Please read the following setup and answer the 5 questions at the end. Lakeside Hospital

A hospital just can't afford to operate a department at 50 percent capacity. If we average 20 dialysis patients, it costs us $425 per treatment, and we're only paid $250. If a department can't cover its costs, including a fair share of overhead, it isn't self-sufficient and I don't think we should carry it.

Peter Lawrence, M.D., Director of Specialty Services at Lakeside Hospital, was addressing James Newell, M.D., Chief Nephrologist of Lakeside's Renal Division, concerning a change in Medicare's payment policies for hemodialysis treatments. Recently, Medicare had begun paying independent dialysis clinics for standard dialysis treatments, and the change in policy had caused patient volume in Lakeside's dialysis unit to decrease to about 50 percent of capacity, producing a corresponding increase in per-treatment costs. By February of the current fiscal year, Dr. Lawrence and Lakeside's Medical Director were considering closing the hospital's dialysis unit. Dr. Newell, who had been Chief Nephrologist since he'd helped establish the unit, was opposed to closing it. Although he was impressed by the quality of care that independent centers offered, he was convinced that Lakeside's unit was necessary for providing back-up and emergency services for the outpatient centers, as well as for treatment for some of the hospital's seriously ill inpatients. Furthermore, although the unit could not achieve the low costs of the independent centers, he disagreed with Dr. Lawrence's cost figure of $425 per treatment. He resolved to prepare his own cost analysis for their next meeting.

BACKGROUND

Approximately twenty years ago, at Dr. Newell's initiative, Lakeside had opened the dialysis unit, largely in response to the growing number of patients with chronic kidney disease. The hospital's renal division had long provided acute renal failure care and kidney transplants, but the the most common treatment for end-stage renal disease was hemodialysis. During dialysis, a portion of a patient's blood circulates through an artificial kidney machine and is cleansed of waste products. Used three times a week for 4 to 5 hours, the kidney machine allows people with chronic kidney disease to lead almost normal lives. The dialysis unit had 14 artificial kidney machines. Because of space limitations, they used only 10 at any one time, reserving the other four for breakdowns and emergencies. Open six days a week with two shifts of patients daily, the unit could provide 120 treatments a week, which meant they could accommodate 40 regular patients. From 1973, the year that Medicare began reimbursing for dialysis, all dialysis patients at Lakeside had been covered by Medicare. Until recently, the unit had operated at almost 100 percent capacity, even extending its hours to accept emergency cases and to avoid turning away patients. Patients typically spent their first three months of dialysis in a hospital facility. If there were no complications when this "start-up" period had passed, they were then required to transfer to an independent center. Most independent dialysis centers were centrally owned and operated, and were organized into satellite groups spread throughout urban and suburban areas. The facilities were modern and attractively designed and, because they were separate from hospitals' institutional environments, hey offered psychological advantages to patients. Centrally managed with low overhead, they could achieve economies unobtainable by similar hospital units. Supplies and equipment were purchased in bulk, for example, and administrators watched staff scheduling and other costs closely. As a result, their per treatment costs were significantly lower than those in a hospital facility. For example, a treatment in a center operating at 100 percent capacity with 40 patients could cost as little as $160.

LAKESIDE DATA

Lakeside's direct and allocated costs for the Renal Dialysis Unit in the previous fiscal year are detailed in Exhibit 1. Dr. Newell also obtained the unit's cost center report for the same fiscal year (Exhibit 2), which provided a breakdown of the unit's direct costs. Dr. Newell intended to use the prior year's costs to calculate the per-treatment cost at various volume levels for the current year. He also wanted to find the point at which the unit's revenue would meet its costs. He commented:

• I plan to use only those costs that can be traced directly to dialysis treatments, and not any overhead costs. If the unit's revenue meets its direct costs, it is self-sufficient. Peter's treatment cost of $425 is misleading since it includes substantial overhead, and this year's overhead will differ from last year's because of the unit's decrease in volume. Also, even though this year's overhead can't be calculated until the end of the fiscal year, I think I can come up with an estimate. First, though, I plan to calculate the "real" cost of a treatment and, from there, define a "fair share" of overhead.

In reviewing the cost center report, Dr. Newell realized that the nature of the costs varied. He commented:

• There are three types of costs I need to consider in this analysis: those that vary in proportion to volume, those that vary with significant changes in volume, and those that remain the same regardless of the unit's volume. The first and the last are pretty clear. Medical supplies, purchased laboratory services, and water usage all change according to the number of treatments provided. The other non-personnel expenses will stay essentially the same regardless of the number of treatments. Salary and wages, and employee expense costs are more complicated. Although they didn't change during the last year, the unit's number of treatments also remained fairly steady. However, the significant reduction in volume this year might cause a corresponding reduction in salary and employee expenses. Last year, we employed seven hemodialysis technicians, seven nurses, and one administrator (our nephrologists are all on the hospitals' physicians' payroll). However, since I had anticipated that volume would fall, I didn't replace the nurse and two technicians who left in January of this year. So, as of February, our annualized salaries have decreased by $84,000 and our fringe benefits have decreased by $8,400, for a total of about $92,400. Finally, just as a precaution, in case Peter asks, I had my secretary call a hospital equipment supply manufacturer to discuss the resale value of our 14 machines. They told her that machines used for four years or more could not be sold, even for scrap. We purchased all 14 machines five years ago for $210,000.

LAKESIDE HOSPITAL Exhibit 1. Cost Allocation Report Prior Fiscal Year Allo- Total to be Intern Direct cated Allo- Depre- Admin. and Operation Laundry House- Nursing Physician Medical Medical Social Resident Total Cost Center Expenses Expenses cated cation General of Plant and Linen keeping Dietary Admin Salaries Supplies Pharmacy Records Services Services Expense Basis of Sq. Payroll Sq. Lbs. Sq. No. of Hrs. of Hrs. of Dir. Phrm. No. of Hrs. of Hrs. of General Services Allocation Footage $ Footage Processed Footage Meals Service Service Supp. $ Rev. $ Records Service Service Depreciation 2,275,079 2,275,079 2. Admin and general 6,042,311 85,998 6,128,309 85,998 3. Operation of plant 1,626,535 151,616 1,778,151 78,990 72,626 4. Laundry and linen 482,869 119,396 602,265 35,036 52,251 32,109 Housekeeping 1,135,662 163,455 1,299,117 38,221 88,955 30,550 5,729 Dietary 773,913 316,246 1,090,159 89,557 97,563 72,880 5,586 50,660 Professional Support 7. Nursing administration 321,118 364,392 685,510 27,392 280,065 25,152 1,591 19,305 10,887 8. Physician salaries 1,285,577 347,899 1,633,476 25,886 251,790 20,589 15,884 33,750 9. Medical supplies 1,241,042 153,031 1,394,073 55,830 35,668 31,180 4,655 25,698 10. Pharmacy 328,023 215,218 543,241 46,310 105,037 36,660 25,566 1,645 11. Medical records 306,508 254,995 561,503 53,510 114,791 48,967 37,727 12. Social Services 309,143 199,636 508,779 35,694 125,144 21,941 16,857 . Intern/resident services 640,795 417,985 1,058,780 95.880 143.676 78,559 2,588 60,332 36,880 70 Inpatient Care-Special 14. Operating rooms 3,179,736 1,620,903 258,775 424,651 163,490 177,601 100,337 143,015 78,645 114,008 160,381 4,800,639 15. Electrocardiology 349,552 79,326 18,155 27,760 16,590 159 12,843 1,723 418 609 1,069 428,878 16. Anesthesiology 1,232,988 549,354 37,583 327,866 28,898 5,583 26,489 12,062 2,468 108,405 1,782,342 17. Radiology 2,909,080 1,153,768 188,876 579,206 173,123 4,688 134,451 15,242 5,169 7,251 45,067 695 4,062,848 18. Laboratory 2,173,298 1,355,247 245,890 656,483 225,301 4,203 173,181 3,904 46.285 3,528,545 19. Blood bank 889,190 310,878 65,932 131,297 60,473 1,719 46,556 516 4,385 1,200,068 20. Physcial therapy 775,470 198,581 58,990 61,822 40,336 3,506 25,663 5,169 42 3,053 974,051 21. Renal dialysis 1,050,048 277,267 15,550 69,550 12,320 6,954 9.855 9.471 65,477 279 1,827 12,556 50,878 22,550 1,327,315 22. Oxygen therapy 1,065,514 23,917 5,733 7,728 5.352 318 4.013 42 731 1,089,431 Ambulatory Care 23. Emergency 446,164 805,198 16,881 118,542 15,252 12,094 11,839 177,477 28,864 20,706 52,233 7,123 344,187 1,251,362 24. Other (OPD) 1,592,046 1,603,159 168,492 316,613 155,195 2.419 118,397 286,031 10,319 13,520 171,000 132,791 228,382 3,195,205 Inpatient Care-General 25. Adults and children 9,620,154 7,624,138 423,039 1,546,300 389,047 327,861 311,222 883,269 685,510 937,353 1,191,424 138,977 298,354 285,425 206,357 17,244,292 26. Intensive care 776,834 1,166,839 102,879 492,925 94,187 35,011 72,242 100,660 68,186 48,721 27,360 29,509 95,159 1,943,673 Total 42,828,649 2,275,079 6,128,309 1,778,151 602,265 1,299,117 1,090,159 685,510 1,633,476 1,394,073 543,241 561,503 508,779 1,058,780 42,828,649LAKESIDE HOSPITAL Exhibit 2. Cost Center Report-Dialysis Unit Prior Fiscal Year Expense Item Oct-Nov Dec-Jan Feb-Mar Apr-May Jun-Jul Aug-Sep Total Supplies and Purchased Services Water usage $ 3,528 $ 3,480 $ 3,456 $ 3,440 $ 3,496 $ 3,496 $ 20,896 Medical supplies: 83.904 81,800 81,810 81,612 82,400 82.280 493,806 Purchased lab services 4.232 4.052 4,000 3.988 4.084 4.120 24,476 Total $ 91,664 $ 89,332 $ 89,266 $ 89,040 $ 89,980 $ 89,896 $ 539,178 Professional salaries and wages: Nurses $ 35,000 $ 35,000 $ 35,000 $ 35,000 $ 35,000 $ 35,000 $ 210,000 Technicians 31,500 31,500 31,500 31,500 31,500 31,500 189,000 Subtotal $ 66,500 $ 66,500 $ 66,500 $ 66,500 $ 66,500 $ 66,500 $ 399,000 Fringe benefits 6.650 6.650 6.650 6,650 6.650 6.650 39,900 Total $ 73,150 $ 73,150 $ 73,150 $ 73,150 $ 73,150 $ 73,150 $ 438,900 Administrative expenses Salaries and wages 5.500 $ 5,500 $ 5,500 $ 5,500 $ 5,500 $ 5,500 $ 33,000 Fringe benefits 550 550 550 550 550 550 3,300 Total personnel $ 6,050 $ 6,050 $ 6,050 $ 6,050 $ 6,050 $ 6,050 $ 36,300 Administrative supplies 1,570 1,570 1,570 1,570 1,570 1,570 9,420 Major equipment depreciation 4,375 4,375 4,375 4,375 4,375 4,375 26,250 Total $ 11,995 $ 11,995 $ 11,995 $ 11,995 $ 11,995 $ 11,995 $ 71,970 Total costs $176,809 $174,477 $174,411 $174,185 $175,125 $175,041 $1,050,048 Number of treatments 980 956 944 940 956 960 5,736 Cost per treatment $180.42 $182.51 $184.76 $185.30 $183.19 $182.33 $183.06