Managed care contracting demands intimate knowledge of per-unit costs

Activity-based costing employs financial and operational data

About three years ago Scott Glennie, CPA, decided he absolutely had to have a better idea of costs per procedure for the 11-physician eye clinic where he serves as associate clinic administrator. Like many physician practices, Spokane (WA) Eye Clinic was trying to come to grips with how to best negotiate managed care contracts when it didn’t have an idea of what a specific procedure cost the practice.

The solution for the clinic is one that experts predict more practices will settle on: adopting activity-based cost accounting, which breaks down costs by CPT code. The idea of activity-based costing is to combine the financial data that accountants have traditionally collected with operational data of the practice.

Although activity-based costing provides an extra level of detail to traditional accounting systems, experts say these details are essential if a practice wants to sign a managed care contract that reimburses enough to at least cover the practice’s costs.

"For [managed care] contracting purposes, you have to get those costs to a CPT code level. Traditionally, the cost accounting systems do not provide the detail to do that," says Joey Havens, CPA, of the Horne CPA Group of Hattiesburg, MS.

In Spokane Eye Clinic’s case, the practice’s goal in implementing activity-based cost accounting was to determine whether a $35 charge for a routine eye exam and a $50 charge for a more extensive consultation would allow the practice to make a profit. The first step: determining a per-unit cost for an eye exam and for each other CPT code representing the 12 major services the practice provides.

To get this figure, the practice determined a per-unit cost, because that is how services are priced in the marketplace. By comparing a practice’s per-unit cost against a contract at prevailing market rates, a practice will quickly get a sense of how efficiently it provides care, Glennie says.

The first step in calculating any per-unit cost is to define what professional and administrative activities compose the service provided. It is the provision of service which ultimately leads to revenue being recognized by the practice.

Glennie identified four activities which occurred with any consultation conducted by the practice:

• scheduling an appointment;

• treating a patient;

• preparing medical transcripts;

• collecting payment on the account.

"An activity can be practically anything," says Rod Nelson, CPA, of the Dallas-based ATAC Health Care CPA Network. A practice has a lot of discretion in how it defines activities related to a CPT code. However, Nelson cautions practices to make the activities selected specific enough so that a unit cost can be attached to each.

Later the sum of the activity unit costs will be used to determine the unit cost for the CPT code.

Once activities are defined, the practice needs to determine which of the expenses on its general ledger are direct costs for each of the activities. Direct costs are those that are directly related to a given activity. For example, the cost of a physician’s time is directly related to provision of patient care.

Direct costs related to each activity are accumulated in a cost pool for the activity.

For a simple activity like appointment scheduling, expenses related to receptionist time are the only direct costs. Salaries, payroll taxes, and employee benefits expense of the receptionist are included in the scheduling cost pool based on an estimate of receptionist time spent on scheduling as a proportion of total receptionist time.

For the patient treatment activity, the largest direct costs are physician and assistant time. Costs related to salaries, payroll tax, and benefits need to be applied to the activity’s cost pool, but in this instance, a more precise method of cost estimation should be used, says Glennie.

The expense related to physician and assistant time is generally so significant that it requires time and motion studies. That was the approach at Spokane Eye Clinic. The mean number of minutes a professional spent on each CPT code was determined. Provider compensation expense was assigned to activity cost pools proportionate to the total time spent on that activity.

Generally other direct costs to be included in the patient treatment cost pool pertain to medical supplies.

Indirect costs, such as rent and utilities, are not specifically related to any activity. They need to be accumulated in a separate cost pool, a portion of which will be allocated across all activities by using cost drivers.

A cost driver is simply a sensible means of allocating a cost to various activities, says Havens. Rent and utilities expense might be allocated to activity cost pools on the basis of square footage. So the patient treatment activity is assigned rent and utilities expense according to exam room square footage as a proportion of total office square footage.

Spokane‘s administrative costs, including the administrator’s compensation expense, are allocated solely to revenue-generating activities (patient care) on the basis of patient visits (e.g., number of consultations as a percentage of total patient visits).

Once all expenses of the practice have been allocated to activity cost pools, a per-unit-activity cost can be calculated. Sum all costs in a pool and divide by units of activity. For the scheduling function, units of activity would be appointments scheduled, for example. As indicated earlier, the cost of a consultation at Spokane was calculated as the sum of the per-unit costs for scheduling, patient care, transcription and collections.

The time required to perform time and motion studies and all the analysis that activity-based costing entails is significant, Glennie acknowledges. However, a practice also derives huge benefits from the process in terms of familiarity with its cost structure and the relationships between various cost components.

When Spokane did activity-based costing, the clinic determined areas of the practice that were ripe for re-engineering. "Activity-based costing resulted in us changing our scheduling and our medical records functions," says Glennie.

For example, the clinic previously kept charts on any given patient at each of its three clinics. "It was a crazy idea and we eliminated it. We now have one medical record that exists at the clinic where the patient is treated," he says.

Prior to activity-based costing, the clinic also did not have electronic scheduling. Every appointment was first written in a book, then later inputted into the computer, effectively meaning every appointment was scheduled twice. "When you do that 50,000 times, it’s not very efficient," Glennie says. Since implementing electronic scheduling, the per-unit cost of that activity has improved dramatically.

Although large clinics often have the personnel on staff who can implement activity-based costing, small clinics do not, says Glennie. Hiring an outside accounting firm to do the work may be worth the expense, particularly for practices that don’t have a good handle on their per-unit costs.