Cost accounting supports clinical evaluations

Healthcare Financial Management, April, 1994 by Caryl E. Carpenter, Linda C. Weitzel, Nelda E. Johnson, David B. Nash

COST CONTAINMENT

This article describes how a hospital cost accounting system was used to evaluate the financial impact of the use of a new and expensive drug at a 700-bed academic medical center.

Hospital cost accounting systems have changed considerably in recent years. Prior to the advent of Medicare's prospective payment system, the Medicare Cost Report was the only approximation of cost accounting in most hospitals. As hospital payment methods have changed, so have the concepts of cost accounting for hospitals.(a) Today, most hospitals that have invested in new cost accounting systems have done so to improve productivity and cost management, to evaluate the profitability of various services or products, or to evaluate managed care contracts.(b)

Concurrent with the advances in cost accounting have been the changes in clinical practice as new procedures, technologies and products emerge. Since many of these new products are extremely expensive, hospitals have had an increasingly vested interest in evaluating their financial and clinical impact before or shortly after their introduction.

Traditionally, analysts have used costs-to-charges ratios developed from data taken from the Medicare Cost Report to approximate costs at the patient level. These cost estimates have suffered from a number of biases that have been noted elsewhere.(c) Today's new cost accounting systems can provide much better evaluations, as illustrated in the following example of Thomas Jefferson University Hospital (TJUH), a 700-bed academic medical center in Philadelphia, Pennsylvania, and how it used its cost accounting system to evaluate the financial impact of a new and very expensive drug, Zofran.

The cost accounting system

The clinical financial management system (CFMS) at TJUH integrates clinical and financial data from the medical records, billing and cost accounting systems. The cost accounting component of the system uses a bottom-up approach that begins with cost determinations at the procedural level. The CFMS system utilizes relative value units determined by management engineering studies to estimate each cost component of a procedure. Unit costs are divided into fixed and variable as well as direct and indirect components. For example, the cost for a complete blood count would include direct variable costs for labor and supplies, direct fixed costs for equipment and space, and a fair share of indirect overhead costs such as medical records, utilities, or housekeeping. Unlike the traditional step-down allocation method used in the Medicare Cost Report, the CFMS system offers a customized allocation of indirect costs, first to departments and then to procedures within a department.

The CFMS system uses medical record information to identify sub-groups of patients with various clinical characteristics. The billing system provides utilization data, indicating the number and type of procedures or services these patients received. The cost accounting system provides the unit costs for each procedure. These costs are aggregated to determine an average cost per patient.

The CFMS system is normally used by financial administration staff to monitor the hospital's performance by payer, product line, and service and can be used for planning, marketing, and quality assurance. Data from the system also can be used to evaluate third-party contract proposals or the impact of regulatory changes. In addition, the system's capabilities increasingly are in demand for clinical evaluation studies.

The new product

Zofran is a new pharmaceutical product that can prevent the severe episodes of nausea and vomiting associated with some cancer chemotherapy treatments and is believed to be a more effective treatment than traditional anti-nausea and vomiting medications.(d) Because of its efficacy and the absence of significant side effects, Zofran was quickly adopted by physicians for use as the primary medication of its type, and within months of its commercial debut it had been added to the formulary of many hospitals across the United States. One major teaching hospital reported that expenditures for Zofran alone consumed 10 percent of the hospital drug budget within the first year of use.(e) By 1992, Zofran had become the number one drug in the pharmacy budget at TJUH; Zofran expenditures for FY92 were almost $400,000.

The rapid growth of the use of Zofran might not have been of concern were it not for its substantial cost. Zofran is much more expensive than the traditional therapy it replaced.

The cost analysis

TJUH first used its CFMS system to determine the cost-per-case for traditional anti-emetic therapy. A list of the 12 drugs most commonly used to treat nausea and vomiting was developed by physicians who treat cancer patients at TJUH. This was an important component of the analysis because prior to the availability of Zofran, TJUH physicians often had to prescribe four or five different combinations of medications.

Once a list of drugs was developed, the total cost of these pharmacy products for all patients in DRG 410 (maintenance chemotherapy) was obtained through the CFMS system, and the average cost-per-case was calculated. This cost was found to be about $30 per admission. Using the same process, it was determined that the average pharmacy cost-per-case for patients who received Zofran was $300. This ten-fold difference in cost-per-case prompted a more detailed analysis.