Activity-based accounting can boost bottom line

Understanding dollar allocation can help practices

Managed care and changes in Medicare reimbursement policy are forcing providers to flip-flop the way they price their products and services.

This shift is forcing medical practices to move away from their traditional cost-plus thinking and Medicare average costs per visit mentality to find new ways of using their accounting system to manage business operations.

One approach gaining popularity is activity-based accounting and management.

"Rather than tracking dollars according to how they have been spent, activity-based accounting helps identify and analyze how you put all your resources to work with a particular activity," says Stephen Jessup, principal with Jessup & Richmond, a Battle Creek, MI, accounting and health care consulting firm.

"Your current accounting system may report you spent $200,000 on nursing wages last year. That’s good to know. But even better is being able to understand how those dollars were allocated according to a specific activity and the profit or loss it produced," notes Jessup.

Most accounting and financial management systems simply group costs according to a broadly defined function like labor, supplies or equipment. Activity-based accounting redefines these expenditures as resources, then identifies the specific activities they support and how they are used.

Employees don’t consume wages; activities do

"This requires a change in mind set. Activity-based accounting assumes, for instance, that employees don’t consume wages. Activities consume wages. The goal then is to uncover the different kinds of activities the practice performs, what resources they consume, and if they are being effectively allocated," notes Jessup.

These activities are then assigned to a so-called cost objective. The cost objective is an intentionally vague term that simply means "the question you want answered."

Once the costs for each activity associated with the objective — or question you want to solve — have been broken down and distributed, they can be analyzed to find an answer to the question being asked.

"This approach gives you more options to work with. For instance, it encourages re-engineering specific activities rather than randomly cutting what might be irrelevant costs, like office supplies, or slashing wages or personnel across the board," states Jessup.

The following case study is a simplified example of how activity-based accounting could be applied to a home health care agency asked to bid on an HMO contract.

Situation. ABC Home Care is one of several agencies currently serving Mountain View HMO, which has decided to contract out all its home care business to one exclusive agency. ABC delivered some 1,500 visits to Mountain View last year.

Based on Mountain View’s projected 950 new admissions for the next fiscal year, many of which will involve brief assessment visits, ABC estimates it would make approximately 3,800 visits under an exclusive contract.

After calculating its past cost of servicing Mountain View using its current accounting and cost allocation techniques, ABC estimates it would lose $41,929 by accepting the contract.

Determine cost objects. The cost object in this example is the cost to the agency of an exclusive contract with High Mountain HMO. This is calculated by determining the resources this contract would consume and their allocation.

A fundamental function of activity-based accounting is to track, account for, and then accurately assign all the costs associated with each home care-related activity.

Based on a series of employee interviews and time studies, the agency determines:

— Travel consumes 20% of a skilled nurse’s (SN) time and does not vary by type of visit or payer.

— SN admission visits account for 20 % of nurse production time.

— Repeat visits consume about 25% of total SN production time.

— SN documentation accounts for 35% of a nurse’s time.

— Administration admission and intake takes twice as long for Mountain View patients compared to other clients.

Assign resources. Using the data from its general ledger, ABC determines how its resources (dollars) are actually being used for specific kinds of activities.

For instance, interviews with staff uncover that the $1.7 million ABC spent last year on skilled nursing wages and benefits is divided among four basic activities:

Assign Activity Costs. ABC assigns activity costs to three categories: the High Mountain HMO contract; other payers; and unassigned administration. The object is to determine how much of its current total resources an exclusive contract with the HMO would consume.

"Next, you want to break down total costs in the general ledger, identify your major costs, and see how they have been used," notes Jessup.

Tip: This hypothetical example contains over $429,833 in unassigned administration costs related to activities that could not be identified. Ideally, unassigned costs should amount to no more than 10% of total costs.

Bottom line. After assigning costs to each payer, the agency finds rather than the $41,928 potential loss it originally projected, it could actually lose nearly $225,000 ($224,000 in projected revenues minus $449,351.89 in activity costs) if it accepts the HMO’s contract offer.

Options. "The beauty of this technique is if the provider decides the contract is still worth pursuing, it now has specific information it can use to make management decisions about where to refigure its staff and procedures, plus changes it can suggest to the HMO about revamping its operation to make it more efficient," notes Jessup.

For instance, because skilled nurse documentation ($74,509.80), intake worker case openings ($46,507.46), clerical time spent opening and closing cases ($25,522.39), and skilled nurse admission visits ($89,328.36) appear to account for a large percentage of the potential costs associated with the High Mountain HMO contract — and it has already been established that admissions to this HMO take nearly twice as long as other clients — possible alternatives include:

— redesigning High Mountain’s admission process and/or forms;

— streamlining data entry and transfer systems;

— revamping the HMO’s authorization process.

Another area to explore might be "rethinking documentation requirements so nurses spend more time caring for patients than writing down what they did," Jessup suggests.