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Los Reyes Hospital (B) I’m very concerned about your department’s financial performance. We’d been planning on a surplus of about $74,000 from you, and you’ve run a deficit of over $125,000. Unless something is done to turn this trend around, the hospital will have to begin a series of layoffs that will affect all departments. Maria Delgado, Chief of Medicine of Los Reyes Hospital, stared at the memorandum from the hospital’s Vice President for Medical Affairs. A similar memorandum had been sent to all chiefs of service, expressing concern that the results of the most recent quarter’s operations were considera- bly worse than budgeted. Dr. Delgado knew she had some explaining to do. In fact, she, along with several other chiefs, had been asked to make a presentation at the next Executive Committee meeting of the hospital concerning the role that their departments had played in the hospital’s poor performance, and their plans for corrective action. In reviewing the budgeted and actual results, Dr. Delgado discovered that almost all of her de- partment’s variation could be attributed to four case types and four hospital services. For reasons of simplicity, she decided to base her presentation on these only. Exhibit 1 shows the original quarterly budget for these four case types: DRG089 (Simple pneumonia & pleurisy, age over 17), DRG014 (Specific cerebral vascular disorders except transient ischemic attack), DRG096 (Bronchitis & asthma, age over 17), and DRG140 (Angina pectoris). It also shows the budgeted variable expenses per case for the four hospital services: routine care (i.e. the hospital stay), radiology films, laboratory tests, and pharmacy units (such as prescriptions). Since the hospital negotiated all of its managed care contracts on the basis of diagnosis, it was paid on a per-case basis. Its anticipated revenue for each DRG is shown in Exhibit 1, as is the an- ticipated utilization of services and the variable expense per unit for each service for each DRG. Using these estimates, the hospital’s fiscal affairs department had calculated total variable ex- pense per case for each DRG. The revenue and total variable expense per case then had been multi- plied by the anticipated number of cases to give total revenue and total variable expenses by DRG. The latter was deducted from total revenue to give the contribution to fixed expenses from each DRG. The department’s fixed expenses (including its allocated overhead) were then deducted from the total contribution to give a total budgeted surplus of $73,650 for the quarter. Exhibit 2 is similar to Exhibit 1, except that it shows actual results. As it indicates, instead of a surplus, the department incurred a deficit of $125,475. It was this that led to the concern expressed in the memorandum from the hospital’s Vice President for Medical Affairs. Dr. Delgado outlined some of her thinking about the deficit: Our budget is a little tricky to understand. The average expense per day figures all use what the hospital calls “variable expenses.” I think this is right, since our fixed expenses shouldn’t change with small changes in the number of patients, but it makes the amounts look awfully low. Apart from the expenses, one reason for the deficit is that the hospital re-negotiated payment rates with HealthStop [a local managed care provider], and the result was lower payment rates for several of our DRGs. But I don’t think that’s the whole story. We overspent our fixed expenses a bit, for example, but I think that’s okay since we had about an 8 percent increase over budget in the number of patients we treated during the quarter, and I remember having to bring in some agency nurses to cover the extra workload. TCG149 • Los Reyes Hospital (B)2 of 4 In preparation for her presentation to the Executive Committee, Dr. Delgado asked her staff as- sistant, Asher Hawkins, to prepare a report containing a complete breakdown of the reasons behind the deficit. He began by reasoning that the department had essentially no control over the number or mix of cases seen. He thus prepared a flexible budget (Exhibit 3), which s Showed that the change in the number and mix of cases seen in the department should have led to a surplus of $206,025. Using similar reasoning, he prepared an analysis of the variance due to the lower prices that had been negotiated with the managed care providers. This analysis is contained at the bottom of Ex- hibit 3, and shows that $150,000 was a result of the price changes. Since the department had had almost nothing to do with these negotiations, this finding made him feel quite good. At this point, Mr. Hawkins felt that he had accomplished the majority of his task. He had found $132,375 in positive variances due to the changes in volume and mix, and $150,000 in negative variances due to changes in prices. Since he felt that the department could control neither, and since the two almost offset each other, he felt that there was little left to explain. Mr. Hawkins then met with Dr. Delgado to show her the results of his work. At the meeting, it became clear that Dr. Delgado was not satisfied. This is not good enough. First of all, the two don’t really offset each other, so that’s an issue. Secondly, though, there’s something else going on here. It’s clear from your analysis that the situation is even worse than I had originally thought. This [Exhibit 3] suggests that we should have had a surplus of slightly over $206,000 instead of $73,000. That makes our deficit look really bad. I’ve got more explaining to do than I had thought. You’re going to need to dig a little more deeply into the issues here, and I’m going to need to see your analysis soon, since the meeting is early next week. Assignment 1. Be sure you understand how Exhibit 3 was prepared. Do you agree with Mr. Hawkins’ analyses so far? 2. Besides changes in the number of cases and the payment rate per case, what are the other reasons why actual results might have diverged from budget? 3. Calculate the variance associated with each of the reasons you gave in Question 2. How, if at all, might this information be used by Dr. Delgado in managing the department? How might it be used by the hospi- tal’s administration? What other information concerning cases, costs, and revenues would you suggest Dr. Delgado see on a regular basis? How might your answer be affected by the hospital’s decision about the types of responsibility centers in its management control system? LOS REYES HOSPITAL (B) Exhibit 1. Original Budget for the Department of Medicine Overall BudgetDRG 089DRG 014DRG 096DRG 140Total Number of cases30020010050650 $3,750,000 1,725,750 $2,024,250 1,950,600 $73,650 Radiology # films per case5641 Expense per film$25$25$25$25 Total expense per case$125$150$100$25 Laboratory # tests per case101035 Expense per test$15$15$15$15 Total expense per case$150$150$45$75 Pharmacy # units per case55201221 Expense per unit$5.00$5.00$5.00$5.00 Total expense per case$275$100$60$105 Total variable expense per case$2,800$3,150$1,955$1,205 LOS REYES HOSPITAL (B) Exhibit 2. Computation of Actual Overall Results Actual number of cases Revenue per case Total revenue Variable expenses per case Total variable expenses Contribution Total fixed expenses Surplus (deficit) V Routine Care ariable expense detail Average #days per case Average expense per day Total average expense per case Radiology Average # films per case Average expense per film Total average expense per case Laboratory Average expense per test Average # tests per case harmacy Total average expense per case P Average # units per case Average expense per unit Total average expense per case Total average variable expense per case DRG 089 275 $5,500 $1,512,500 $2,952 $811,800 $700,700 $240 10 $2,400 6$240 $88 $48 $4 60 $4 22 $24 $144 8 $21 $168 $3,346 $836,500 $763,500 $240 12 $2,880 7$21 10 $24 $168 $210 DRG 140T 75700 otal $3,300$3,850,000 $247,500 $1,673$1,859,625 1,990,375 $2,166 $125,475$216,600 $273,400 $122,025 1,985,100 ($125,475) 86 $240$240 $1,920$1,440 32 $24$24 $72$48 65 $21$21 $126$105 20$4 12 $4 $80 $1,673$2,166 $3,346 $2,952 Overall Budget Actual number of cases Budgeted revenue per case Exhibit 3. Flexible Budget and Related Variances D DRG 140Total 75700 $3,000 Total revenue$$787,500 $837,500 Budgeted variable expenses per case Total variable expenses Contribution Total fixed expenses Surplus Revenue Volume Variance Actual-Budgeted cases Budgeted Unit revenue $ $2,800 $3,150 $770,000 $880,000 -25 $6,000 $225,000 $4,000,000 $1,205$1,955 $90,3751,843,375$195,500 $304,500 $134,625 $2,156,625 1,950,600 $206,025 025$0 $5,000 $6,500 50 $3,000 Variance($150,000)$2,800 25 $167,500 250 $70,000 ($157,500) $3,150 -50 $325,000 Expense Volume Variance Budgeted-Actual cases Budgeted expense per case Variance Contribution Margin Variance ($80,000) Revenue Price Variances Actual-Budgeted revenue per case ($500) Actual number cases 275 Revenue price variance ($137,500) $75,000$250,000 0-25$0 $1,955 $1,205 ($30,125) ($117,625) $44,875$132,375$0 $300($100) ($100) 75100 $22,500($150,000)($10,000) ($25,000) Original budget Los Reyes Hospital Original Budget for the Department of Medicine Overall budgetDRG 089DRG 014DRG 096DRG 140Total Number of cases30020010050650 Revenue per case$6,000$6,500$5,000$3,000 Total revenue$1,800,000$1,300,000$500,000$150,000$3,750,000 Variable expense per case$2,800$3,150$1,955$1,205 Total variable expenses$840,000$630,000$195,500$60,250$1,725,750 Contribution$960,000$670,000$304,500$89,750$2,024,250 Total fixed expenses$1,950,600 Surplus (Deficit)$73,650 Variable expense detail: Routine care #days per case91174 Expense per day$250$250$250$250 Total expense per case$2,250$2,750$1,750$1,000 Radiology #films per case5641 Expense per film$25$25$25$25 Total expense per case$125$150$100$25 Labaratory #test per case101035 Expense per test$15$15$15$15 Total expense per case$150$150$45$75 Pharmacy #units per case55201221 Expense per unit$5$5$5$5 Total expense case$275$100$60$105 Total variable expense per case$2,800$3,150$1,955$1,205 Actuals Los Reyes Hospital Actuals for the Department of Medicine Overall budgetDRG 089DRG 014DRG 096DRG 140Total Number of cases27525010075700 Revenue per case$5,500$6,400$4,900$3,300 Total revenue$1,512,500$1,600,000$490,000$247,500$3,850,000 Variable expense per case$2,952$3,346$2,166$1,673 Total variable expenses$811,800$836,500$216,600$125,475$1,990,375 Contribution$700,700$763,500$273,400$122,025$1,859,625 Total fixed expenses$1,985,100 Surplus (Deficit)($125,475) Variable expense detail: Routine care #days per case101286 Expense per day$240$240$240$240 Total expense per case$2,400$2,880$1,920$1,440 Total expense$660,000$720,000$192,000$108,000$1,680,000 Radiology #films per case6732 Expense per film$24$24$24$24 Total expense per case$144$168$72$48 Total expense$39,600$42,000$7,200$3,600$92,400 Labaratory #test per case81065 Expense per test$21$21$21$21 Total expense per case$168$210$126$105 Total expense$46,200$52,500$12,600$7,875$119,175 Pharmacy #units per case60221220 Expense per unit$4$4$4$4 Total expense case$240$88$48$80 Total expense$66,000$22,000$4,800$6,000$98,800 Total variable expense per case$2,952$3,346$2,166$1,673