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Copyright © Springer Publishing Company, LLC. All Rights Reserved.
CHAPTER 8: COST-FINDING, BREAK-EVEN, AND CHARGES • Differentiate between direct and indirect costs
relevant to nursing care settings• Explain how to incorporate volume in
calculating total variable costs• Give at least two examples of projects where
a break-even analysis might be useful• Describe and critique at least two methods
for setting prices in health care settings
1
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COST ALLOCATION
2
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COST DRIVER CRITERIA
• Measurable in units relevant to the cost center
• “Fair”—related to the actual amount of indirect resource use by the cost center
• Allows for cost control by the cost center
3
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COST-FINDING
4
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DIRECT DISTRIBUTION METHOD OF COST ALLOCATION • Relatively simple, but ignores indirect costs
generated by nonrevenue cost centers• Identify all direct costs for each cost center
(operating expense budget)• Classify cost centers as profit or cost centers• Determine cost drivers using accepted criteria • Allocate costs using the overhead rate• Allocate costs using cost pools 5
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STEP-DOWN METHOD OF COST ALLOCATION • Identify all direct costs for each cost center• Classify cost centers as nonrevenue or revenue
cost centers• Determine cost drivers using accepted criteria • Select the order of entering cost centers into the
step-down process, beginning with nonrevenue cost centers
• Remove cost centers from step-down procedures when all their costs are allocated
• Calculate total indirect costs and total costs allocated to each revenue cost center
6
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ACTIVITY-BASED COSTING (ABC)
7
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CODING SYSTEMSMDCs and DRGs: •Identify average patient resource consumption by diagnosis CPT® and HCPCS Codes:•Coding specific services, procedure, and products by the amount of resources requiredRBRVS and RVUs:•Assign costs to the value of the physician’s work, the practice expense, and malpractice liability insurance
8
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CODING SYSTEMS (CONT’D)Omaha System:•Combines information for problem classification, the intervention plan and outcomes rating, used by nurses and other health professionals in settings across the continuum of careOutcome and Assessment Information Set (OASIS):•Required by Medicare for home health agencies (HHAs). Data items address adult home health areas such as health status, functional status, the support system, and client sociodemographics 9
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BREAK-EVEN ANALYSIS
• Principle – profits and costs change with change in volume
• Cost-volume-profit (CVP) analysis• Factors include fixed costs, variable costs,
price, payor mix and product mix• Formula to find p*, q* – where price or
volume covers costs of production
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COSTS
• Fixed Costs – remain constant• Variable Costs – vary• Total Cost = TFC + TVC
11
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WHAT ARE THE TOTAL AND PER-EXAM COSTS?
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Number of Exams
Total Fixed Cost
Fixed Cost per Exam
Variable Cost per Exam
Total Variable Cost
Total Cost Total per-Unit Cost
1 $10,000 $10,000 $10 $10 $10,010 $10,010
200 $10,000 $50 $10 $2000 $12,000 $60
500 $10,000 $20 $10 $5000 $15,000 $30
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AS THE VOLUME OF EXAMS INCREASES, WHAT HAPPENS TO:• Total fixed costs?• Per-unit fixed costs?• Per-unit variable cost?• Total variable cost?• Total cost?• Per-unit cost?
13
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AS VOLUME INCREASES:
14
Total Fixed Cost
$0
$5,000
$10,000
$15,000
0 200 400 600
Volume
Co
st
($)
$5000
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AS VOLUME INCREASES:
15
Fixed Cost Per Exam
$0
$50
$100
$150
0 200 400 600
Volume
Co
st
($)
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AS VOLUME INCREASES:
16
Variable Cost Per Exam
$0
$5
$10
$15
0 200 400 600
Volume
Co
st
($)
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AS VOLUME INCREASES:
17
Total Variable Cost
$0
$2,000
$4,000
$6,000
0 200 400 600
Volume
Co
st
($) $6000
$4000
$2000
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AS VOLUME INCREASES:
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Total Cost
$0$5,000
$10,000$15,000$20,000
0 200 400 600
Volume
Co
st
($)
$5000
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AS VOLUME INCREASES:
19
$0
$50
$100
$150
0 500 1000
Co
st
($)
Volume
Total Per-Unit Costs
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COST VARIATION RELATED TO VOLUME
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Total Costs Per-unit Costs
Fixed No change Change
Variable Change No change
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TOTAL COST = TOTAL FIXED COST + TOTAL VARIABLE COST• TVC varies with volume—TFC does not• TVC = VCU x UOS• Example:VC per exam = $10UOS (volume) = 1, 200, 500TVC = VC x UOS = ?
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TVC = VCU X UOS
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Number of Exams
Variable Cost per Exam
Total Variable Cost
1 $10 $10
200 $10 $2000
500 $10 $5000
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TOTAL REVENUE
• TR = RU x UOS• As variable cost = cost per unit x volume,• Total revenue = price per unit x volume of
goods sold or delivered• Cost, revenue, and volume data are all needed
to compute a break-even equation
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BREAK-EVEN ANALYSIS
• Principle – profits and costs change with changes in volume
• Breaking even: the revenue from selling goods or services equals the total costs of producing goods or services
• Concept: TR = TC, or• RU x UOS = FC + (VCU x UOS)
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BREAK-EVEN FORMULAS
Total Revenue = Total Cost
RU * UOS = TFC + (VCU * UOS)
• Break-even volume:
UOS = TFC ÷ (RU – VCU)
• Break-even price (RU):
RU = TC/Q
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DATA: BREAK-EVEN W/O PROFIT
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Volume Total Cost Total Revenue
100 $15,000 $11,000
200 $12,000 $12,000
500 $11,000 $15,000
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BREAK-EVEN WITH PROFIT TARGET• Profit: revenues must cover costs and profit• TR = TC + Profit• RU x UOS = TFC + (VCU x UOS) + P• Break-even volume with profit target:UOS = (TFC + P) ÷ (RU – VCU)
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BREAK-EVEN ANALYSIS FOR PROFIT
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Number of Exams
Total Fixed Cost
Total Revenue
Total Cost Profit or Loss
100 $10,000 $8000 $11,000 -$3000
200 $10,000 $12,000 $12,000 $0
500 $10,000 $18,000 $18,000 $3000
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CONTRIBUTION MARGIN
• Unit Contribution Margin = Unit Price - Unit Variable Cost
• Total Contribution Margin = Unit CM x UOS• CM: not profit – per unit $ amount available to first
cover fixed costs, then contribute to profits
UCM = $36 - $10 = $26
TCM = $26 x 500 = $13,000
$13,000 covers FC and $3000 profit for 500 exams
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COMPLICATING ISSUES• Product mix• Payor mix• Client mix• Volume forecasting• Changes in prices and costs• Capitation• New financing mechanisms such as bundled
payments for ACOs
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CUSTOMER-FOCUSED PRICING• Customer-specific or value-based: set price
based on the value the customer attributes to the product– Need to know the customer– Difficult to justify in economic terms
• Skimming: set high price with inelastic demand so customer is not price sensitive
• Elasticity—extent that a change in price creates change in consumer demand
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MARKET-FOCUSED PRICING• Penetration or market share pricing: low price
with elastic demand, expect costs of production to with volume or expect increased competition
• Shadow pricing: set price under or over the competitor(s)—risk perception of collusion or downward price spiral (price war)
• Special offers or discounts: to individual or corporate clients
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PROFIT-FOCUSED PRICING METHODS• Cost-plus pricing: set the price at the cost of
production plus a profit margin (break-even)• Target return pricing: set the price to achieve
a targeted return on investment• These methods are relatively simple but don’t
take consumer demand, price sensitivity, or market conditions into account
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