked if the type of cost information provided
by this cost accounting system would have been helpful in preparing
any of the reports. Of the 13, 9 evaluators responded that it would
have been, and 2 gave a qualified "yes." The qualification was that
it would be helpful only if all hospitals adopted such a cost
accounting system and could report comparable information. The other
2 evaluators indicated that the information would not have been help-
ful for any of the reporting. This last opinion was expressed with
particular emphasis upon the reporting requirements of regulatory
agencies such as the Social Security Administration and the Price
Commission. The 2 evaluators giving a negative response stated that
both of the cited regulatory agencies, while indicating cost and sta-
tistical data could be submitted for evaluation, were reluctant to use
such data when it was submitted.
The evaluators then were asked to what agencies or groups they
would provide such cost information. All 13 indicated they would pre-
sent the cost data to their boards of directors, while 11 of the 13
stated they would provide it to governmental agencies, third-party
payers, and volunteer planning agencies. When asked if such infor-
mation would be made available to consumer groups, only 6 responded in
All of the evaluators indicated they would use a cost accounting
system such as the one developed here as a budgetary and planning
model, but only 9 of the evaluators indicated they would use the in-
formation produced by such a cost accounting system as the basis for
the internal allocation of resources. Concerning pricing decision,
however, all of the evaluators stated that they would use the output
of this cost accounting system for establishing and justifying rates
or prices. Finally, all 13 stated they felt the cost accounting
system would be of more benefit to internal decision making than to
The preponderance of the responses to these questions tended to
favor this cost accounting system as an internal management decision
making tool. However, most evaluators would provide the output to
those groups outside the hospital who had a requirement for such data.
The last question asked if the evaluator would implement such a
system in his hospital. Of the 13 evaluators, 8 indicated they would;
3 gave a qualified "yes," stating they would prefer to study the Medi-
care implication further; and 2 indicated they would not. These last
2 indicated that the cost accounting system was adequate but that they
had to consolidate their records with other hospitals under the same
ownership, and the proposed cost accounting system would make them in-
compatible with existing reporting schemes.
In total, the evaluators who reviewed the cost accounting system
and its output generally were favorable toward the cost accounting
system. As the responses discussed have indicated, the cost account-
ing system seems to provide useful information. Most indicated they
would implement such a cost accounting system.
Requirements of External Users
The procedural aspects of the cost accounting system were tested
by generating the reports required. Hospital managers then evaluated
the output. The remaining step of the evaluation procedure is to de-
termine the reporting requirements of external cost information users
and to compare the output with those requirements.
Identified were 4 different external groups. They were 1) the
Social Security Administration, under Title XVIII of the Social
Security Act (Medicare); 2) regulatory agencies that administer price
control programs; 3) third-party-payers; and 4) interested consumer
groups. The reporting requirements of each will be outlined below.
The Social Security Administration
In 1965 the Congress of the United States enacted Title XVIII of
the Social Security Amendment of 1965, commonly referred to as Medicare.
Under the provisions of Title XVIII people over 65 years of age were to
have medical payments made in their behalf by the Social Security
Administration. Section 139f(b) of Title XVIII states the following:
The reasonable amount paid to any provider of
services with respect to services for which
payment may be made under this part shall,
subject to the (deductible and co-insurance)
provisions of section 1395e of the Title,
be the reasonable cost of such services,
as determined under section 1395x(v) of this title.1
The restrictions of section 1395x(v) were listed as follows:
The reasonable cost of any service shall be
determined in accordance with the regulations
establishing the method or methods to be used,
and the items to be included, in determining
such cost for various types or classes of
institutions, agencies and services...Such
regulations may provide for determination of
the costs of services on a per diem, per unit,
per capital, or other basis, may provide for
using different methods in different cir-
cumstances, may provide for the use of esti-
mates of costs of particular items or services,
and may provide for the use of charges or a
percentage of charges where this method
reasonably reflects costs.
Such regulations shall (A) take into account
both direct and indirect costs of providers
of services in order that, under the methods
of determining costs, the costs with respect to
individuals covered by the insurance programs
established by this subchapter will be borne
by individuals so covered and the costs
with respect to individuals not so covered
will not be borne by such insurance programs....
In order to define "reasonable costs," the Social Security Com-
missioner formed the Health Insurance Benefits Advisory Council. The
council consisted of representatives of the hospital, nursing home,
and insurance industries as well as representatives of Federal, state,
and local governmental agencies that purchase health care. After a
year of deliberation, a Principles of Reimbursement for Provider Costs
was produced. This document set out 4 general reimbursement princi-
ples and 12 principles pertaining to specific reimbursable costs.3
The specific principles indicated what indirect costs, in addition to
the direct costs, would be considered reimbursable. The general
principles hold more significance for this research. The pertinent
general principles are:
1. Costs related to patient care. Payments to
providers must be based on the "reasonable
costs" of services covered under Title XVIII
and related to care of beneficiaries.
Reasonable costs includes all necessary and
proper costs incurred in rendering the services,
subject to principles relating to specific
items of revenue and cost.
2. Determination of Cost of Services to Beneficiaries.
Total allowable costs of a provider shall
be apportioned between beneficiaries and
other patients so that the share borne by the
program is based upon actual services received
by program beneficiaries. To accomplish this
apportionment, the provider shall have the
option of either of the two following methods.
a) Departmental method-the ratio of
beneficiary charges to the total
patient charges for the services
of each department is applied to the
cost of the department.
b) Combination method-the cost of
"routine services" for program
beneficiaries is determined on the
basis of average cost per diem of
those services for all patients;
to this is added the cost of ancillary
services used by beneficiaries, determined
by apportioning the total cost of ancil-
lary services on the basis of the ratio of
beneficiary charges for ancillary services
to total patient charges for such services.
3. Adequate Cost Data. Providers receiving
payments on the basis of reasonable cost, must
provide adequate cost data. This must be based
on financial and statistical records capable
of verification by qualified auditors. The
cost data must be based on an approved method
of cost finding and on the accrual basis
Consequently, the reimbursement for "reasonable costs" as broadly
outlined in the statutes has been very narrowly defined by later regu-
lations and procedures. Of all the guidelines which explain procedure,
however, there seem to be only 2 requirements that cost and statisti-
cal information must meet.
Adequacy. Adequacy seems to imply the availability of detailed
cost and statistical data to at least the departmental level.
Verifiability. The cost information reported must be capable of
verification by qualified auditors.
Cost Information Required by
On August 15, 1971, Executive Order 11615, established a freeze
on prices, rents, wages, and salaries for a period of 90 days and es-
tablished a Cost of Living Council responsible for administering the
Economic Stabilization Program. Since that time price controls have
been in effect for the health industry. The Internal Revenue Service
was delegated the operational responsibility of developing reporting
procedures and formats.