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Note on Full Cost Accounting in Health Care
Author(s):
Young, David W.
Functional Area(s):
   Management Accounting
Setting(s):
   Healthcare Management
Difficulty Level: Beginner
Pages: 17
Teaching Note: Not Available. 
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First Page and the Assignment Questions:
    The question “What did it cost?” is important in many organizations. Arriving at an answer can be much more difficult than it might first appear. Obviously, it is rather easily answered if we are discussing the purchase of inputs (supplies, labor, and so on) for the service-delivery process. Even calculating the full cost of a “unit” produced—whether it is a dialysis procedure or 50 minutes of psychotherapy—is relatively easy as long as the organization provides completely homogeneous goods or services. Complications arise, however, when we introduce multiple goods and services into an organization, particularly when we use different kinds and amounts of resources to provide them. This note discusses these matters.

USES OF FULL COST INFORMATION

    Information on the full cost of carrying out a particular endeavor has four basic uses: pricing, profitability assessment, comparative analyses, and external reporting. Most managers use cost information for one or all of these purposes at different times and under varying decision-making scenarios.

Pricing

    One of the basic functions of cost information is to assist management in setting prices. Clearly, cost information is not the only information that management uses for this purpose, but it is an important ingredient in the decision-making process. In a similar vein, some hospitals and other healthcare providers (such as nursing homes and home health agencies) are paid on the basis of their full costs, thereby creating the need for a full-cost analysis that effectively establishes the “price.” However, because cost-based payment systems are generally thought to contribute to rising healthcare costs, many insurers and other payers currently pay on some sort of fixed-price basis, where the price is a predetermined amount per unit of service, such as a day of inpatient care, a discharge, or an outpatient visit. In these sorts of fixed-price situations, a healthcare provider is a price-taker, and a full cost analysis is not used in setting prices.

Profitability Assessments

    Even if an organization is a price taker, however, it must calculate full costs if management is to know whether a particular product or service is financially viable.1 If a product is not covering its full costs, it is, by definition, a “loss leader.” Since an organization cannot have all its products be loss leaders, full cost accounting serves to highlight where cross subsidization is taking place.

Comparative Analyses