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ACCOUNTING AND FINANCE CONCEPTS FOR THE NON-ACCOUNTANT
I. Purpose of Financial Accounting
II. Purpose of Managerial Accounting
III. Financial Statements – Purpose and Relationships A. Balance Sheet B. Income Statement C. Statement of Changes in Financial Position
IV. Accounting Process A. Recording Transactions B. Chart of Accounts C. General Ledger
V. Balance Sheet A. Assets B. Liabilities C. Equity
VI. Income Statement A. Revenue B. Expense
2 C. Net Income (Loss)
VII. Effects of Transactions on the Balance Sheet Equation
VIII. Statement of Changes in Financial Position A. Sources B. Uses
IX. Comparison of Balance Sheet Accounts Based on Accounting Basis A. Cash B. Modified Cash C. Accrual
X. Financial Statement Analysis A. Rate of Return on Assets B. Accounts Receivable Turnover C. Inventory Turnover D. Current Ratio E. Quick Ratio F. Working Capital Ratio G. Gross Profit Ratio H. Net Profit Ratio I. Gross Collection Ratio J. Net Collection Ratio K. Contribution Margin
3 XI. Payroll A. Employer Taxes 1. Federal Unemployment 2. State Unemployment
B. Employer/Employee Taxes 1. Medicare Tax 2. Social Security Tax C. Workers‟ Compensation
XII. Internal Controls A. Elements of a System B. Management of Responsibilities C. Procedures D. Checklist
XIII. Overhead Analysis A. Basis of Calculations B. Important Measures C. Other Bases D. Benchmarking
XIV. Relative Value Units
4 XV. Establishing a Fee Schedule A. RUUs B. Costs C. Payor Contracts D. Use in Auditing EOBs
XVI. Cost Accounting A. Purposes B. Type Costs C. Costing Methods D. Break-Even Analysis
XVII. Budgeting A. Benefits B. Components C. New Services
XVIII. Financing A. Operating Costs B. Capital Equipment Purchases
XIX. Corporate Structure and Tax Implications A. Sole Proprietor B. Partnership C. Limited Partnership
5 D. Corporation E. Limited Liability Company
XX. Definitions: Accounting Accounts Payable Accounts Receivable Accrual – Basis of Accounting Accrued Liabilities Acquisition (Historical) Cost Allowance for Estimated Uncollectible Receivables Amortization Assets Bad Debt Expense Balance Sheet Capital Leases Capitalization Capitation Cash-Basis Accounting Chart of Accounts Collection Agency Write-Offs Common Stock Contractural Write-Offs Corporation Current Assets
6 Current Net Realizable Value Current Liabilities Current Replacement Cost Deferred Revenue Deficit Depreciation Donated Capital Financial Accounting The Financial Accounting Standards Board (FASB) Goodwill Gross Charges – FFS Equivalents for Capitation Plan Patients Gross Charges Income Statement Incurred But Not Reported (IBNR) Intangible Assets Intercompany Accounts Payable Intercompany Receivables Interest Expense Interest Income Liabilities Limited Liability Company Long-Term Liabilities Managerial Accounting Modified Cash-Basis Accounting Net Assets
7 Noncurrent Expenses Paid in Advance Nonoperating Revenues Notes Payable – Long-Term Notes Receivable – Short-Term Occupancy Expense Operating Expenses Operating Subsidy Income Organizational Costs Owners‟ Equity Partnership Patient Refunds Payroll Tax Withholdings Payable Preferred Stock Prepaid Expenses Professional Corporation Provision for Cash Basis Conversion Realized Gains and Losses – Investments Retained Earnings Revenue and Expense Summary Revenues The Securities Exchange Commission (SEC) Stockholders‟ Equity Surplus Treasury Stock Undistributed Earnings
8 Unrealized Gains and Losses – Investments Valuation Allowance Withhold
9 I. PURPOSE OF FINANCIAL ACCOUNTING The presentation of reports for use by persons outside a company (bank, investors). The need for some degree of uniformity requires that these reports are more standardized than those used in managerial accounting principles (GAAP). GAAP is developed by the Financial Accounting Standards Board (FASB) and the Securities and Exchange Commission (SEC). Examples are balance sheet, income statement and statement of changes in financial position.
II. PURPOSE OF MANAGERIAL ACCOUNTING The preparation of reports for use by persons within a company. Examples are department profit and loss statements, statement of projected cash receipts and disbursements, employee productivity reports. Reports may also be used for benchmarking, practice valuations,(buy-in/buy-out).
III. PRIMARY FINANCIAL STATEMENTS A. Balance Sheet
B. Income Statement
C. Statement of Changes in Financial Position
Relationship Between Balance Sheet and Income Statement The Income Statement helps to account for the change in retained earnings between the beginning and end of the accounting period.
Retained Earnings, Jan. 1, 1998 Add Net Income for 1998 Subtract Dividends Paid in 1998 Retained Earnings Dec. 31, 1998
$55,000 8,000 3,000 $60,000
14 V. BALANCE SHEET The Accounting Equation (Assets – Liabilities = Owner‟s Equity) The Balance Sheet presents a snapshot at a moment in time of all past activities. It also presents a list of company assets, liabilities and equity. A. Assets – Economic resources that have the potential to provide future benefits to a practice. Current Assets – cash and other assets that are expected to be turned into cash, sold or consumed within one year from the date of the balance sheet (cash, prepaid expenses, A/R, inventories) Fixed Assets – Those held and used for longer than one year (land, furniture, equipment and buildings) Intangible Assets – Note order of liquidity – Assets quickly converted to cash are listed first. Valuation Methods of Balance Sheet Items – Cash – Cash on hand or in bank Accounts Receivable – Amount of cash expected to be collected. Equipment – Acquisition (historical) cost less accumulated depreciation. Buildings - Acquisition (historical) cost less accumulated depreciation. Patents - Acquisition (historical) cost less accumulated amortization. Inventory – Amount of cash paid Land - Amount of cash paid Common Stock – Amount invested by owners when the stock was first issued. B. Liabilities – Creditors‟ claims on the assets. Current Liabilities – Those that are expected to be paid within one year. (portion of note payable to banks, A/P to suppliers, wages & payroll taxes) Long-Term Liabilities – Those to be paid after one year. Valuation – At the present value of cash required to pay the liabilities. Note order of demand
15 C. Shareholders‟ Equity – The owners‟ claims on the assets. Paid-In Capital – Funds invested by shareholders for an ownership interest. Retained Earnings - Earnings realized since formation in excess of dividends distributed to shareholders. Reinvested by management for the benefit of shareholders.
16 VI. INCOME STATEMENT
Presents the results of the operating activities of a practice for a period of time. A. Revenues – measure the inflow of assets in the form of cash and promises to pay (accounts receivable) in cash in the future. (cash vs. accrual)
B. Expenses – measure the outflow of assets in the form of cash and promises to pay (liabilities) in cash in the future. (cash vs. accrual) Cost of Goods Sold – measures the cost of inventories sold to customers.
For each expense, either an asset decreases or a liability increases (accounts payable).
C. Net Income – A measure of the excess of net asset inflows from revenues over net asset outflows from expenses for a period. Net Loss – When expenses exceed revenues.
17 VII. EFFECTS OF TRANSACTIONS ON THE BALANCE SHEET EQUATION
Each transaction has one of the following effects or combination of effects: 1. 2. 3. 4. Increases both an asset and a liability or shareholders‟ equity Decreases both an asset and a liability or shareholders‟ equity Increases one asset and decreases another asset Increases one liability or shareholders‟ equity and decreases another liability or shareholders‟ equity.
Examples: 1. a. An inventory of frames is purchased from a supplier b. Stock is sold to a new doctor 2. 3. 4. Supplier of frames inventory is paid A YAG laser is purchased and paid for Stock purchased from departing doctor, to be paid over 12 months
1. a. An inventory of frames is purchased from a supplier Inventory (+) Account Payable (+) b. Stock is sold to a new doctor Cash (+) Stock (+) 2. Supplier of frames inventory is paid Cash (-) Account Payable (-) A YAG laser is purchased and paid for Equipment (+) Cash (-) Stock purchased from departing doctor, to be paid over 12 months Note payable (+) Treasury stock (-)
18 VII. EFFECTS OF TRANSACTIONS ON THE BALANCE SHEET EQUATION (Continued)
If I borrow money, what is effect on Income Statement – Balance Sheet – Earn interest on savings account: Income Statement – Balance Sheet – Pay Malpractice Insurance & Expense it: Income Statement Balance Sheet – Pay for new slit lamp: Income Statement Balance Sheet – Record Depreciation on slit lamp: Income Statement Balance Sheet –
If I borrow money, what is effect on Income Statement – No effect Balance Sheet – Increase Cash, Increase Liability Earn interest on savings account: Income Statement – Increase Interest Income (increase owner equity) Balance Sheet – Increase Cash Pay Malpractice Insurance & Expense it: Income Statement – Increase Expense (decrease owner equity) Balance Sheet – Decrease Cash Pay for new slit lamp: Income Statement – No effect Balance Sheet – Increase Equipment, Decrease Cash Record Depreciation on slit lamp: Income Statement – Increase Depreciation Expense Balance Sheet – Increase Accum. Depreciation (contra asset account)
19 VIII. STATEMENT OF CHANGES IN FINANCIAL POSITION
Reports the sources (inflows) and use (outflows) of cash during the accounting period. It relates to the income statement in that it shows how operations affected cash. It explains the change in cash caused by accounts receivables, inventories, buildings, equipment, etc.
- Operations – Selling goods and services to customers/patients - New Financing – Long-term borrowing or sale of stock - Sale of land, buildings, equipment, etc.
-Dividends - Reduction in financing – repay liabilities, buy its common stock - Buy land, buildings, equipment, etc. (noncurrent assets)
20 VIII. STATEMENT OF CHANGES IN FINANCIAL POSITION (Continued)
Comparative Balance Sheet
Assets Current Assets: Cash Accounts Receivable Optical Inventory Total Current Assets Noncurrent Assets: Equipment Accumulated Depreciation Total Noncurrent Assets Total Assets
Year 1 $ 20,000 15,000 40,000 75,000
Year 2 $ 28,000 45,000 55,000 128,000
210,000 90,000 300,000 $375,000
310,000 100,000 410,000 $538,000
Equity Year 1 Current Liabilities: Accounts Payable – Suppliers Salaries Payable Total Current Liabilities Noncurrent Liabilities: Loan Payable $ 13,000 8,000 21,000 Year 2 $ 33,000 11,000 44,000
Shareholders‟ Equity Stock Retained Earnings 15,000 Total Shareholders‟ Equity 279,000 Total Equity $375,000
35,000 299,000 $538,000
21 VIII. STATEMENT OF CHANGES IN FINANCIAL POSITION (Continued)
Sources of Cash Operations: Net Income $ 20,000 Additions: Depreciation Expense not using cash 10,000 Increased Accounts Payable 20,000 Increased Salaries Payable 3,000 Subtractions: Increased Accounts Receivable 30,000 Increased Optical Inventory 15,000 Cash Provided by Operations 8,000 Proceeds of Loan 100,000 Total Sources of Cash $108,000 Uses of Cash Purchased Laser Total Uses of Cash Net Increase (Decrease) in Cash for Year
$100,000 100,000 $ 8,000
IX. COMPARISON OF BALANCE SHEET ACCOUNTS BASED ON ACCOUNTING BASIS
Assets Cash Investments Notes Receivable Due From Employees Equipment Equipment – Accumulative Depreciation Inventories for Resale Buildings Buildings – Accumulative Depreciation Leasehold Improvements Leasehold Improvements – Accumulative Depreciation Prepaid Insurance Premiums Receivables From Patients A/R – Allowable for Uncollected Accounts Prepaids (other than Insurance Premiums) Liabilities Notes and Loans Payable Payroll Withholdings Payable Construction Contracts Payable Accrued Retirement Plan Contribution Payables to Vendors, Employees, etc. Accrued Employer Payroll Liabilities Patient Deposits Deferred Compensation
Cash X X X X
Modified Cash X X X X X X X X X X X X
Accrual X X X X X X X X X X X X X X X
X X X
X X X X X X
X X X X X X X X
Equity Partnership Contributed Capital Undistributed Earnings Partners‟ Drawing Accounts Current Income/Loss Corporation Stock (Common, Preferred, Treasury) Contributed Capital in Excess of Par Dividends Retained Earnings Current Income/Loss LLC‟s LLP‟s Members‟ Capital Members‟ Distributions Current Income/Loss
X X X X
X X X X
X X X X
X X X X X
X X X X X
X X X X X
X X X
X X X
X X X
23 X. FINANCIAL STATEMENT ANALYSIS A. Rate of Return on Assets: Measures a company‟s operating performance in using assets. Profitability Measure.
Net Income + Interest Expense (Net of Income Tax Savings) Average Total Assets Net Income Interest Expense Tax Rate Total Assets Jan. 1 Total Assets Dec. 31 $100.00 $ 15.00 40% $550.00 $650.00
Rate of Return =
$100 .00 15.00 (15.00 X .40) 100 15 6 109 = = = 18.1666% 600 600 1 / 2(550 650 )
For each dollar of assets used, we earned $.1817 before payments to suppliers of capital. B. Accounts Receivable Turnover/Days in AR – This ratio indicates the number of days that it takes your accounts receivable to turn over. 1st Method AR Turnover =
Net Re venue AverageAccounts Re ceivable
Net Revenue Accounts Receivable 1/1 Accounts Receivable 12/31
$300,000 50,000 70,000
$300 ,000 $300 ,000 = = 5 times per year turnover 1 / 2(50,000 70,000 ) 60,000
Days in Accounts Receivable =
365 days 365 = = 73 days ARTurnover 5
24 X. FINANCIAL STATEMENT ANALYSIS (Continued) 2nd Method Average Collection Period = Accounts Receivable Net Annual Billing Days in Year $160,000 800,000 365 ACP =
AccountsRe ceivable AverageDailyBilling
160 ,000 160 ,000 = = 73days 800 ,000 365 2,191 .78
C. Inventory Turnover – Reflects how many times the inventory is sold during the period.
InventoryTurnover AnnualCostofOpticalGoodsSold = AverageInventory TimesPerYe ar
365 Days TurnoverRate
Annual Cost of Optical Goods Sold Inventory 1/1/xx Inventory 12/31/xx
$96,000 14,000 18,000
96,000 96,000 = = 6 times (14,000 18,000 ) 2 16,000
365 = 60.83 days 6
Average Days in Inventory =
D. Current Ratio =
This liquidity ratio indicates the ability of the practice to meet its current obligations. This is a common liquidity ratio but its trends are difficult to interpret. An equal increase in current assets and current liabilities results in a decline in the ratio and an equal decrease results in an increase in the ratio (if assets exceed liabilities). We are looking for a number greater than 1.00.
25 X. FINANCIAL STATEMENT ANALYSIS (Continued)
Cash MarketableSecurities Accounts Re ceivable E. Quick Ratio = CurrentLiabilities
This liquidity is also known as the acid test ratio. Only the current assets that can be quickly converted into cash are included in the numerator. A careful analysis should be done to decide whether receivables should be included and inventory excluded because the inventory might be converted into cash more quickly than the receivables.
F. Working Capital Ratio =
Working Capital is assets minus liabilities. This ratio measures the turnover of inventory and receivables into cash.
G. Gross Profit Ratio A profitability ratio that measures the effect of cost of goods sold on revenue. Gross Profit Ratio =
Total Re venue CostofGoodsSold Total Re venue
Optical Sales $100,000 Lens and Frame Cost - 35,000 GPR =
100 ,000 35,000 65,000 = = 65% 100 ,000 100 ,000
Therefore, 65 cents of every dollar of sales is available to cover other expenses and to yield a profit.
26 X. FINANCIAL STATEMENT ANALYSIS (Continued)
H. Net Profit Ratio A profitability ratio that measures the profit (Net Income) after paying for lens, frames and all other expenses. Net Profit Ratio =
Optical Sales 100,000 Lens and Frames Cost 35,000 Other Expenses 30,000 NPR =
35,000 100 ,000 35,000 30,000 = = 35% sales 100 ,000
Therefore, 35 cents of every dollar of sales is available to owners.
I. Gross Collection Ratio This ratio indicates the revenue that is collected from each dollar charged. From this ratio, you can estimate the amount of services that must be rendered to provide a certain level of collections. Gross Collection Ratio =
NetCollections GrossCh arg es
This ratio is a function of your gross charges and may not be a good benchmarking statistic.
J. Net Collection Ratio This ratio indicates the revenue that is collected from each dollar of net charges. Net charges are defined as gross charges less contractural adjustments. A collection ratio of less than 100 percent would occur from bad debts and/or an increase in accounts receivable. Net Collection Ratio = K. Contribution Margin Revenues minus Direct Cost = Contribution Margin (Amount available to cover fixed costs)
NetCollections NetCh arg es
27 XI. PAYROLL ACCOUNTING
A. Employer Taxes 1. Federal Unemployment Rate - .008 on the first $7,000 of wages paid Paid each quarter, but filed annually on Form 940/940EZ
2. State Unemployment Rate – Experience Based Filing – Quarterly
B. Employer/Employee Taxes 1. Medicare Tax Rate – 1.45% on all wages paid during the calendar year. Paid with each payroll, filed quarterly on Form 941
2. Social Security Tax Rate – 6.2% on all wages paid up to the Social Security wage base. Currently $87,900 for 2004 Paid with each payroll, filed quarterly on Form 941 Sometimes these two taxes are referred to as FICA taxes with a combined rate of 7.65%.
3. Federal and State Income Tax Withholding. C. Workers‟ Compensation Rates are generally set by each state for each employee classification.
D. Section 125 Plans
E. Work Time Straight Time Overtime Comp Time
28 XII. INTERNAL CONTROLS
A. Elements of a System 1. An organizational plan that provides a segregation of responsibilities. Must provide clear lines of authority and responsibility. No department should control the accounting records relating to its own operations. No one person should control all phases of a transaction without the intervention of some other person who provides a cross-check. The initiation and authorization of a transaction should be separated from the recording and custody of the asset. 2. A system for authorizing and recording transactions that provides reasonable accounting controls. Chart of accounts. Procedure manuals. 3. Sound practices to be followed in carrying out organizational responsibilities. Division of duties. Employment authorization forms. Payroll rate authorization forms. Competitive quotes from several vendors. Independent count of merchandise received. Bonding of employees. 4. The number and quality of personnel adequate to do the job. Match qualification of personnel with position. Provide adequate employee training. Develop means of measuring employee performance.
B. Managements Responsibilities Management is responsible for initiating, installing and supervising a system of internal control to protect corporate assets. Then, management must monitor the system to determine that it continues to meet its purpose.
29 XII. INTERNAL CONTROLS (Continued)
C. Internal Control Procedures
An effective internal control system provides for custody over cash and other assets and protects it from theft. The following procedures are necessary to provide effective controls by segregating cash handling, record keeping, and verification. 1. 2. 3. 4. 5. 6. Handling cash should be limited to specific persons designated as responsible for its accountability. Each cash receipt should be recorded immediately upon receipt. All fee tickets (charge slips) should be controlled and accounted for. Cash receipts should be deposited daily. Ideally, only petty cash should be kept overnight. Any cash kept on premises should be locked in a secure place. Persons who handle cash should be bonded. Persons who receive over-the-counter payments should not be permitted to post to accounts receivable unless there is adequate control over charge slips and receipts to provide accountability. Missing ticket reports must be worked. Persons who receive mail payments should not be permitted to post to accounts receivable. All non-contractural adjustments to accounts should be approved by someone other than the person who records them. Approved vs. posted adjustments should be reconciled daily by someone other than the posting person. Refunds should be reviewed and approved by someone independent of the preparation process. The authority to purchase should be segregated from the person who makes payment of purchase. Supplies should be received by someone other than the person ordering and other than the person approving payment. Payments should be by check unless authorized from petty cash. Checks should be prenumbered and locked in a secure place. Check signers should have all supporting documents with the checks. Cash balances should be verified daily through a daily cash report. Monthly bank reconciliations should be made by a person who does not maintain the records nor has custody over cash receipts or payments. Perform periodic physical inventory.
9. 10. 11. 12. 13. 14. 15. 16.
30 XII. INTERNAL CONTROLS (Continued)
D. Internal Control Checklist
Cash Fund Petty cash or change fund maintained (imprest system) A custodian is responsible for this fund Fund reimbursement is made directly to this custodian Custodian has no access to accounting records Physically secure place for fund storage Surprise audits conducted periodically Rule: no employee check cashing Cash Receipts All cash custodians bonded All cash receipts deposited daily Daily list of mail receipts Daily reconciliation of fee tickets (charge slips) Daily reconciliation of cash collections required Cashier personnel separated from accounting duties Cashier personnel separated from credit duties Cash custodian apart from negotiable instruments Bank account properly authorized Comparisons made between duplicate deposit slips and detail of accounts receivable Comparisons made between duplicate deposit slips and cash book Cash Disbursements Preparation and check signing functions completely separate Support required for check signature Control exercised if check-signing machine used Limited authorization to sign checks No access to cash records or receipts by check signers Detailed listing of checks required Check listings compared with cash book No checks payable to cash are allowed Checks are prenumbered Physical control over unused checks Mutilation required of voided checks All disbursements made by check unless specifically authorized from petty cash Control over and prompt accounting for interbank transfers Bank Reconciliation Reconciliation between bank and books conducted at least monthly Person responsible for reconciling bank statement is independent from accounting or cashier duties Bank statement sent directly to the person responsible for reconciliation
31 XIII. OVERHEAD ANALYSIS
A. Basis of Calculations Overhead =
ExpenseofItem TotalNetPa tientCollections
B. Important Ratios Personnel (30.26) Occupancy ( 7.57) Marketing ( 1.13) Total (53.86)
C. Other Bases Per FTE Provider Per Square Foot Per Physician Work RVU Per Patient
D. Benchmarking The process of analyzing and comparing performance measures with other practices.
1. Bases for Comparison National Data – MGMA Specialty Society Data Other Local Practices
2. Fallacies to Consider Unique Practice Characteristics Location Patient Mix Service Mix Practice Style
E. Expense Classification
32 XIV. RELATIVE VALUE UNITS Relative Value Units (RVU‟s) – The Resource Based Relative Value Scale adopted RVU‟s to represent the value of services. There are three components as follows: A. Physician work expense. B. Practice overhead expense. C. Practice malpractice expense.
Procedure code 99213 was originally given an RVU of one and all other services were scaled from that code. To adjust the national RVU‟s for regional cost differences, geographic practice cost indices (GPCI‟s) were established for each component.
33 XV. ESTABLISHING A FEE SCHEDULE RVU‟s For most practices, the charges for each service were not established using the RBRVS system. We priced each service so that our charge was equal to or greater than the highest allowable from any payor. Therefore, using the assigned RVU‟s to develop a fee schedule may require repricing all services.
Costs Determine total costs, including desired physician compensation. Divide total costs by total RVU‟s to arrive at cost per RVU. For each procedure code, multiply cost per RVU by the RVU‟s assigned to that code.
Payor Contracts As mentioned above, a common practice is to price each service to assure the price equals or exceeds the highest amount paid by any payor. Use in Auditing EOB‟s Load allowables of each payor into your practice management system if it allows. Otherwise, you are relying on personnel to catch payment errors.
34 XVI. COST ACCOUNTING
A. Purposes Setting Fees Break-even Analysis Adding or dropping a service Contract Negotiation
B. Type Costs Fixed Variable Step Variable
C. Costing Methods Traditional Relative Value Units Activity-Based Costing
D. Break-Even Analysis Direct Cost – If the service stops the cost typically stops. Indirect Cost – Costs that do not vary with the volume of services.
36 XVI. COST ACCOUNTING (Continued)
B. Type Costs
Incremental costs will reduce per unit profit initially. Potential increases in volume must be sufficient to justify incurring incremental costs.
Break-Even Analysis Fixed Costs Per $Revenue 1.60 .80 .533 .40 .32
Revenue 100,000 200,000 300,000 400,000 500,000
Fixed Costs 160,000 160,000 160,000 160,000 160,000
Variable Costs* 20,000 40,000 60,000 80,000 100,000
Net Margin (80,000) -080,000 100,000 180,000
Per Unit Margin <.80> -0.267 .25 .36
*20% of revenue
37 XVI. COST ACCOUNTING (Continued)
C. Cost Methods Traditional – Indirect and support costs are assigned to cost centers. These costs are then assigned to outputs (revenue centers) based on volumes of items such as labor, machine hours, units produced, etc. This method will provide inaccurate information when the cost center resources are not u sed in proportion to the basis upon which they were allocated. Relative Value Units – This costing method is easy to use but is not good for decision making. Basically, all practice costs, except physician salary and benefits, are divided by the total Relative Value Units to obtain a cost per RVU. Each service is then assumed to generate costs directly proportional to the RVUs for that service. Costs are not associated to a service based on the use of those resources represented by the costs. Activity Based Costing – This method allocates all costs to services based on resource utilization. It requires an understanding of the relationship between cost and services. To identify the best indicators of the cost relationship requires an analysis of all activities performed in the practice and determination of the resources used to perform each activity and what drives costs. Cost drivers are used as the bases for assigning the costs to the services. A drawback of this method is its high implementation cost.
D. Break-Even Point Analysis To determine whether or not to add a new service, we often calculate the number of services required to break even. This calculation requires use of the contribution margin concept. The contribution margin is the excess of revenue over variable costs. The contribution margin less fixed costs yields net income.
Contribution Margin Income Statement Charges $500,000 Variable Costs 100,000 Contribution Margin 400,000 Fixed Costs 150,000 Operating Income 250,000
Based on the above income statement, variable costs are 20 percent of charges. Therefore, 80 percent of each dollar of charges is available to cover fixed costs. When sales reach a level that the contribution margin equals fixed costs, we have a break-even level of sales.
38 XVI. COST ACCOUNTING (Continued)
Break-even Sales =
150 ,000 .80
FixedCosts ContributionM arg inperDollarofSales
BES = $187,500
Contribution Margin Income Statement at Break-Even Sales Charges $187,000 Variable Costs 37,500 (20% of Sales) Contribution Margin $150,000 Fixed Costs 150,000 Operating Income -0-
39 XVII. BUDGETING The budget provides a basis for setting priorities, allocating resources, and monitoring and controlling revenues and costs. A. Benefits 1. To project cash flows 2. To manage effectively thru planning and monitoring 3. Establish benchmarks for performance evaluation.
B. Components of a Budget 1. Operating Budget 2. Capital Budget 3. Cash Flow Statement
C. New Services 1. Estimating Volume 2. Payor Allowables 3. Line Item Expenses 4. Financing Requirements
40 XVIII. FINANCING A. Operating Costs 1. Retain Portion of Profit 2. Line of Credit
B. Capital Equipment Purchases 1. Leasing 2. Bank Loans 3. Retained Earnings
41 XIX. CORPORATE STRUCTURE AND TAX IMPLICATIONS
A. Sole Proprietor No protection between you and your business. Personal assets are at risk. No record keeping requirements by Secretary of State. B. Partnership Owners are called partners (Must have at least two or more) Not a tax paying entity. (Activity of business flows thru to partners) Can be formed with a verbal agreement. Partners are jointly and severally liable for the actions of other partners. No limit on types of owners. Files document with the Secretary of State Limited partners are not liable for partnership debt and only their investment is at risk. There has to be a general partner responsible for management. C. Corporation Owners are called stockholders (2 or more). Separate legal entity. Has perpetual life. A tax paying entity (except when Subchapters Selection is made). File Articles of Incorporation with the Secretary of State. Statutory requirement for meetings, minutes, and resolutions. Shareholders are generally not liable for debts of the corporation. Subchapter S Status – a) allows taxation treatment similar to partnership. b) stringent rules to maintain status. c) limited to 75 owners. d) owners must be individuals, estates or trusts. e) corporation cannot own more than 80 percent of the stock of other corporations and may not be part of an affiliated group. D. Limited Liability Company Owners are called members (2 or more). Separate legal entity like a corporation. Treated as a partnership for tax purposes since 1988. File Articles of Organization with the Secretary of State. No statutory necessity to keep minutes, hold meetings, or make resolution. No member is personally responsible for its debts.
42 XV. CORPORATE STRUCTURE AND TAX IMPLICATIONS (Continued)
The LLC can have any two of the following and still retain its partnership tax status: a) Limited Liability b) Continuity of Life c) Centralized management d) Free transferability of interests Requires carefully drafted Operating Agreement Advantages over “C” Corporations No corporate-level tax; Ability to specially allocate money and losses; No double-tax on liquidation; Property with debt in excess of basis may be contributed to an LLC and can be structured to avoid gain recognition; A person contributing appreciated assets to an LLC in exchange for membership interests is not required to recognize gain on exchange; Stock for services is always taxable; receipt of an interest in an LLC for a profits interest is generally not taxable; and Liquidating and nonliquidating distributions of appreciated property from an LLC are generally received without gain. Advantages over “S” Corporations The pass through treatment of S corporations is neither as flexible nor as advantageous as the pass through treatment of partnerships; LLCs can have more than 35 members, whereas S Corporations may not have more than 35 shareholders. Corporations, partnerships, certain trusts, and nonresident aliens cannot be shareholders of an S Corporation, but they may be members of an LLC; S Corporations may only have one class of stock and income and losses must be allocated among the shareholders pro-rata. LLCs permit non-pro-rata distributions and special allocations of profits and losses, provided such allocations have substantial economic effect within the meaning of IRC Section 704(b); Failing to satisfy the requirements to be an S Corporation results in the loss of eligibility and C Corporation status. The risk is avoided with LLCs. The tax basis of LLC assets may be stepped-up at death of a member under Section 754, whereas the inside basis of an S Corporation‟s assets may not be stepped-up; and
43 XV. CORPORATE STRUCTURE AND TAX IMPLICATIONS (Continued)
A member‟s adjusted basis in its membership interest is increased by its share of debt in the LLC; whereas an S Corporation‟s debt does not increase shareholder‟s stock basis.
Advantages over Limited Partnerships Limited partners may jeopardize their limited liability by participating in control of the business of the partnership. Members of an LLC, on the other hand, are permitted to be active in the LLC‟s business while retaining limited liability; No member is required to have the general liability of a general partner; and Members are not automatically classified as limited partners under the passive loss rules.
Advantages over General Partnerships Members of an LLC are not jointly and severally or unlimitedly liable for partnership liabilities.
Accounting: A system for measuring the results of business activities and communicating those measurements to interested users. We will consider the concepts and procedures used by accountants to make these measurements. Accounts Payable: Amounts on open account owed by the organization to outside persons or entities for goods and services received by the organization. These accounts are usually control accounts for individual accounts payable balances that may be contained in a subsidiary ledger. Accounts Receivable: The open account amounts (debts) owed to the organization by other entities (including customers, patients and third-party payers) as a result of the services provided to its customers and patients. Amounts assigned to “Accounts receivable” are due to “Gross feefor-service charges.” Assignment of a charge into Accounts receivable” is initiated at the time an invoice is submitted for payment. For example, if an obstetrics practice establishes an open account for accumulation of charges when a patient is accepted into a prenatal program, and the charges will not be posted until after delivery, then “Accounts receivable” will not reflect these charges until an invoice is created. Deletion of charges from “Accounts receivable” is done when the account is paid, turned over to a collection agency or written off as a bad debt. “Accounts payable (refunds) to patients and payers” are subtracted from “Accounts receivable” before reporting “Accounts receivable.” Accrual Basis of Accounting: An accounting method where revenues are recorded as earned when services are performed rather than when cash is received. Cost is recorded in the period during which it is incurred, that is, when the asset or service is used, regardless of when cash is paid. Costs for goods and services that will be used to produce revenues in the future are reported as assets and recorded as costs in future periods. The accrual method balance sheet includes not only the assets and liabilities from the ash basis balance sheet, but also includes the receivables from patients, prepayments, and deferrals of costs, accruals of costs and revenues and payables owed to suppliers. Accrued Liabilities: Current liabilities accrued at the end of an accounting period to reflect the proper amount of expenses for the organization under the accrual basis of accounting. Generally, no invoices or other billings are received within the accounting period, and the liability for these items is estimated or obtained from other sources. Acquisition (Historical) Cost: The cash or cash-equivalent paid to acquire an asset. (Balance Sheet) Allowance for Estimated Uncollectible Receivables: Estimated amount of uncollectible receivables. An historical analysis of bad debt write-offs as well as contractual adjustments is usually required to determine periodic credits to this account. Amortization: As a general rule, amortization is used to record the consumption or utilization over time of intangible property. Accumulated amortization is a contra-account to the related intangible asset. Amortization is recorded periodically, that is monthly, as an expense of the
45 profit/loss or income statement. amortization. The offsetting entry is to increase (credit) accumulated
Assets: Resources owned by the business. Assets may be tangible (physical in character) such as land, buildings and equipment, or a direct right to tangible property such as amounts due from patients and third-party agencies, or they can be intangible such as goodwill, patents, licenses and leaseholds. Bad Debt Expense: This account is used for uncollectible accounts receivable and notes receivable. An historical analysis of bad debt write-offs is usually required to determine periodic credits to this account. Other methods may be used, but a consistent and justifiable method of estimating the periodic charge to provision for bad debts (and the corresponding credit to either the Allowance for Estimated Uncollectible Receivables account or the Allowance for Bad Debts – Patients Account) should be applied systematically. Balance Sheet: Also known as the Statement of Financial Position because it lists the organization‟s assets, liabilities and owners‟ equity (capital) at a particular point in time. It is a snapshot of the financial situation on a given date. Capital Leases: A capital lease meets any of the following criteria: Lease transfers ownership to lessee during or at the end of the lease term. Lease contains a bargain purchase option. Lease term (including any bargain renewal options) is 75 percent or more of estimated economic life of property. Present value of the minimum lease payments (excluding tax credits and executory costs, for example, maintenance, taxes and insurance) equals 90 percent or more of fair market value of leased property, minus investment tax credit. Capitalization: Expensing of the costs of furniture, fixtures and equipment over time. A common criterion for capitalization is a unit cost of $500 or more. Other criteria for capitalization include: A unit cost sufficiently large to justify the cost of control incident to an equipment or property ledger. Depreciable life of two years or more but less than the life of buildings to which the equipment or fixtures may be affixed. Used in organizational operations. Sufficient individuality and size to make control feasible by means of identification tags or numbers. Capitation: A set amount of money received or paid out according to an managed-care contract. Also known as a “cap rate,” capitation is based on the number of enrollees in a health plan (membership) rather than on actual services delivered. It is usually expressed in units of permember per-month (PMPM). A health plan may adjust the capitation rate based on such factors as age and sex of the enrollee. A capitation contract is one in which the practice agrees to provide medical services to a defined population for a fixed price per beneficiary per month, regardless of the actual services provided. Capitated contracts, which always contain an element of risk, include commercial HMO, Medicare and Medicaid capitation contracts.
46 Cash-Basis Accounting: An accounting method where revenues are recorded when cash is received and costs are recorded when cash is paid out. Receivables, payables, accruals and deferrals arising from operations are ignored. On a pure cash basis, long-lived (fixed) assets are expensed when acquired, leaving cash and investments as the only assets, and borrowings and payroll withholdings as the only liabilities. Chart of Accounts: A coding structure that provides the framework from which financial statements and management reports can be developed. Collection Agency Write-Offs: Any accounts turned over to a collection agency. corresponding accounts receivable should be credited. The
Common Stock: A type of stock whereby equity claims are held by the “residual owners” of the organization, who are the last to receive any distribution of earning or assets. It represents the stated or par value of stock issued to owners. Contractural Write-Offs: Differences between adjusted gross charges and the amount actually collected as settlements for particular accounts. These write-offs may be the result of negotiating a payment less than adjusted gross charges with an individual patient or third-party agency (contractural adjustment). Corporation: A for-profit organization recognized by law as a business entity separate and distinct from its shareholders. A medical practice organized as a corporation can either be a „C‟ corporation or a „S‟ corporation as designated by the Internal Revenue Code. The primary difference between these two types of entities is the way they are taxed and how distributions are made. A „S‟ corporation is a flow-through entity, meaning all the income whether or not distributed is taxed at the individual shareholder level. A „C‟ corporation can retain earnings and be taxed at both a corporate and individual level if there are dividend distributions. See also Business Corporation, Professional Corporation. Current Assets: Cash and other assets that are expected to be converted to cash, sold or consumed in the normal course of operations within one year. Current Liabilities: Liabilities that mature and require payment from current assets or through the creation of other liabilities within one year. Current Net Realizable Value: The net amount of cash you would receive if the asset was sold. Current Replacement Cost: The cash or cash-equivalent paid to acquire an asset with equivalent service potential of the asset being replaced. Deferred Revenue: Revenue received in one period applicable to services to be rendered in some future period. Deficit: The excess of expenses and other outflows over revenues and other inflows. Depreciation: As a general rule, depreciation is used to record the consumption or utilization over time of tangible property. Accumulated depreciation is a contra-account to the related fixed
47 asset. Depreciation is recorded periodically, that is monthly, as an expense on the profit/loss or income statement earnings in the statement of operations. The offsetting entry is to increase (credit) accumulation depreciation. Donated Capital: Increase in owners‟ equity due to assets contributed to the corporation. Financial Accounting: The preparation of reports for use by persons outside a company (bank, investors). The need for some degree of uniformity requires that these reports are more standardized than those used in managerial accounting and this standardization is provided by the application of “generally accepted accounting principles” (GAAP). GAAP is developed by the Financial Accounting Standards Board (FASB) and the Securities and Exchange Commission (SEC). Financial Accounting Standards Board (FASB): The official rule-making body in the private sector. It establishes a broad set of financial reporting objectives to guide the financial reporting process and issues statements of Financial Accounting Standards. Goodwill: Gross Charges - FFS Equivalents for Capitation Plan Patients: Gross charges under capitation contracts for assigned enrollees under a patient-care contract are recorded in this account. This account is used to record accrual-basis revenues under risk-sharing arrangements such as bonuses and risk-pool allocations; however, the Fees Collected account series should be used to reflect revenues actually collected on these accounts. Gross Charges: Established usual and customary rates are the full price for services before charge restrictions imposed by Medicare or contractural adjustments required by third-party payers, such as commercial insurance carriers or other adjustments. Services include all medical/surgical services provided by physicians and midlevel providers as well as professional and technical components of ancillary services such as radiology and laboratory. Income Statement: It is a measure of the results of operations representing the difference between revenue and expense for the reported period. The income statement is used to summarize results of business operations for a period of time, not longer than one year, to determine if the organization is operating efficiently. Incurred But Not Reported (IBNR): This liability represents claims that the organization is legally responsible to pay for services it has contracted with a managed care organization for on a capitated basis and pays to subcontractors on a fee-for-service basis. It is an amount of money that the organization accrues for future medical expenses. These are medical expenses that the authorization system has not captured and for which claims have not yet been processed. IBNR can be calculated in a number of ways. The most common method is to track the history of claims payment for the specific organization to determine a claims‟ lag ratio and apply this ratio to current operations. IBNR can also be calculated actuarially based on anticipated utilization of a specific population. Another practical approach is to determine the number of referrals authorized but not billed as of a particular date and apply an average claim amount to these open referrals.
48 Intangible Assets: Property rights without physical substance that will benefit future operations of the organization. Intangible assets are purchased from external sources, provide future benefit and are relatively long-lived. Other assets include long-term prepayments, deferred charges, goodwill and assets not included in other categories. Intercompany Accounts Payable: consolidated for financial purposes. Amounts owed by the organization to other entities
Intercompany Receivables: Amounts owed to the organization by other entities consolidated for financial reporting purposes. Interest Expense: Interest incurred on borrowings. Interest Income: Interest earned on marketable securities, certificates of deposit, savings accounts and/or other short-term investments. Liabilities: Liabilities are debts or obligations owed by the organization to creditors. These debts arise as a result of the purchase of goods and services from others on credit and through cash borrowings to finance business operations. Liabilities are also obligations of responsibility to transfer other assets or to provide services to another entity. Limited Liability Company: A legal entity that is a hybrid between a corporation and a partnership providing limited liability to owners like a corporation, while passing profits and losses through to owners like a partnership. Long-Term Assets: Assets that are not expected to be converted to cash, sold or otherwise consumed in the normal course of operations within one year. Long-Term Liabilities: Liabilities that will mature and require payment at some future time beyond one year. Managerial Accounting: The preparation of reports for use by persons within a company. Modified Cash-Basis Accounting: An accounting method that is primarily a cash-basis system as previously defined, but allows the cost of long-lived (fixed) assets to be expensed through depreciation. The modified cash system recognizes inventories of goods intended for resale as assets. Under a modified cash system, purchases of buildings and equipment, leasehold improvements, and payments of insurance premiums applicable to more than one accounting period are normally recorded as assets. Costs for these assets are allocated to accounting periods in a systematic manner over the length of time the practice benefits from the assets. Net Assets: Excess of the not-for-profit entity‟s assets over its liabilities. The balances in these accounts are the cumulative results of original investments, grants, gifts, donations, and revenues and expenditures. Noncurrent Expenses Paid in Advance: Costs incurred (payments) for goods or services that will benefit future operations (beyond a year).
49 Nonoperating Revenues: Revenues not directly related to patient care or the provision of medical services. Notes Payable – Long-Term: Notes payable that mature more than one year from financial statement date. The current portion of any long-term liability should be included in Long-Term Debt – Current Portion, except those obligations to be refinanced or paid from a sinking fund. Notes Receivable – Short-Term: Amounts owed to the organization by other entities where the obligation is represented by a note with a maturity of one year or less. Occupancy Expense: Expenses related to the occupancy and use of land and buildings. In the event that another legal entity owns the land or buildings, any rental fees, commissions or charges paid to the other entity are charged to this account. For the purpose of peer comparison (for example, comparative data or cost survey), a fair market rental value may be charged to this account even if no rent is otherwise charged to the organization by the owning entity. Operating Expenses: Expired costs incurred in the process of providing medical services to the organization‟s patients. Excludes all costs pertaining to nonoperating activities such as general investments, endowments, etc. Operating Subsidy Income: Operational support (operating subsidies) received by medical practices from a parent organization such as a hospital, health system, PPMC, MSO or other large integrated system. Organizational Costs: Costs incurred in the original incorporation and start-up of a business operation. These costs are generally amortized over a period of five years. Owners’ Equity: A residual interest or claim of the owners to the assets after creditor claims are settled. (Legally, creditors are first in line to receive reimbursement.) Owners‟ equity derives from two sources: 1) contributed capital, which is the investment of cash or other assets by the owner or owners; and/or 2) retained earnings, the accumulative results of income, less losses and withdrawals over the years. Partnership: A legal entity where two or more individuals have agreed that they will share profits and losses and assets and liabilities, although not necessarily on an equal basis. The partnership agreement is typically formalized in writing. Patient Refunds: Refunds of amounts collected from patients that should not have been collected or that need to be returned for some other reason. The corresponding credit is cash or accounts payable. This account should be used only if the specific revenue in which the payment was originally recorded is not used. Payroll Tax Withholdings Payable: Actual liabilities for Payroll Tax Withholdings. These accounts are credited (increased) for amounts withheld from employees and are debited (decreased) when payment is made to the appropriate agency, authority or plan.
50 Preferred Stock: A type of stock whose holders are given certain priority over common stockholders in the payment of dividends and liquidation/termination of the entity. Usually the dividend rate is fixed at the time of stock issue. Prepaid Expenses: Payments for goods or services that will benefit future operations. Professional Corporation: A legal entity whose shareholders must typically all be licensed to practice in the same profession as that practiced by the organization. State law determines whether all shareholders must be licensed. Provision for Cash Basis Conversion: An account used to convert revenues recorded on the accrual basis to collections recorded on the cash basis. This adjustment is optional and is provided for the organization that may wish to compute revenues on both the cash and accrual basis. Realized Gains and Losses – Investments: Gains or losses recognized on closed and sold securities during the period. Retained Earnings: Net income (or loss) over the life of the corporation minus all distributions to owners. Revenue and Expense Summary: A summary account for use in the closing of revenue and expense accounts when financial statements are prepared. Revenues: Inflows of cash and other items of value received or to be received for services rendered. There are different measures of these inflows of cash for fee-for-service (FFS) revenues, depending upon whether the organization identifies gross charges, adjustments and allowances; whether the organization uses the cash, modified cash or accrual basis of accounting; and whether a prepaid plan pays discounted FFS or capitation. Securities Exchange Commission (SEC): The Securities Act of 1933 gave Congress the ultimate legal authority to prescribe accounting methods to be used in preparing financial statements for shareholders of publicly owned corporations. This authority was delegated to the SEC, a federal agency. The SEC delegated most of the responsibility for accounting principle development to the accounting profession. Stockholders’ Equity: Net assets of the corporation; that is, the excess of the corporate entity‟s assets over its liabilities. The balances in these accounts are the cumulative result of the owners‟ investments and the equity originating from net earnings retained by the corporation. Surplus: The excess of revenues and other inflows over expenses and other outflows. Treasury Stock: Capital stock repurchased by the corporation that has not been retired. Treasury stock is usually carried on the balance sheet at acquisition cost. Undistributed Earnings: Difference between revenues and expenses allocated to the partners as earned capital. This account tracks the prior year‟s net earnings/losses.
51 Unrealized Gains and Losses - Investments: The accounting recognition of the difference between the fair market value of carried investments and the adjusted cost (current “book” value) of those investments for the period. Valuation Allowance: Adjustments to investments to reflect the unrealized appreciation or depreciation in the fair market value of the investment at the end of the period. At the end of the period, changes in the fair market value of equity and debt securities of a not-for-profit medical organization should be recorded here. Withhold: A percentage of the primary care capitation rate that is withheld every month and used to cover the cost overruns (excess medical expenses) in referral or organizational services. Typically used in capitation contracts or other risk-sharing arrangements, this account is reconciled at year-end. If the entire amount of the withhold was not required to cover cost overruns, the remainder may be distributed or kept in the account to fund the risk pool as determined by contract terms.
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