EDN 816 Module 3 Accounting Principles for Nurse Leaders Example

Why the Unit Was Full and Still Lost Money: Accounting Principles Every Nurse Leader Needs

Student Name

Doctor of Education Program, Aspen University

EDN 816: Financial Management in Healthcare Environments

Instructor Name

Month Day, Year

Why the Unit Was Full and Still Lost Money: Accounting Principles Every Nurse Leader Needs

The manager of Linden Ferry Medical Center's 28-bed telemetry unit opened her annual report and found that the unit had lost $0.7 million, although it had been nearly full all year and her staff had worked a great deal of overtime to keep up. She asked the finance office how a full unit could lose money and whether the loss meant the unit might be closed. The answer lies in a handful of accounting principles that shape every number a manager sees. This paper explains those principles, applies them to the telemetry unit's results and shows why the reported loss says less than it seems to about the unit's value to the hospital.

Accrual Accounting and Matching

Linden Ferry, like other hospitals, uses accrual accounting: it records revenue in the period care is delivered rather than when payment arrives, and expenses in the period resources are used rather than when bills are paid. The matching principle pairs the costs of a period with the revenue they helped produce. For a manager, accrual accounting means that a month's report reflects the care delivered that month, even though many payments arrive weeks later, and that salaries earned in the last days of a month appear in that month even if they are paid in the next.

Revenue Is Recorded Net

Under the revenue recognition standard adopted across industries, known as Topic 606, a hospital records revenue at the amount it expects to collect for the services it provides (Financial Accounting Standards Board, 2014). Gross charges are reduced by contractual adjustments, the differences between charges and the rates payers have agreed to, and by implicit price concessions, the amounts the hospital expects not to collect from patients even at the outset. Charity care is not recorded as revenue at all, because the hospital never expected payment. The telemetry unit's revenue of $14.2 million is therefore the net amount the hospital expects to receive for its patients' care, a fraction of the unit's gross charges.

Depreciation and Donor Restrictions

Two other principles affect a manager's reports. The cost of buildings and equipment is spread over their useful lives through depreciation, so the telemetry unit's monitors, bought for $1.2 million and expected to last eight years, add $150,000 of expense each year rather than $1.2 million in the year of purchase. And gifts given for a specific purpose, such as a donation for nurse education, are recorded as net assets with donor restrictions and can be spent only for that purpose; a manager cannot redirect a restricted gift to cover overtime.

Direct and Indirect Costs

The telemetry unit's loss comes mostly from cost allocation. Direct costs are those the unit causes and controls: nursing salaries and benefits, supplies, its own equipment. Indirect costs belong to departments that support all units, such as housekeeping, the pharmacy, information technology, administration and the building itself. To report a full cost for each unit, the finance office allocates indirect costs to units using statistics such as square footage, patient days or staff hours. Allocation is useful for pricing and for understanding the full cost of care, but it can mislead managers who read an allocated result as the effect of their own decisions.

The Unit's Results

The table separates the telemetry unit's results into direct and allocated components.

Why Closing the Unit Would Hurt

Each year the unit adds $2.9 million to cover costs the whole hospital shares. If it closed, that contribution would disappear, but most of the $3.6 million in allocated costs would not: the pharmacy, information systems, administration and building would still exist and would be allocated to other units. Only about $0.5 million of support costs would end. The hospital would be $2.4 million worse off. The reported loss is real as an accounting figure, but it answers the question of what the unit costs in full, not the question of what the hospital would gain by closing it. For decisions about adding, keeping or closing services, contribution margin is the relevant measure.

What Would Improve the Result

The analysis also points to what the manager can influence. The unit's direct costs rose because overtime filled vacancies at premium rates; filling those positions would lower direct cost per patient day. Average length of stay on the unit exceeded the expected stay for its diagnosis groups by 0.4 days, and because most payments are fixed per stay, each extra day added cost without revenue. Documentation that fully captures patients' conditions affects the diagnosis group assigned and therefore the payment the hospital receives. These are direct levers; the allocation formula is not. Nationally, hospitals with higher expenditures per adjusted discharge tend to be less profitable (Bai & Anderson, 2016), which is why cost per case deserves a manager's attention.

Better Costing Methods

Traditional allocation spreads indirect costs using broad statistics that may bear little relation to how patients actually use resources. Time-driven activity-based costing estimates the cost of care by mapping the process each patient follows, timing how long each person and resource is engaged, and multiplying by the cost per minute of each resource. A systematic review found that the method is applicable in health care and can cost processes efficiently, although its value for bundled payment and coordination across settings remained to be shown (Keel et al., 2017). Linden Ferry is piloting the method in its outpatient services, a subject of Module 6.

Estimates and Judgment

Accounting figures also rest on estimates. Revenue depends on assumptions about what payers and patients will pay, and those estimates are adjusted as payments arrive. Amounts owed to or by Medicare under cost report settlements may not be known for years. Managers should treat monthly results as good estimates rather than exact figures and should ask finance about large adjustments rather than assume they reflect their own performance.

Questions to Ask Finance

Nurse leaders who understand these principles can ask better questions: What is my unit's contribution margin, not only its fully allocated result? Which indirect costs would change with my unit's volume? How is my revenue estimated, and how often is it adjusted? What is the cost of each overtime hour compared with a filled position? How does documentation affect the payment my patients generate? Each question moves the conversation from a single reported number to the decisions that change it.

Conclusion

The telemetry unit was full and still showed a loss because of how accounting measures it: revenue recorded net of adjustments, costs recorded as they are used, and indirect costs allocated across units. Its contribution margin of $2.9 million shows that it supports the hospital, and closing it would leave the hospital $2.4 million worse off. The manager's real opportunities lie in the direct costs and length of stay she controls. Accounting principles, understood this way, give nurse leaders a clearer view of both the value of their units and the levers they hold.

References

Bai, G., & Anderson, G. F. (2016). A more detailed understanding of factors associated with hospital profitability. Health Affairs, 35(5), 889-897. https://doi.org/10.1377/hlthaff.2015.1193

Financial Accounting Standards Board. (2014). Revenue from contracts with customers (Topic 606) (Accounting Standards Update No. 2014-09). https://www.fasb.org/page/PageContent?pageId=/standards/accounting-standards-updates.html

Keel, G., Savage, C., Rafiq, M., & Mazzocato, P. (2017). Time-driven activity-based costing in health care: A systematic review of the literature. Health Policy, 121(7), 755-763. https://doi.org/10.1016/j.healthpol.2017.04.013