HFMA’S INTRODUCTION TO HOSPITAL ACCOUNTING FIFTH EDITION HFMA’S INTRODUCTION TO HOSPITAL ACCOUNTING FIFTH EDITION Michael Nowicki Health Administration Press Chicago, IL Your board, staff, or clients may also benefit from this book’s insight. For more informa- tion on quantity discounts, contact the Health Administration Press Marketing Manager at (312) 424-9470. This publication is intended to provide accurate and authoritative information in regard to the subject matter covered. It is sold, or otherwise provided, with the understanding that the publisher is not engaged in rendering professional services.
If professional advice or other expert assistance is required, the services of a competent professional should be sought. The statements and opinions contained in this book are strictly those of the author(s) and do not represent the official positions of the American College of Healthcare Executives or the Foundation of the American College of Healthcare Executives. Copyright © 2006 by the Healthcare Financial Management Association. Printed in the United States of America.
All rights reserved. This book or parts thereof may not be reproduced in any form without written permission of the publisher. 10 09 08 07 06 5 4 3 2 1 Library of Congress Cataloging-in-Publication Data Nowicki, Michael, 1952- HFMA’s introduction to hospital accounting / Michael Nowicki. A rendition of the 4th ed.
Berger, published by Kendall/Hunt Pub. ISBN-13: 978-1-56793-254-6 ISBN-10: 1-56793-254-1 (alk. HFMA’s introduction to hospital accounting, 4th ed.8322—dc22 2006041103 The paper used in this publication meets the minimum requirements of American National Standard for Information Sciences—Permanence of Paper for Printed Library Materials, ANSI Z39. ∞ Acquisitions editor: Audrey Kaufman; Project manager: Amanda Bove; Cover designer and layout editor: Robert Rush Health Administration Press Healthcare Financial Management A division of the Foundation Association of the American College of Two Westbrook Corporate Center Healthcare Executives Suite 700 One North Franklin Street Westchester, IL 60154 Suite 1700 (800) 252-4362 Chicago, IL 60606 (312) 424-2800 CONTENTS Foreword .xvii 1 Nature and Function of Hospital Accounting .1 2 Analysis of Business Transactions .31 3 Journal, Ledger, and Trial Balance .51 4 Worksheets, Financial Statements, and Closing Entries .77 5 Prepaid and Accrued Expenses .95 6 Deferred and Accrued Revenues .113 7 Depreciation and Revenue Deductions .125 8 Accounting Cycle Summary .143 9 Development of Interim Financial Statements .165 10 Expansion of the Chart of Accounts .185 11 Special Journals and Ledgers .199 12 Revenues, Receivables, and Cash Receipts .219 13 Payroll Accounting Procedures .237 14 Expenses, Payables, and Disbursements .253 15 Principles of Fund Accounting .285 17 Inventories and Current Liabilities .319 v vi Contents 18 Plant Assets and Depreciation .341 19 Long-Term Investments .359 20 Long-Term Liabilities .377 21 Statement of Cash Flows .397 22 Analysis and Interpretation of Financial Statements .461 About the Author .469 DETAILED CONTENTS Foreword .xvii 1 Nature and Function of Hospital Accounting .1 The Economic Environment .5 The Need for Statistical and Financial Information .8 The Accounting Function .12 The Balance Sheet .13 Statement of Operations .29 2 Analysis of Business Transactions .31 Learning Accounting Techniques with Manual Systems .31 Documentary Evidence of Transactions .32 The Accounting Equation .32 Debit and Credit Methodology .36 Use of Accounts .39 The Need for More Detailed Information .47 3 Journal, Ledger, and Trial Balance .51 Chart of Accounts .71 vii viii Detailed Contents 4 Worksheets, Financial Statements, and Closing Entries .77 The General Worksheet .80 Closing the Books .85 Summary of the Accounting Procedure .92 5 Prepaid and Accrued Expenses .95 The Matching Principle .109 6 Deferred and Accrued Revenues .116 Summary of Adjustments for Prepayments and Accruals .121 7 Depreciation and Revenue Deductions .129 Summary of Adjustments for Depreciation and Revenue Deductions .139 8 Accounting Cycle Summary .143 Journalizing and Posting Transaction Entries .144 Expansion of the Worksheet .144 Journalizing and Posting Adjusting Entries .151 Journalizing and Posting Closing Entries .159 Detailed Contents ix 9 Development of Interim Financial Statements .165 Monthly Trial Balances .165 Developing the Adjusting Entries for September .180 10 Expansion of the Chart of Accounts .185 Balance Sheet Accounts .185 Statement of Operations Accounts .197 11 Special Journals and Ledgers .199 Overview of the System .215 12 Revenues, Receivables, and Cash Receipts .219 Recording Inpatient Revenues .219 Recording Outpatient Revenues .227 Recording Cash Receipts .229 Reconciling Control Accounts and Subsidiary Records .234 13 Payroll Accounting Procedures .237 Compilation of Gross Payrolls .239 Recording the Payroll .247 Payroll-Related Costs .249 14 Expenses, Payables, and Disbursements .256 Recording Cash Disbursements .261 Summary of Procedures for Recording Transactions .268 15 Principles of Fund Accounting .273 Nature of Fund Accounting .274 Types of Funds .283 x Detailed Contents 16 Quick Assets .299 Accounting for Notes Receivable .314 17 Inventories and Current Liabilities .319 Inventory Valuation Methods .338 18 Plant Assets and Depreciation .341 Acquisition of Plant Assets .341 Depreciation of Plant Assets .345 Disposal of Plant Assets .355 19 Long-Term Investments .359 Investments in Bonds .360 Investments in Stocks .374 20 Long-Term Liabilities .377 Nature of Bonds Payable .377 Issuance of Bonds .379 Bond Interest and Amortization .382 Early Extinguishment of Debt .394 21 Statement of Cash Flows .397 Nature of the Statement of Cash Flows .400 Detailed Contents xi Equation for the Statement of Cash Flows .404 Classification of Cash Flows .406 Form and Content of the Statement of Cash Flows .414 22 Analysis and Interpretation of Financial Statements .419 Basic Analytical Techniques .421 Analysis of Operating Results .428 Analysis of Financial Position .461 About the Author .469 FOREWORD T his fifth edition of HFMA’s Introduction to Hospital Accounting marks a continuing commitment by the Healthcare Financial Management Association (HFMA) to introduce and maintain educational materials that together represent the body of knowledge of healthcare financial man- agement—a profession still dedicated to providing the nation’s healthcare in a cost-effective manner.
It also marks a change of publishers to Health Administration Press, a division of the American College of Healthcare Exec- utives; we are delighted to be working with such an excellent publisher and association on this important work. The origins of this book date back 50 years, to a time when professor Stanley A. Pressler of the Indiana University Graduate School of Business encouraged one of his students, L. Vann Seawell, to study the accounting and financial management practices in hospitals.
This study developed into a mimeographed booklet used in a correspondence course in hospital account- ing offered by Indiana University and the American Association of Hospital Accountants (later to become HFMA). The success of the course and the encouragement of Sister Mary Gerald and Bob Shelton led Vann to write Principles of Hospital Accounting, which was published in 1960 by Physicians’ Record Company and later revised and re-titled Introduction to Hospital Accounting and published by HFMA in three editions in 1971, 1977, and 1986, and was reprinted in 1992. After the book had been out of print for ten years, Michael Nowicki, who teaches healthcare accounting at Texas State University and began his teaching career under the tutelage of Allen Herkimer, a prolific author of HFMA-published textbooks himself, approached HFMA for permission to bring out a fourth edition, which was published by Kendall/Hunt in 2002. Nowicki has served HFMA in a num- ber of local and national leadership capacities, including as a member of HFMA’s board of directors, and is the author of The Financial Management of Hospitals and Healthcare Organizations, which was published in its third edition in 2004 by Health Administration Press, HFMA, and the Association of University Programs in Health Administration.
Joining Nowicki in the fourth edition was Steven Berger, who has over 20 years of healthcare accounting experience and also has served HFMA in a number of local and national leadership capacities, as well as teaching HFMA seminars. (Due to increasing professional commitments, Steve was unable to participate in the preparation of the fifth edition.) xiii xiv Fo re w o rd This fifth edition includes an all-new chart of accounts, glossary of healthcare accounting terms, as well as reference to HFMA’s Principle and Practices (P & P) Board issue analyses, which provide the healthcare industry with short-term, practical assistance on emerging issues in healthcare account- ing and financial management. Examples include the relationship of commu- nity benefit to hospital tax-exempt status and the accounting recognition of other-than-temporary declines in investments for tax-exempt organizations. HFMA is grateful to Nowicki for continuing the Association’s tradition of leadership in providing educational resources to the healthcare industry.
We know that this fifth edition will be as successful as the previous four editions. Clarke, DHA, FHFMA President and CEO, Healthcare Financial Management Association PREFACE A ccounting is an essential service activity found in all economic enti- ties and organizations, regardless of type or size. Accounting is generally divided into two major fields: financial accounting and managerial accounting. The primary purpose of financial accounting is to provide useful financial information, generally historical in nature, about an organization’s financial activities and affairs.
This information is intended to be used for purposes of intelligent decision making by interested external groups, such as investors, creditors, other resource providers, governmental agencies, and the general public. The primary purpose of managerial accounting is to provide useful financial information, generally current or prospective in nature, to internal users to improve management decision making. Because such decisions directly affect the manner in which limited resources are allocated and employed in our economy, the information gen- erated by the accounting process plays a significant role in determining the types and quantities of products and services that are produced and con- sumed. With this in mind, the recording and reporting of adequate and reli- able financial information relevant to users’ needs clearly must be viewed as a function of extreme importance in our economic system.
The economic entity with which this book is specifically concerned is the hospital, organized and operated on a not-for-profit basis. This emphasis on accounting as related to the hospital organization in particular seems war- ranted because, although the basic principles of accounting are substantially the same for all types of organizations, not-for-profit hospitals have many unique characteristics that require specialized applications of accounting principles and procedures. In addition, the healthcare business has grown to have massive economic and social significance, demanding an increasingly higher order of accounting and financial reporting practices. It seems reason- able to assume that this requirement will be realized most effectively and quickly through educational materials and programs dealing specifically with the particular accounting and financial reporting problems of hospitals and other healthcare entities.
Healthcare organizations of all types can benefit greatly from the use of time-proven accounting techniques, reporting prac- tices, and business methods that have been developed by commercial organ- izations. It also should be noted that, although this book is focused largely on hospitals, the principles and practices described generally are applicable to most other entities comprising the healthcare industry. xv xvi Pre f a c e In seeking solutions to the serious problems being encountered cur- rently in the provision of high-quality healthcare at reasonable costs, hospi- tal managers and other interested groups are more heavily dependent than ever before on the information provided by highly sophisticated accounting systems. The effectiveness of hospital managers at all levels is directly related to the quality of the information developed by accountants, including busi- ness office personnel engaged in the least glamorous bookkeeping tasks.
A similar dependency on, and need for, more and better financial information about hospitals also exists with respect to third-party payers, lending institu- tions, federal and state agencies, and other external groups. Your interest in hospital accounting may arise from a desire to become a hospital accountant or auditor, or from a need to increase your capabilities in these areas. On the other hand, you may be preparing yourself for a career in hospital administration as a non-accounting executive, recognizing that your preparation would not be adequate or complete without a study of accounting principles.