Examining the effect of PPS on cost accounting systems - prospective payment system

Healthcare Financial Management, March, 1993 by Zabihollah Rezaee

ACCOUNTING

PPS has shifted much of the economic risk of health care from patients and third-party payers to hospitals. As a result, there has been a strong incentive for hospitals to understand and control the costs associated with providing patient care services. However, the general prediction made when PPS was implemented was that an adequate cost accounting system designed for use after PPS implementation would be useful to hospitals, but that hospitals should not expect too much from it.(a)

The study discussed in this article addresses the following questions: What major effect has PPS implementation had on cost-accounting systems? Have hospitals made major changes in their cost-accounting systems in response to the implementation of PPS? Have hospital cost-accounting systems become more sophisticated? How effectively and efficiently are hospitals using cost information in decision making and performance evaluation?

Methodology

Two hundred and fifty U.S. hospitals with 500 or more beds were mailed a survey asking questions regarding changes in their cost-accounting systems as a result of PPS implementation. The survey contained four sections. The first section asked subjects about their perceptions regarding the usefulness and relevance of cost-accounting systems for hospitals and the impact of PPS implementation on their facility's cost-accounting systems.

The second section asked for factual data regarding the cost structure and cost determination process in their facility both before and after PPS was implemented. The third section asked questions regarding the development of standard costs for patient service centers since PPS implementation. The fourth section asked for demographic data to be used for classifications purposes. Ninety-eight hospitals completed the surveys (a 39.2 percent response rate.)

The survey responses indicate that the majority of surveyed hospitals did not make major changes in their cost-accounting systems following PPS implementation, although respondents did note both an increased level of sophistication of their cost-accounting systems and an increased use of a standard cost system for performance evaluation and variance analysis.

The majority of surveyed hospitals still use the traditional cost-to-charge ratio as the method of establishing a standard cost for each procedure or item provided by patient services cost centers. The greatest change attributed to PPS implementation was an increased level of attention paid to costs and volume. Hospital management now uses cost information more for decision making and performance evaluation.

Usefulness of cost information

Results presented in Exhibit 1 indicate that prior to the implementation of PPS, a majority of responding hospitals used cost information primarily for tax planning (82 percent) or overall financial planning (59 percent). The most significant impact of PPS implementation was on the use of cost information for pricing decisions, performance evaluations, and budgeting and forecasting. Prior to PPS implementation, only 31 percent of responding hospitals used cost information for pricing decisions, compared to 96 percent doing so following PPS implementation. Less than 20 percent used cost information for budgeting and forecasting and performance evaluation before PPS was implemented, compared to more than 87 percent now doing so.

Impact on cost-accounting systems

Results presented in Exhibit 2 indicate that most surveyed hospitals believe that PPS implementation affected their cost-accounting systems. About 97 percent of respondents said that PPS implementation increased the level of sophistication of their cost-accounting systems. About 94 percent of respondents believed that PPS implementation encouraged them to pay closer attention to costs and volume and served to enhance the efficiency, effectiveness, and economy of providing healthcare services.

More than 87 percent of respondents reported that the implementation of PPS increased the awareness and understanding of cost components and measurements and as the determination of "true" costs of providing specific services. Fifty-one percent of responding hospitals said that PPS implementation promoted the use of a standard cost system for performance evaluation and variance analysis. Only 3 percent of hospitals that responded felt that PPS implementation TABULAR DATA OMITTED TABULAR DATA OMITTED had a negligible impact on their cost-accounting systems.

Results indicate the importance of an adequate cost-accounting system for today's hospitals. A changing economic environment and changing methods of third-party cost reimbursement have made cost accounting a high priority in the healthcare industry. Improved cost-accounting systems are inevitable under PPS, and accurate cost information is essential for more profitable and efficient hospital operations.

TABULAR DATA OMITTED

Developing standard cost systems

Results presented in Exhibit 3 show that the majority of hospitals (64 percent) responding to the survey used traditional cost-to-charge ratios for cost assignment and determination before PPS was implemented, compared to 33 percent after its implementation. Only a small percentage of surveyed hospitals used cost systems such as microcosting, patent-acuity costing, and relative-value units before the implementation of PPS.