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© Jones and Bartlett Publishers. NOT FOR SALE OR DISTRIBUTION

Essentials of

Cost
Accounting
for

HEALTH CARE ORGANIZATIONS

Third Edition

STEVEN A. FINKLER, PhD, CPA

Program in Health Policy and Management
Robert F. Wagner Graduate School of Public Service
New York University
New York, New York

DAVID M. WARD, PhD

College of Health Professions
University of New England
Biddeford, Maine

JUDITH J. BAKER, PhD, CPA

The Resource Group
Dallas, Texas
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Library of Congress Cataloging-in-Publication Data

Finkler, Steven A.
Essentials of cost accounting for health care organizations / Steven A. Finkler, David M. Ward, Judith J. Baker.
— 3rd ed.
p. ; cm.
Includes bibliographical references and index.
ISBN-13: 978-0-7637-3813-6
ISBN-10: 0-7637-3813-1
1. Health facilities—Costs—Accounting. 2. Hospitals—Cost of operation—Accounting. 3. Cost accounting.
I. Ward, David M. (David Marc), 1964- II. Baker, Judith J. III. Title.
[DNLM: 1. Costs and Cost Analysis. 2. Health Facilities—economics. 3. Accounting—methods. 4. Econom-
ics, Hospital. WX 157 F499e 2007]
HF5686.H7F563 2007
657’.8322042—dc22
2006028724
6048

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Printed in the United States of America

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Dedication

To Lilli, Joanne, and R.W. (the Bear)

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Contents

Preface . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .xiii
About the Authors . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .xvii

PART I COST ACCOUNTING FOUNDATIONS . . . . . . . . . . . . . . . . . . .1

CHAPTER 1 Introduction to Cost Accounting . . . . . . . . . . . . . . . . . . . . . . . . . .3

The Purpose of Cost Accounting . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .4
Costs for Reporting vs. Costs for Management Planning and Control . . . . . .7
Good Cost Accounting Systems . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .8
The Human Element in Cost Accounting . . . . . . . . . . . . . . . . . . . . . . . . . . . . .9
Suggested Reading . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .10
Exercises . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .10

CHAPTER 2 Cost Definitions . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .13

Definition and Characteristics of Costs . . . . . . . . . . . . . . . . . . . . . . . . . . . . .15
Cross-Subsidization of Costs . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .19
True Cost, Economic Cost, and Accounting Cost . . . . . . . . . . . . . . . . . . . . .21
The Long Term vs. the Short Term . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .24
Departmental vs. Product-Line Costing . . . . . . . . . . . . . . . . . . . . . . . . . . . . .26
External Costs . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .30
Notes . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .31
Suggested Reading . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .31
Exercises . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .31
Problems . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .31

CHAPTER 3 Product Costing . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .33

The Need for Product Costing . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .34
Job-Order and Process Costing . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .34
Process Costing . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .36
Job-Order Costing . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .37

v
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Hybrid Approaches to Product Costing . . . . . . . . . . . . . . . . . . . . . . . . . . . . .40

Standard Costing Systems . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .41
Microcosting . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .46
Product Costing and Computers . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .46
Notes . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .47
Suggested Reading . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .47
Exercises . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .47
Problems . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .48

CHAPTER 4 Cost Allocation . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .49

What Is Cost Allocation? . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .51
Determining Overhead Application Rates . . . . . . . . . . . . . . . . . . . . . . . . . . .52
Cost Allocation and Motivation . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .59
Allocating Joint Costs . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .63
Traditional Cost Allocation for Health Care Organizations . . . . . . . . . . . . . .66
Is Good-Enough Cost Finding Good Enough? . . . . . . . . . . . . . . . . . . . . . . . .76
Notes . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .79
Suggested Reading . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .79
Exercises . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .79
Problems . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .80

CHAPTER 5 Costing for Nonroutine Decisions . . . . . . . . . . . . . . . . . . . . . . . .83

Cost Information for Nonroutine Decisions . . . . . . . . . . . . . . . . . . . . . . . . . .84
Sunk Costs Are Irrelevant . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .85
The Role of Volume . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .86
Terminology for Relevant Costing . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .88
Examples of Nonroutine Decisions . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .88
Cost-Benefit and Cost-Effectiveness Analysis . . . . . . . . . . . . . . . . . . . . . . . .92
Notes . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .94
Suggested Reading . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .94
Exercises . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .94
Problems . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .95

CHAPTER 6 Cost-Volume-Profit Analysis . . . . . . . . . . . . . . . . . . . . . . . . . . . .97

The Cost-Volume-Profit Relationship . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .98
Breakeven Analysis . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .100
Caveats . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .107
Mixed Costs and Step-Fixed Costs . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .111
Using Breakeven Analysis for Decision Making . . . . . . . . . . . . . . . . . . . . .112
Suggested Reading . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .113
Exercises . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .113
Problems . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .114
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CONTENTS vii

PART II COST ACCOUNTING INFORMATION FOR

PLANNING AND CONTROL . . . . . . . . . . . . . . . . . . . . . . . . . .117

CHAPTER 7 Predicting Future Costs . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .119

Using Groups for Estimating Costs . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .121
Indexing for Inflation . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .122
Cost Estimation Using Linear Regression . . . . . . . . . . . . . . . . . . . . . . . . . .125
Forecasting . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .136
Learning Curves . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .150
Suggested Reading . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .155
Exercises . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .155
Problems . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .156
Case Study—Part 1 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .157

CHAPTER 8 Budgeting . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .159

The Role of Budgeting . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .160
Budgeting Philosophy . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .162
The Master Budget . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .163
The Long-Range Budget . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .164
The Operating Budget . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .165
The Cash Budget . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .167
Program Budgets . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .175
The Capital Budget . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .175
Special-Purpose Budgets . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .187
The Negotiation and Approval Process . . . . . . . . . . . . . . . . . . . . . . . . . . . .187
Flexible Budgets . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .188
Note . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .188
Suggested Reading . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .188
Exercises . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .189
Problems . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .189
Case Study—Part 2 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .191
Appendix 8–A: Present Value and Compound Interest Tables . . . . . . . . . . .193

CHAPTER 9 Flexible Budgeting and Variance Analysis . . . . . . . . . . . . . . . .199

Traditional Variance Analysis . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .201
Flexible Budget Variance Analysis . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .203
Calculation of Variances . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .210
Variance Analysis and Management Control . . . . . . . . . . . . . . . . . . . . . . . .214
Revenue Variances . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .218
Notes . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .225
Suggested Reading . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .225
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Exercises . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .225
Problems . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .226
Case Study—Part 3 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .227

CHAPTER 10 Management Control . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .229

Is Management Control a Science? . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .230
Responsibility Centers for Management Control . . . . . . . . . . . . . . . . . . . . .231
The Management Control Process . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .233
Key Variables . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .235
Internal Control Systems . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .237
Transfer Pricing . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .242
Management Control of Projects . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .242
Notes . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .250
Suggested Reading . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .250
Exercises . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .251
Problem . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .251

PART III ADDITIONAL COST ACCOUNTING TOOLS TO

AID IN DECISION MAKING . . . . . . . . . . . . . . . . . . . . . . . . . .253

CHAPTER 11 Cost Accounting Ratios . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .255

Financial Ratios . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .256
Development of a New Set of Ratios . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .257
Some Cost Accounting Ratios . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .258
Comparisons . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .260
Notes . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .262
Suggested Reading . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .262
Exercises . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .262
Problems . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .263

CHAPTER 12 Measuring Productivity . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .265

Productivity Defined . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .266
The Traditional Approach to Measuring Productivity . . . . . . . . . . . . . . . . .266
The Total Productivity Ratio . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .267
The Partial Productivity Ratio . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .268
Productivity and Indirect Costs . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .270
Managing Discretionary Costs . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .273
Notes . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .280
Suggested Reading . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .280
Exercises . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .281
Problems . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .281
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CHAPTER 13 Inventory . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .283

Inventory Costing . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .284
Minimization of Inventory Costs . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .291
Inventory Issues Related to Health Care Manufacturing . . . . . . . . . . . . . . .303
Notes . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .303
Suggested Reading . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .303
Exercises . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .303
Problems . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .304

CHAPTER 14 Dealing with Uncertainty . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .305

Uncertainty . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .306
The Expected Value Technique . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .306
Simulation Analysis . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .313
Network Cost Budgeting . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .319
Linear Programming . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .326
Notes . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .331
Suggested Reading . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .331
Exercises . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .332
Problems . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .332

CHAPTER 15 Information Systems for Costing . . . . . . . . . . . . . . . . . . . . . . . .335

Considerations in Designing Costing Systems . . . . . . . . . . . . . . . . . . . . . . .336
The Risks of Do-It-Yourself Computing . . . . . . . . . . . . . . . . . . . . . . . . . . .338
Suggested Reading . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .342
Exercises . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .343

CHAPTER 16 Performance Evaluation and Incentive Compensation . . . . .345

Responsibility Centers . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .346
Evaluating Investment Centers and Their Managers . . . . . . . . . . . . . . . . . .349
Creating Compensation Incentives . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .353
Notes . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .358
Suggested Reading . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .358
Exercises . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .358
Problem . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .359

PART IV COST ACCOUNTING FOR THE FUTURE . . . . . . . . . . . . .361

CHAPTER 17 New Approaches to Cost Accounting . . . . . . . . . . . . . . . . . . . .363

Is There a Problem with Traditional Cost Accounting? . . . . . . . . . . . . . . . .364
Kaplan’s Four-Stage Cost Model . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .365
An Alternative: New Generally Accepted Accounting Principles
for One Unified System . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .367
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The Japanese Alternative . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .369

Dashboards . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .370
Balanced Scorecards . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .371
Notes . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .372
Suggested Reading . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .373
Exercises . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .373

CHAPTER 18 Activity-Based Costing . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .375

What is ABC? . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .376
Why Use ABC? . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .378
Two Approaches to ABC . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .378
Tracing vs. Allocating in ABC . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .378
ABC Allocation Principles . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .379
What Should Be Allocated in ABC? . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .380
An ABC Example in the Pharmacy . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .381
Designing and Documenting an ABC Project . . . . . . . . . . . . . . . . . . . . . . .386
Commencing an ABC Project in the Day Surgery . . . . . . . . . . . . . . . . . . . .387
Another Approach to ABC . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .389
The Activity-Based Management Concept . . . . . . . . . . . . . . . . . . . . . . . . . .390
Does ABC Make Sense for Health Care Organizations? . . . . . . . . . . . . . . .391
Notes . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .392
Suggested Reading . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .392
Exercises . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .392
Problems . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .393

Chapter 19 Total Cost Management: Measuring the Costs of Quality . . .395

Cost Accounting and Quality Management . . . . . . . . . . . . . . . . . . . . . . . . .396
An Introduction to TQM . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .397
A Focus on Time . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .399
A Focus on Cost . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .400
Total Cost Management . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .401
The Quality of Cost Data . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .416
A Focus on Customers . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .419
Notes . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .419
Suggested Reading . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .420
Exercises . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .420
Problems . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .421

Chapter 20 Summary and Issues for the Future . . . . . . . . . . . . . . . . . . . . .423

Cost Accounting Foundations . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .424
Cost Accounting Information for Planning and Control . . . . . . . . . . . . . . .427
Additional Cost Accounting Tools to Aid in Decision Making . . . . . . . . . .429
Cost Accounting for the Year 2010 and Beyond . . . . . . . . . . . . . . . . . . . . .431
Additional Future Issues . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .433
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Notes . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .438
Suggested Reading . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .439
Exercises . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .439

Glossary . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .441

Index . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .461
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Preface

Cost accounting is an essential part of health care management. As managed care has taken hold, all
health care organizations have increased their focus on the measurement and control of costs. All
health care managers, not just accountants, are becoming more and more aware of the importance of
understanding as much about costs as they possibly can.
A number of textbooks are available in the cost accounting field. However, these generic cost ac-
counting texts focus primarily on manufacturing industries and only secondarily on service industries
such as health care. Their emphasis is therefore largely on the process of converting raw materials into
finished goods. Such books give a great deal of attention to determining the cost of work-in-process
and by-products. However, cost accounting texts written expressly for health care are scarce.
This book thoroughly covers the essentials of cost accounting from a health care perspective, in-
cluding all of the basic tools of cost accounting common to all industries, using health care examples.
Essentials of Cost Accounting for Health Care Organizations, Third Edition, focuses on costing issues
and concepts unique to the health care field. The tools covered are all practical, although not all are
commonly used. Some approaches, such as learning curves, are commonly used in other industries but
not in health care. It is our hope that readers will see the value of some of these less frequently used
techniques and adopt them for use in their organizations.
The main theme of the book is the generation of useful cost information to aid managers in making
decisions. The contents are therefore oriented toward both current and future accountants who will
generate the information, as well as all current and future health care managers who want to know the
types of information potentially available.
Essentials of Cost Accounting for Health Care Organizations does not rely heavily on debits, cred-
its, journal entries, and other technical accounting terminology. This omission was intentional to make
the book accessible to a wide range of readers—students and faculty in university programs for health
administration (both undergraduate and graduate), as well as individuals already working in the field of
health administration. The need to obtain improved information to facilitate decisions is critical at all
levels of management.
In keeping with the first and second editions, this book provides a thorough conceptual foundation.
In this third edition, we have continued to follow the trend of the health care industry, moving away
from a dominant focus on hospitals. The concepts and examples used in the text address not only hos-
pitals but also nursing homes, physician practices, managed care organizations, clinics, surgicenters,
and a wide range of other types of health care organizations.

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In the third edition, we also continue to integrate personal computers (PCs) and the internet. Many
chapters provide examples designated as “Excel® Problems.” These problems are specifically designed
to be solved with a computer-based spreadsheet application like Microsoft Excel®. In addition, we
have created ancillaries at www.jbpub.com/catalog/0763738131 that include data sets and Excel® tem-
plates that readers can download to solve the Excel® problems. On this site, we also include instruc-
tions on specific Excel® tasks related to the chapters and the problems.
The text is broken into four parts. Part I provides the foundations of cost accounting. Part II ad-
dresses the use of cost accounting for planning and control. Part III provides additional cost accounting
tools to aid in decision making, and Part IV discusses the latest trends and techniques in cost account-
ing.
Part I provides the reader with a solid base in the essentials of cost accounting. The chapters in this
section introduce costing and cost definitions. Various approaches to product costing and cost alloca-
tion are discussed. Breakeven analysis is also covered in the section, as are techniques for making non-
routine decisions.
A primary focus of cost accounting is on developing information that managers can use for planning
and control. Once the reader is familiar with the foundations of cost accounting provided in Part I, Part
II presents a number of specific tools for improved planning and control. The chapters in this section
focus on forecasting and predicting future costs, budgeting, flexible budgeting and variance analysis,
and management control.
Part III addresses a number of additional cost accounting tools that can be helpful in generating
management information for decision making. Specifically, there are chapters on cost accounting ra-
tios, productivity measurement, inventory, uncertainty, information systems, and performance evalua-
tion.
For the past several decades, literature critical of current cost accounting practices throughout all
U.S. industries has been growing. The concern is that costing has evolved primarily into a tool for ex-
ternal reporting of financial results rather than for managing the organization. This concern has led to a
movement to revise cost accounting practices drastically to make them more relevant. The criticisms of
cost accounting and a number of suggested approaches for improvement are discussed in Part IV. A
new chapter about activity-based costing has been added to this third edition. The chapters in this part
also examine total quality management and the future of costing.
The last chapter summarizes the book. Some instructors may choose to assign this last chapter at the
beginning of the course to provide an in-depth overview of the material. It can then be assigned again
at the end, for review, and to integrate the great breadth of material covered in the book.
Each chapter begins with a set of specific learning objectives listed for the reader. In addition, we
present key application questions, which serve as examples of typical questions readers will be able to
answer after completing the chapter. The key application questions are followed by a set of key terms
used in the chapter. Each of the key terms is shown in boldface italics the first time it appears in the
chapter, and all are defined in the glossary at the end of the book. Each chapter has exercises and ques-
tions for discussion.
An instructor’s manual is available online for instructors who adopt the book for classroom use.
The manual includes solutions to all questions and problems at the end of the chapters and an exami-
nation test bank with solutions, along with PowerPoint slides arranged by chapter.
While the task of updating and revising is certainly easier than creating, putting together the third
edition of this book proved to be quite a challenge. We have attempted to create a book that provides
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a thorough, clearly written, comprehensive coverage of cost accounting. However, we recognize that
there is always room for improvement. Readers are encouraged to use the resources at
www.jbpub.com/catalog/0763738131 to email us to point out errors or unclear passages, or to suggest
additional applications or other improvements. All contributions will be acknowledged in the next
edition. Any corrections to errors in the text will be posted on the Web page.
Our thanks go to the many individuals who helped us in the process of developing this book.
Steven A. Finkler
David M. Ward
Judith J. Baker
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