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Hospitals, nursing facilities and retirement homes

Management accounting is important for hospitals, nursing facilities and retirement homes because patients and insurance organizations require proof of the costs of treatment. The main object of analysis is the individual case of a particular patient. Invoicing is usually based on (legally) regulated tariffs.

External case-related services (e.g. X-rays) can be assigned to the “case” (person treated). Many purchases from the hospital pharmacy and aids from the hospital warehouse can also be assigned to the case. In a production company, one would speak of external service and direct material costs, which are charged directly to the product, i.e. the case, using warehouse withdrawal slips or vendor invoices.

Services from the kitchen, especially special catering or drinks, can also be recorded on a case-by-case basis.

In cost accounting, purchases of medicines or auxiliary materials for cost centers, e.g. a nursing or bed ward, which cannot be allocated directly to the individual case, are referred to as material overheads. These items are included in the proportional planned cost rate of the respective cost center, e.g. an inpatient ward.

Personnel costs are usually the most important cost type in a hospital. They are planned and reported by cost center. By recording services, it is possible to determine how many working hours are used directly for the care of individual patients (case-related proportional costs) and what proportion of hours is used for operational readiness (fixed costs of the cost centers).

The availability of a surgical suite incurs fixed costs of service readiness  such as rent, imputed depreciation and maintenance of the installed equipment and facilities as well as basic cleaning. These costs cannot be allocated to an individual operation on the basis of causation. They are incurred in order to carry out operations at all.
The surgical team must ensure that all the equipment required for a particular operation is in working order and that the cutlery and aids are ready for use. These persons must be present during the operation so that they can provide immediate support in the event of complications. The same applies, mutatis mutandis, to the anesthesia team and to cleaning and disinfection after each operation.
The costs incurred for these functions are proportional costs of the operation, they are caused by the case.

If management accounting of a hospital is to be set up, the requirements of a manufacturing company can be assumed in many areas. However, some special features must be taken into account for the system:

• • The master data must not only be collected on a customer-specific basis, but also on a case-specific basis.
  • External services are usually ordered on a case-specific basis, not item-specific
  • Inventory levels must be continuously updated for both aids and medicines (pharmacy).
  • The time spent by staff in surgery and medicine should also be recorded per case as far as possible. In nursing, this is only possible to a limited extent, as the workload can rarely be measured per patient.
  • The amount of work required for a decision-relevant management accounting system in a hospital is greater than in other economic sectors.

This effort is worthwhile for the following reasons:

• • Better decision-making basis for the management staff, especially for the control of service readiness costs and directly case-dependent costs,
  • Meaningful, performance-related calculations for negotiations with health insurers and state funding bodies,
  • Possibility of cost control in the cost centers, taking into account the current level of activity.

Banks

Many banks use the money deposited by their customers to finance loans. They charge interest on the loans granted and use them to pay interest on the depositors’ balances as well as to cover their own costs and profits. In addition to this business with interest differentials, banks have developed countless additional products designed to increase a bank’s profitability. Some examples:

• • Financial consulting for bank customers
  • Securities trading (shares, bonds and other investment products)
  • Financing export and import transactions.
  • Foreign exchange, coin and precious metal trading.

Bank managers focus on both, the profitability of the individual customer and on the profitability of the products offered. The purchase prices for shares, bonds and other traded products can usually directly be charged to the respective customer order. This also applies to the fees to be paid to suppliers on an item-related basis (direct costs of the order).

But the costs of actual banking operations can only rarely be charged to individual products or clients according to their origin. If for example the “Research” cost center recommends buying or holding certain shares, the costs of this recommendation can neither be charged directly to the individual client advisor nor to the client buying on the basis of this recommendation but only to all advisors and all customers.

The bank fees invoiced for the purchase or sale of individual securities can be charged to the client, his advisor or the security, but it is not possible to trace which portion of the fee is attributable to the advisor and which one to the executing traders.

This chain of arguments is intended to show that although the revenues generated from banking transactions can be determined per customer, the costs for the generation of these revenues arise in several cost centers. There it is seldom possible to record the time spent on individual products or customers in a way that reflects the source of the work, because in many cases there is no direct cause-and-effect relationship between the work performed and the product or customer.

Insurance Companies

By paying a premium (one-off or recurring), policyholders want to ensure that they do not have to pay themselves for financial claims arising from losses  and to prevent to go bankrupt or lose significant parts of their assets as a result. In the knowledge that not all policyholders suffer losses, the insurance company tries to persuade as many customers as possible to sign an insurance policy and thus spread the risk across all customers.

The insurance company is financially successful if the premiums from all customers cover over time the costs of all insured losses to be paid as well as the company’s entire operating costs and its profit. This means that insurance management has a lot to do with statistics and estimating the financial development of risks. This is because the proportional product costs arise on the one hand from the losses that occurred and have to be paid for, and on the other hand from building up provisions for losses that are likely to occur (example: damage to buildings that may result in coastal areas from the melting of ice at the North and South Poles or damage caused by earthquakes or forest fires). Statistical analyses can be used to forecast the development of already known types of damage, while the insurance company’s specialists must estimate types of damage that have not yet occurred but are expected.

Incurred and expected claims are the main proportional product costs of an insurance company and must therefore be taken into account in the product calculation.
The sales organization of an insurance company is responsible for the net proceeds and contribution margins of existing and newly concluded insurance contracts. It must therefore know for each contract which product was or is to be sold to which customer groups via which sales channel, via which sales organization, in which region and by which salesperson.

This requires multidimensional planning and determination of the contribution margins per

• • Claim type (product)
  • Product group
  • Customer (policyholder), possibly industry
  • Salesperson
  • Insurance broker
  • Sales region.

Like in a production or service company insurance companies must also determine the contribution margins achieved in the various product and market dimensions after deducting the proportional fixed costs and the fixed costs that can be clearly allocated to a specific dimension.

The key difference is that the proportional production costs of insurance companies also include the assumed costs of risks that have not yet materialized.

The extent to which an insurance company covers potential financial risks through reinsurance is not examined further here.

Management Accounting for Different Types of Companies

Private companies, many foundations and associations as well as public organizations and their administrative units manufacture products and services. All these organizations must be able to cover at least the costs of a period under review with the revenue of this period (year) and, where appropriate, to achieve a profit in line with the market. (See the post “Profit in Line with the Market“).

Consumption-related disbursements usually happen before customers pay. Therefore, it must be ensured that sufficient cash and cash equivalents or open credit lines are available at all times to pay the amounts due. For this, financial accounting is the appropriate instrument in all organizations. However, financial accounting is not suitable for planning and controlling an organization as it cannot process neither quantities nor services and relate their costs to the revenues according to cause.

Management accounting is the only way to charge costs and services to individual service and product units in line with causation. It calculates the planned and actual costs directly caused by the manufacturing of a product or service unit and deducts them from the net revenue generated. The result is the contribution margin I. This is used to cover all costs of the organization that are not directly product-related (fixed costs) and to achieve a profit in line with the market.

For decision-relevant management accounting this results in the requirement to split costs into proportional and fixed when planning cost centers and to charge only the proportional costs of the manufactured units to products or other cost centers. This is because there is only a direct cause/effect relationship for the proportional cost center costs. The fixed costs remaining in the cost centers are period costs. They are the responsibility of the cost center managers. They are transferred as cost blocks to the stepwise contribution accounting.

According to current knowledge, only Resource Consumption Accounting (RCA, see L. White, Resource Consumption Accounting) fulfills this requirement. In German-speaking countries, Grenzplankostenrechnung GPK combined with contribution accounting correspond to RCA. RCA shows which costs are caused directly by the manufacture of the individual product unit produced. These costs are to be recorded per unit as inventory receipts and can be charged to the units sold according to their origin. The costs not incurred directly per unit remain in the cost centers. They are to be understood as fixed costs for the period under review. They are fixed costs because they are incurred for the cost center’s readiness to perform.

How to plan cost center costs and to calculate proportional cost rates for product costing is a main topic of this blog. The application of the methodology in different kinds of companies as well as in corporations with many daughter companies or in public administration are discussed in more detail in the following posts. The focus is on:

• • Production and sale of physical products, e.g. industrial and construction companies
  • Pure trading companies
  • Service companies, e.g. consulting companies, auditors, law firms, software developers
  • Transportation companies
  • Banks and insurance companies
  • Healthcare facilities such as hospitals, retirement homes, laboratories
  • Public administrations and educational institutions.

What these types of companies have in common is that they

• • work for several customers,
  • can process several orders for a particular customer, each with several order items,
  • offer different products or services,
  • can divide their organization into cost centers, each of which is the responsibility of one manager,
  •  should charge activities between cost centers according to their origin (Charging Internal Services, no allocation of fixed costs),
  • want to know which customers, products and services generate how much contribution margin.

For the planning and analysis of results by the managers concerned, the contribution margin I per product and per customer is always relevant for decision-making in the various types of companies. Because the fixed costs cannot be allocated to an individual order item according to their origin, the evaluations must always be based on CM I per order item.

The following data model shows that for aggregated reports always 1:n relationships (1 < —>> n) are needed:

Reading method: On a specific date, a customer can purchase one or more products or services. The proportional product costs are defined per unit, customer and date, the CM I is the difference between the net revenue agreed with the customer and the proportional cost. Based on the customer, the product and the date, net revenue, proportional product costs and CM I can be summarized according to all higher-level dimensions.