Being able to explain the fundamentals of hospital accounting is important for a number of reasons. First, the accounting team needs to understand what systems and healthcare accounting software they need. Second, non-accounting executives need to have an understanding of why it’s important to invest in hospital enterprise resource planning (ERP) tools and what they do for the hospital.
Accrual Accounting: The Standard in Healthcare Finance
Most large businesses use accrual accounting. Accrual accounting is also the standard for healthcare accounting.
Accrual accounting means that income and expenses are recognized when they happen rather than when money changes hands. For example, if you receive a service in January and pay for it in February, accrual accounting adds the cost of that service to the books in January. The alternative, cash accounting, goes by when cash exchanges hands and would count that expense on the February books.
The main benefit of accrual accounting is that the hospital’s books will more accurately reflect its current financial health. For example, paying rent for the entire year on January 1 would create a large cash outflow that cash accounting would show as a loss or reduced profit for the month of January followed by higher profits for the remainder of the year. Accrual accounting spreads the rent expense over the entire year so that each month’s profit reflects the goods and services provided and used up during each month.
GAAP in Healthcare
Generally accepted accounting principles (GAAP) are the accounting standard for most hospitals and most public companies and nonprofit companies. GAAP is a set of accounting rules that ensures income statements, balance sheets, and other financial reports are consistent from company to company.
GAAP has general principles that apply to all companies, industry-specific standards such as for healthcare, and additional standards for nonprofits.
Depreciation in Healthcare Accounting
Depreciation is another important healthcare accounting concept. Like accrual accounting, it provides a better understanding of when expenses happen in relation to income. For example, if a piece of medical equipment is supposed to last five years, it makes more sense to divide the cost of buying it over five years instead of counting all of it in the first year. In year one, writing off the full acquisition cost would artificially lower the net income without recognizing the equipment is an asset with remaining use. In the remaining years, it’s important that the books reflect that there is a cost associated with having that asset. Even though it’s already been paid for, once its useful life is used up, the hospital will need to buy a new one and start the cycle again. Depreciation in healthcare is the best way to reduce net income fluctuations and match the cost of assets to when they are used.
Capitalized interest is a subset of depreciation. Capitalized interest is interest on money borrowed to purchase a long-term asset such as a building or piece of medical equipment. The interest is part of the purchase price of the asset. The reason capitalized interest isn’t treated as an expense is the same reason that depreciation in general is used. When a loan is repaid, more money goes toward interest than principal in the early years. However, since the asset is useful over the life of the loan or even longer than the time it takes to repay the loan, the interest expense should be spread over the life of the asset.
Accounts Receivable at Hospitals
Hospitals have one of the most complex accounts receivable setups. They may be paid by patients, private insurers, government programs, charitable organizations, or others. Often, two or more entities are responsible for paying for services, such as the patient and their insurance company. Payment terms may vary by insurance company or government program, and the hospital may not always have the ability to change this. Hospitals also have a number of different ways of billing, such as by accounting for specific procedures performed and supplies used, flat fees, or daily rates.
The hospital must be able to properly track all money it’s owed and allocate payments to the correct accounts. The hospital also needs to consider things like negotiated rates or restrictions on balance billing to ensure that each patient account is billed properly.
Finally, the hospital may need to handle credit balances on patient accounts. A patient may have a credit balance due to a billing error, overpaying their portion of the cost, or having an insurance claim adjusted in their favor. If the patient has left the hospital and isn’t due for follow-up care, the hospital must have a process in place to issue refunds and properly handle any unclaimed funds. For example, a patient who moved or who didn’t give an address may have a credit balance that needs to be turned over to the state government after a certain period of time.
Multi-Entity Healthcare Accounting
Another core hospital accounting concept is multi-entity accounting. Hospitals rarely operate as a single entity. There are usually many different departments. Some services may be performed by outside practice groups or contractors. Non-medical services, such as the cafeteria or parking garage, may also operate independently.
Revenues and costs need to be allocated to each entity. These entities often operate independently and frequently have their own accounting systems. This is especially true if they came together as a result of a merger or are long-standing departments that may have purchased software before the hospital took a more centralized approach.
Allowances in Hospital Accounting
Hospitals rarely receive 100% of what they bill. Insurance companies or patients may challenge the bill. Patients may not be able to afford to pay their bills. This creates a problem in accrual accounting because the hospital will record 100% of the revenue at the time of service even though it likely won’t receive all of that revenue.
Allowances help keep accounting statements accurate by adding a separate line item that adjusts revenue to what the hospital actually expects to collect. Traditionally, accountants might just use an estimated percentage of revenue as an allowance. Modern accounting software allows accountants to accurately estimate and adjust allowances. This can also include using varying allowance rates based on payer, revenue stream, or other appropriate divisions rather than using the same percentage for all revenue.
Related Healthcare Information Systems
A healthcare ERP system isn’t purely an accounting system. In any organization, accounting is a measure of what the organization did. In a hospital, that’s providing patient care. Doctor and nurse hours, medicines given, and disposable supplies used are all things that a hospital needs to track for proper billing and accounting.
The electronic medical record or electronic health record is one of the main sources of data. While the main purpose of these records is facilitating patient care, they also facilitate the accounting process. When doctors and nurses enter information on patient charts, that information is how the billing department knows what to charge the patient.
The key is having a good exchange of information. When electronic records are used, accounting systems and healthcare systems can be linked together. Instead of having an additional step of data entry when the billing department reviews the paper chart, the billing process can be largely automated, with the billing department directly receiving patient care information. The medical coding and insurance claims processes can also be automated in the same manner. In addition to improving efficiency, this also reduces the risk of human errors that can be made during manual data entry at each step of the billing process.