1

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

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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

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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

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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

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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

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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

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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

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Unrealized Gains and Losses – Investments

Valuation Allowance

Withhold

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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 $55,000

Add Net Income for 1998 8,000

Subtract Dividends Paid in 1998 3,000

Retained Earnings Dec. 31, 1998 $60,000

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12

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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

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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.

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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).

Classifications

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.

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VII. EFFECTS OF TRANSACTIONS ON THE BALANCE SHEET EQUATION

Each transaction has one of the following effects or combination of effects:

1. Increases both an asset and a liability or shareholders‟ equity

2. Decreases both an asset and a liability or shareholders‟ equity

3. Increases one asset and decreases another asset

4. 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. Supplier of frames inventory is paid

3. A YAG laser is purchased and paid for

4. 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 (-)

3. A YAG laser is purchased and paid for

Equipment (+) Cash (-)

4. Stock purchased from departing doctor, to be paid over 12 months

Note payable (+) Treasury stock (-)

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VII. EFFECTS OF TRANSACTIONS ON THE BALANCE SHEET EQUATION (Continued)

Examples:

5. If I borrow money, what is effect on

Income Statement –

Balance Sheet –

6. Earn interest on savings account:

Income Statement –

Balance Sheet –

7. Pay Malpractice Insurance & Expense it:

Income Statement -

Balance Sheet –

8. Pay for new slit lamp:

Income Statement -

Balance Sheet –

9. Record Depreciation on slit lamp:

Income Statement -

Balance Sheet –

5. If I borrow money, what is effect on

Income Statement – No effect

Balance Sheet – Increase Cash, Increase Liability

6. Earn interest on savings account:

Income Statement – Increase Interest Income (increase owner equity)

Balance Sheet – Increase Cash

7. Pay Malpractice Insurance & Expense it:

Income Statement – Increase Expense (decrease owner equity)

Balance Sheet – Decrease Cash

8. Pay for new slit lamp:

Income Statement – No effect

Balance Sheet – Increase Equipment, Decrease Cash

9. Record Depreciation on slit lamp:

Income Statement – Increase Depreciation Expense

Balance Sheet – Increase Accum. Depreciation (contra asset account)

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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.

A. Sources - Operations – Selling goods and services to customers/patients

- New Financing – Long-term borrowing or sale of stock

- Sale of land, buildings, equipment, etc.

B. Uses -Dividends

- Reduction in financing – repay liabilities, buy its common stock

- Buy land, buildings, equipment, etc. (noncurrent assets)

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VIII. STATEMENT OF CHANGES IN FINANCIAL POSITION (Continued)

Comparative Balance Sheet

Assets Year 1 Year 2

Current Assets:

Cash $ 20,000 $ 28,000

Accounts Receivable 15,000 45,000

Optical Inventory 40,000 55,000

Total Current Assets 75,000 128,000

Noncurrent Assets:

Equipment 210,000 310,000

Accumulated Depreciation 90,000 100,000

Total Noncurrent Assets 300,000 410,000

Total Assets $375,000 $538,000

Equity

Year 1 Year 2

Current Liabilities:

Accounts Payable – Suppliers $ 13,000 $ 33,000

Salaries Payable 8,000 11,000

Total Current Liabilities 21,000 44,000

Noncurrent Liabilities:

Loan Payable 60,000 160,000

Shareholders‟ Equity

Stock

Retained Earnings 15,000 35,000

Total Shareholders‟ Equity 279,000 299,000

Total Equity $375,000 $538,000

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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 $100,000

Total Uses of Cash 100,000

Net Increase (Decrease) in Cash for Year $ 8,000

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IX. COMPARISON OF BALANCE SHEET ACCOUNTS BASED ON ACCOUNTING BASIS

Modified

Assets Cash Cash Accrual

Cash X X X

Investments X X X

Notes Receivable X X X Due From Employees X X X

Equipment X X

Equipment – Accumulative Depreciation X X Inventories for Resale X X

Buildings X X

Buildings – Accumulative Depreciation X X

Leasehold Improvements X X Leasehold Improvements – Accumulative Depreciation X X

Prepaid Insurance Premiums X X

Receivables From Patients X A/R – Allowable for Uncollected Accounts X

Prepaids (other than Insurance Premiums) X

Liabilities

Notes and Loans Payable X X X

Payroll Withholdings Payable X X X Construction Contracts Payable X X X

Accrued Retirement Plan Contribution X X

Payables to Vendors, Employees, etc. X Accrued Employer Payroll Liabilities X X

Patient Deposits X X

Deferred Compensation X

Equity

Partnership

Contributed Capital X X X

Undistributed Earnings X X X Partners‟ Drawing Accounts X X X

Current Income/Loss X X X

Corporation Stock (Common, Preferred, Treasury) X X X

Contributed Capital in Excess of Par X X X

Dividends X X X Retained Earnings X X X

Current Income/Loss X X X

LLC‟s LLP‟s

Members‟ Capital X X X

Members‟ Distributions X X X

Current Income/Loss X X X

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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 $100.00

Interest Expense $ 15.00

Tax Rate 40%

Total Assets Jan. 1 $550.00

Total Assets Dec. 31 $650.00

Rate of Return = )650550(2/1

)40.00.15(00.1500.100$ X =

600

615100 =

600

109 = 18.1666%

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 = ceivableountsAverageAcc

venueNet

Re

Re

Net Revenue $300,000

Accounts Receivable 1/1 50,000

Accounts Receivable 12/31 70,000

)000,70000,50(2/1

000,300$ =

000,60

000,300$ = 5 times per year turnover

Days in Accounts Receivable = ARTurnover

days365=

5

365 = 73 days

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X. FINANCIAL STATEMENT ANALYSIS (Continued)

2nd

Method

Average Collection Period = lyBillingAverageDai

ceivableAccountsRe

Accounts Receivable $160,000

Net Annual Billing 800,000

Days in Year 365 ACP = 365000,800

000,160=

78.191,2

000,160= days73

C. Inventory Turnover – Reflects how many times the inventory is sold during the period.

arTimesPerYe

urnoverInventoryT =

entoryAverageInv

oodsSoldofOpticalGAnnualCost

nHandInventoryo

sAverageDay=

teTurnoverRa

Days365

Annual Cost of Optical Goods Sold $96,000

Inventory 1/1/xx 14,000

Inventory 12/31/xx 18,000

Turnover = 2)000,18000,14(

000,96=

000,16

000,96= 6 times

Average Days in Inventory = 6

365= 60.83 days

D. Current Ratio = bilitiesCurrentLia

etsCurrentAss

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.

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X. FINANCIAL STATEMENT ANALYSIS (Continued)

E. Quick Ratio = bilitiesCurrentLia

ceivableAccounts

SecuritiesMarketableCash

Re

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 = lkingCapitaAverageWor

Sales

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 = venueTotal

sSoldCostofGoodvenueTotal

Re

Re

Optical Sales - $100,000

Lens and Frame Cost - 35,000

GPR = 000,100

000,35000,100 =

000,100

000,65 = 65%

Therefore, 65 cents of every dollar of sales is available to cover other expenses and to

yield a profit.

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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 = Sales

NetIncome

Optical Sales 100,000

Lens and Frames Cost 35,000

Other Expenses 30,000

NPR = sales

000,30000,35000,100 =

000,100

000,35 = 35%

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 = esGrossCh

ionsNetCollect

arg

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 = esNetCh

ionsNetCollect

arg

K. Contribution Margin

Revenues minus Direct Cost = Contribution Margin (Amount available to cover fixed

costs)

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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

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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.

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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. Handling cash should be limited to specific persons designated as responsible for

its accountability.

2. Each cash receipt should be recorded immediately upon receipt.

3. All fee tickets (charge slips) should be controlled and accounted for.

4. 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.

5. Persons who handle cash should be bonded.

6. 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.

7. Persons who receive mail payments should not be permitted to post to accounts

receivable.

8. 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.

9. Refunds should be reviewed and approved by someone independent of the

preparation process.

10. The authority to purchase should be segregated from the person who makes

payment of purchase.

11. Supplies should be received by someone other than the person ordering and other

than the person approving payment.

12. Payments should be by check unless authorized from petty cash. Checks should

be prenumbered and locked in a secure place.

13. Check signers should have all supporting documents with the checks.

14. Cash balances should be verified daily through a daily cash report.

15. Monthly bank reconciliations should be made by a person who does not maintain

the records nor has custody over cash receipts or payments.

16. Perform periodic physical inventory.

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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

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XIII. OVERHEAD ANALYSIS

A. Basis of Calculations

Overhead = ctionstientColleTotalNetPa

temExpenseofI

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

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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.

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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.

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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.

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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

Revenue

Fixed

Costs

Variable

Costs*

Incremental

Costs

Net

Margin

Fixed Costs

Per

$Revenue

Per Unit

Margin

100,000 160,000 20,000 (80,000) 1.60 <.80>

200,000 160,000 40,000 -0- .80 -0-

300,000 160,000 60,000 80,000 .533 .267

400,000 160,000 80,000 60,000 100,000 .40 .25

500,000 160,000 100,000 60,000 180,000 .32 .36

*20% of revenue

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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.

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XVI. COST ACCOUNTING (Continued)

Break-even Sales = rofSalesinperDollaonMContributi

FixedCosts

arg

BES = 80.

000,150

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-

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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

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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

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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.

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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

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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.

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XVI. DEFINITIONS

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 fee-

for-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

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profit/loss or income statement. The offsetting entry is to increase (credit) accumulated

amortization.

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 per-

member 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.

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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. The

corresponding accounts receivable should be credited.

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

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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.

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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: Amounts owed by the organization to other entities

consolidated for financial purposes.

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).

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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.

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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.

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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.