Cost Behaviors and Allocation

Chandrea D. Taylor

Dr. Laura Forbes

Health Financial Management

November 4, 2012

Throughout the world health care has been and will always remain a major concern. It’s always a good benefit for one to be able to have an affordable health care with a continuous aim to keep the cost of health care from rising. Author Louis Gapenski states that cost behavior is the relationship between an organizations fixed costs, variable costs, and total cost (2012). Fixed costs will remain fixed but variable cost will change roughly in direct proportion to volume. Analyze the complexity of cost behaviors in health care organizations and describe how costs are classified according to their relationship with volume.
When it comes to looking at cost behavior within the health care organization a great deal or majority of the cost goes towards hospital services such as building, equipment, salaried labor, and overhead, which are fixed over the short term (Roberts RR, Frutos PW, Ciavarella GG, Gussow LM, Mensah EK, Kampe LM, Straus HE, Joseph G, Rydman RJ., 1999). Hospital organization fixed costs includes but not limited to capital expenditures, employee salaries and benefits, building maintenance, and utilities (Roberts RR, Frutos PW, Ciavarella GG, Gussow LM, Mensah EK, Kampe LM, Straus HE, Joseph G, Rydman RJ, 1999). The variable costs include health care worker supplies, patient care supplies, diagnostic and therapeutic supplies and medications (Roberts RR, Frutos PW, Ciavarella GG, Gussow LM, Mensah EK, Kampe LM, Straus HE, Joseph G, Rydman RJ, 1999). The difference between the fixed cost and the variable cost for an health care organization in reference to volume; the fixed costs are not saved over a certain period of time if the facility reduces services. While variable costs on the other hand are saved if the health care organization does not provide services.
While researching I discovered that most health care costs are fixed and sunk (Taheri,P.,MD, MBA, Butz,D., PHD,2008). It is stated that fixed cost isn’t affected by the level of patient activity and when sunk they can’t easily be reserved (Taheri,P.,MD,MBA, Butz,D., PHD,2008. For example the average cost per patient will decrease as the volume increases this allows for the fixed cost to spread over a larger number of patients. Authors Steven Finkler, David Marc Ward and Udith Baker states that it is highly unlikely for any health care organization to have variable cost for each type of patient that is uniform (2007). Author David Young states that variable cost will increase in some constant proportion anytime volume increases (2003). An example could be medical supplies within a health care organization. The cost of medical supplies will increase at any given time there’s a direct proportion increase to the number of patient visits.
Discuss the importance of cost allocation and how it may be leveraged by health care organizations.
Author Louis Gapenski states that cost allocation is the process by which overhead costs are assigned to patient services departments (2012). It is important that the health care organization distribute cost effectively and efficiently. The way cost is distributed is very important to giving the health care organization the leverage that needed in order to stay competitive. Also with distribution cost it allows for the departments amongst the health care organization to apply or assign cost to services and goods which if applied accordingly in the best interest of the health care organization will allow leverage among each department. There are four main cost allocation approaches to health care providers such as ratio of cost to charge, relative value unit, hybrid and micro costing/activity based costing which some may overlap each other. It is stated that the most common cost method used today in the health care industry is ratio of cost to charge. It is stated that the objective of cost allocation are to achieve effective cost management through motivating managers to exert a high level of effort in order to make sure that the goals of the health care organization are aligned with each level of manager and or department. With distribution cost accordingly along with implementing the goals of the health care organization should allow a sense a direction.

References
Gapenski, L. (2012.) Healthcare finance: An introduction to accounting and financial management (5th ed.). Chicago: AUPHA Press / Health Administration Press.
Roberts RR, Frutos PW, Ciavarella GG, Gussow LM, Mensah EK, Kampe LM, Straus HE, Joseph G, Rydman RJ. (1999). Distribution of variable vs fixed costs of hospital care. Retrieved from http://www.ncbi.nlm.nih.gov/pubmed/10029127
Steven A. Finkler, David Marc Ward, Judith J. Baker – 2007 Essentials of cost accounting for health care organizations
Taheri, P.,MD,MBA Butz, D.,PhD. (2008) Health Care as a Fixed-Cost Industry: Implications for Delivery. Center for Health Care Economics, University of Michigan, 1500 E. Medical Center Drive, Ann Arbor, MI 48109-0033 Taheri@umich.edu
Young,D.(2003). Management Acounting in Health care Organizations