A Non-Traditional Accounting System
Sooner or later you will want to ascertain and then demonstrate the cost effectiveness of your medical care. By using the process of Activity Based Cost (ABC) management, you will be able to do so. But, if you’re using a traditional accounting system, you won’t know a thing about your activity costs. Here’s how.
Traditional Cost Accounting Methods
In a traditional medical practice cost accounting system, costs are assigned to different procedures and services based on volume. In others words, office costs are spread over the entire office’s product line and you may not know the true profitability of any single medical activity. So, if the office is doing more “procedures” than general medicine, for example, more indirect office overhead costs will be allocated to the procedural portion of the practice.
ABC management, on the other hand, determines the actual costs of the resources that each service consumes. Because general medicine requires more human resources than “technical procedures,” ABC management will assign more costs to the general medical portion of the practice.
Accordingly, most physicians, office managers, and their accountants are surprised that a prior notion of office profitability is different than previously thought. ABC management is just more accurate in measuring medical service profitability than traditional accounting methods.
Medical Activity Cost Drivers
Examples of medical activities that are office cost drivers include such items as monitoring vital signs, taking radiographic images, removing dressings or casts, performing laboratory tests or veni-punctures, surgical set-ups or operative procedures; etc.
However, in the office setting, the most economically important activities are listed as specific CPT codes for each medical specialty. The most important end result of ABC management is the shift of general overhead costs to low volume services from high volume services. These effects are not symmetrical as there is a bigger dollar effect on the per-unit costs of the low volume service.
ABC Managerial Accounting Improvements
ABC management improves office managerial cost accounting systems in three ways:
- It increases the number of cost pools used to accumulate general overhead office costs. Rather than accumulate overhead costs in a single office-wide pool, costs are accumulated by activity, service or procedure.
- It changes the base used to assign general overhead costs to services or patients. Rather than assigning costs on the basis of a measure of volume (employee or doctor hours), costs are assigned on the basis of medical services or activities that generated those costs.
- It changes the nature of many overhead costs in that those formerly considered indirect, are now traced to specific activities or services. The office service mix may then be adjusted accordingly, for additional profit.
In order to perform an ABC analysis for your medical office, calculate the cost of delivering a single unit of medical or surgical activity using only the work component of the resource based relative value scale (RBRVS).
Do this by adding up your office’s average variable expenses for the prior 1-3 years. Now, count the number of work resource based relative value units (RBRVUs) delivered for each CPT code for the same time period, using the latest edition of the Federal Register to obtain the latest list of RVUs by CPT code. Then divide total variable expenses by the total number of work RVUs in order to arrive at the marginal cost of a single unit of service for the time period being evaluated.
For example, if your office had variable expenses of $480,000, and produced 80,000 work RVUs last year, it cost $6, on top of the office’s fixed expenses, to deliver one unit of work product. So, if an HMO plan offers to reimburse you at a rate of $11 per member, per month, and you can expect to reasonably deliver on average of one RVU pm/pm, you’ll earn enough on the contract to cover your marginal costs and some of your fixed and direct expenses.
Remember, this method assumes that you have the excess operating capacity and time slots, available and unused, to see the additional patients of the new plan without adding extra overhead expenses to service the contract.
If not, or if you plan for capitation to become a major portion of your practice, you might want the capitated contract(s) to cover all your office expenses, so be sure to include both the fixed and other direct costs to your variable cost calculations. ABC determines the actual costs of resources rendered for each activity and represents a real measure of practice profitability. Office service mix can then be changed to either maximize revenues or better suit your practice personality.
Suppose however, that a medical service is competitively priced but still shows that the CPT code is unprofitable. For example, the costs of special requests can adversely affect office profits. Yet, special patient requests are one of the biggest reasons that a CPT code or procedure isn’t profitable.
In this case, look closely at activity costs and determine which ones are being performed inefficiently. Improving the efficiency of those kinds of medical services, or referring them out or abandoning them all together, will increase office profitability.
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