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By Daniel Horan, CPA, Horan
Martello & Morrone P.C.

Managed care payors are currently seeking out nursing homes to provide subacute care for their subscribers. The services to be provided include respiratory therapy, extensive physical therapy, and wound care and traumatic brain injury therapy. Skilled nursing facilities wishing to provide any of these services and be successful in this market must--

* identify services to be provided,

* develop the programs,

* cost out the services,

* market the services, and

* enter into a contract with a managed care payor.

Each service under consideration by the provider facility must be planned from beginning to end. After the facility identifies a service, it must then quantify the number of beds it will dedicate to the service and determine the additional staffing necessary, and cost of additional drugs and supplies. With this information the facility is prepared to define the cost centers and develop the total cost of providing each service.

Cost centers, the basis for cost accounting, are identifiable organizational units through which activities are performed. They may be revenue producing (e.g. inhalation therapy, and wound care) or support services (e.g. housekeeping, and dietary). Tracking costs to specific cost centers can best be accomplished when a long-term care facility's chart of accounts identifies costs by specific cost center designations. This is true, both for revenue producing and nonrevenue producing cost centers. An example of the financial information that results from such a chart of accounts is demonstrated in the accompanying exhibit.

Allocating Nonrevenue Producing Costs

The costs related to nonrevenue producing cost centers should be allocated to revenue producing centers through a fair and understandable technique. There are several methods for allocating these costs; the two most common are direct and step-down.

Direct Allocation. This method calls for the distribution of support costs evenly to all patient service centers. Direct allocation results in every patient service revenue center carrying the same dollar overhead burden.

Step-Down Allocation. This method calls for costs to be apportioned based on the utilization of specific service resources. The basis used to allocate costs should reflect the most sensible method of allocating cost (e.g., square feet for building depreciation and utilities, and hours of service for housekeeping). Step-down allocation is more equitable in assigning costs to cost centers and frequently preferred over direct cost allocation because it is more specific, relatively straightforward, and easy to implement.

The first allocation of the nonrevenue producing centers' costs is made to the cost centers they service. These centers are not closed after the first allocation. They remain open, accumulating their portion of the costs of all nonrevenue producing centers from which services are received. The first allocation is followed by a second allocation of all costs remaining in the nonrevenue producing centers. The second allocation is the step-down.

The step-down method of cost allocation is illustrated in the exhibit under the heading Distribution of Non-Revenue Departments. The costs in the non-
revenue producing cost centers are distributed to the revenue producing cost centers using allocations based on measurements such as square feet, hours of service, and meals served.

With the exception of Administration and Fiscal, the example in the exhibit does not show allocations of other non-revenue producing costs to other non-revenue producing cost centers, before distributing them to the revenue producing cost centers. A double-apportionment method recognizes that services rendered by certain nonrevenue producing departments or centers are utilized by certain other nonrevenue producing centers, as well as revenue producing centers.

Determining Unit of Service Costs

There are numerous methodologies for determining costs for each unit of service. Two of the most common are ratio of cost to charges (RCC) and resource-based unit cost development. RCC assumes that there is a reasonable direct relationship between charges associated with a unit of service and the resources required to provide it. Resource-based unit cost development can range from a relative value based unit (RVU) to a discrete cost accounting that assigns the actual resources required to produce a unit of service based on time and motion studies and other like measures. Although costly, this method gives providers the most accurate cost data.

A RVU based methodology is a better option for nursing homes that wish to perform more refined cost allocation then RCC allows. An RVU typically defines the intensity of resources required to produce a unit of service. While used mainly in physician's practices it can be applied to nursing homes. Time and motion studies facilitate a long-term care provider's ability to capture the cost of direct hands-on care of services used for a particular type of patient. These types of studies have been done by the Medicare and Medicaid programs in developing the Resource Utilization Groups (RUGs). Long-term care providers have, therefore generally not found it necessary to perform their own cost accounting functions. Most of these payments have been determined by the payors, and the types of patients cared for have not varied greatly based on resources required by the patients.

Length of Stay. When developing the costs for a group of patients it is important not to overlook the costs related to the length of stay. For example, the cost of admission for a ten-day stay could be the same as the cost of admission for a 200-day stay. On a per diem basis, however, the cost of admission for a ten-day stay patient would be twenty times greater than that of the 200-day patient. This disparity also holds true for other cost centers where the preparation for the patient admission is more intense than the ongoing cost. Therefore, the costs developed for each RUG must be developed taking the length of stay into consideration.

With more changes on the horizon for long-term care facilities, private insurance companies will become significant payors of services. Providers will have to negotiate rates with the payors. In order to be successful in negotiating the rates, the provider must know what the services cost. In order to know what the services cost, they must have an adequate cost accounting system.

The Cost System

Planning and implementing a cost
system requires a thorough understanding of the--

* organizational structure of the facility,

* procedures used, and

* type of cost information desired and required by management.

The cost system with its operating accounts must correspond to the organizational division of authority so that individual department heads can be held accountable for the costs incurred in his or her department. The concept of authority and responsibility is closely allied with accountability, which recognizes the need for measuring an executive's discharge of his or her responsibility.

The cost system must reflect the care delivery procedures, and the processes and methods of the facility for which it is designed. The cost accountant designing the system must have knowledge about the type of pay (e.g., hourly wages or contracted services), the method of collecting hours worked, the control of inventories, and other problems connected with the facility.

A satisfactory cost system is the result of the meeting of minds between the cost executive and the management he or she services. The service rendered by the cost accountant is typified by meaningful cost reports and statements that reach management promptly. The reports indicate the success or failure of a pre-established course of action. Deviations are of significance and interest to management. The cost presentation should enable management to take prompt action based on compact information regarding the activities of the various departments of the facility.

The costs should be presented in a manner that will--

* compute the cost of sales,

* aid in the control and management of the facility,

* measure the efficiency of personnel and materials,

* help in eliminating waste,

* provide comparisons with other facilities;

* aid in establishing prices, and

* furnish data for various other analytical processes.

Michael Goldstein, CPA
The CPA Journal

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