Cutting Costs Through Cost Accounting

September 1, 2003
Mike Pulaski

How to use cost accounting to cut expenses

Over the years, groups have discovered many creative ways to reduce their expenses, and this issue of Physicians Practice presents a number of them in the preceding story. However, the vast majority of groups have ignored one very powerful approach to expense reduction: cost accounting.

Cost accounting is a method whereby expenses are allocated by department, project, or other cost center as defined by the organization (including individual physicians). It can open up new avenues of expense reduction, but it can sometimes be a challenge to get everyone on board.

Change group culture

Traditionally, expense reduction starts with examining each process and procedure of the medical group and the related resources used (labor, supplies, space, etc.). Procurement processes, resource costs, and reimbursements for services are all part of the picture. But too often, this exercise identifies many opportunities for savings that are never realized because the group's culture does not permit it.

In other words, the group's culture is tied to its physician compensation formula, which ignores the impact that individual compensation has on expense reduction. In most groups, physicians are paid based on a compensation formula that distributes the practice income minus practice expenses. Obviously, the less costly expenses are, the more the physicians take home. This is why there is an emphasis on expense reduction.

Physician compensation surveys show that a majority of compensation plans in place today include equal expense sharing. That is, a certain number of line item expenses, if not all expenses, are shared equally. Unfortunately, a logical outcome of this method of expense allocation is that no individual physician has a real financial incentive to decrease expenses. Physicians become ambivalent toward expenses because there is no real financial impact for either good or bad operational behavior.

However, they can become quite emotional when they perceive that other physicians are diluting the compensation pool because of inattentiveness to expense control. This is where expense reduction efforts usually "hit the wall" -- in part due to the prevailing compensation formula and in part due to the emotional stress it causes within the group.

Avoid the blame game

Physicians loathe being forced to use "standardized" equipment or follow standard procedures that make them clinically uncomfortable, but which may have economic benefit for the group. Instead, they each have their own "comfort zone" in how they approach a good clinical outcome, and it may differ markedly from others in the group with respect to resource use. When there is resentment directed toward one physician for "costing us more in expenses and reducing our take-home pay," expense reduction is not fully addressed, finger-pointing flourishes, and morale sags throughout the organization.

Pay for what you use

A truly successful effort at lowering and maintaining a minimum level of expense combines the effort and ingenuity of all members of the practice. Financial systems and incentives directed toward good operational behavior are most effective.

With a compensation model that holds each physician accountable for his own resource use (each physician is a cost accounting center) the following will happen:

  • If one physician prefers using more and different resources than the others, then he pays for them. Other group members are not financially penalized for one's resource consumption, and there is no ill will created among group members.
  • By employing the pay-as-you-go compensation formula, physicians are constantly challenged to lower their personal expenses -- within their own comfort zone. There are no standardized, one-size-fits-all rules needed.
  • Staff will be motivated to help each individual physician achieve the most cost-effective practice patterns that are consistent with that physician's preferred style.

Just do it

First, get agreement from the group by way of a written and signed "vision statement" that spells out the cost accounting approach to income distribution -- paying for what you use. Avoid doing "what if" spreadsheets for this meeting. Approval needs to be based on principles, not on income differences.

Once the vision statement is signed, then you can begin to add the necessary cost accounting features to your reporting. This is a very labor-intensive step, and can take a number of months to set up. However, having a cost accounting system is valuable for more than just physician compensation matters. Cost accounting can be applied to:

  • The physician pay formula
  • Profit by department, satellite office
  • Profit by physician extender
  • Payer contract negotiations

Finally, choose a date to implement the cost accounting-based physician compensation formula. The first month of a new fiscal year is ideal.

A recent case study of a 23-physician group that was in the process of implementing cost accounting to their compensation formula showed that their operating margin improved 18 percent even before the plan was fully implemented. The group's president, Lee Kelley, MD says, "Our stellar financial performance is attributable to our changing the physician compensation formula. The positive benefits in higher overall productivity, greater cost savings, and increased physician morale are all positive outcomes of the formula."


Give serious thought to implementing a change to your physician compensation formula that embraces cost accounting. You, too, will be amazed how it will positively affect your bottom line as well as group morale.

Mike Pulaski, CEO, Peachtree Orthopedic Clinic, Atlanta, can be reached via editor@physicianspractice.com.

This article originally appeared in the September 2003 issue of Physicians Practice.

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