HLTH 4383 Module 2 Cost Classification and Break-Even Analysis Example

Forty-Three Knees to Break Even: Cost Classification and Break-Even Volume for an Outpatient Total Knee Replacement Program at an Ambulatory Surgery Center

Student Name

American College of Education

HLTH4383: Finance for Healthcare Administrators

Module 2 Assignment

Instructor Name

October 12, 2026

The Proposal

Six orthopedic surgeons who own shares in our composite ambulatory surgery center, the same center whose financial statements were analyzed in the first module, have asked it to begin performing total knee replacements with same-day discharge. Until recently this was a hospital procedure for Medicare purposes, but Medicare's final payment rule for 2020 placed total knee arthroplasty on the covered procedures list for ambulatory surgical centers starting that January (Centers for Medicare & Medicaid Services, 2019), and commercial insurers and Medicare Advantage plans have since contracted for it in this setting. The center already performs knee arthroscopy and ligament reconstruction, so the program would extend an existing service rather than create a new one.

Before the board approves it, the administrator must answer a basic question: how many cases a year does the program need to cover its own costs? Answering it requires sorting each cost correctly, because the answer changes depending on which costs are counted.

Classifying the Costs

Costs can be classified by how they behave as volume changes and by whether they would exist without the program. Variable costs rise with each case; fixed costs stay the same over a relevant range of volume; step-fixed costs hold steady until volume crosses a threshold and then jump (Penner, 2017). A second distinction matters just as much for this decision: incremental costs are those the center would incur only if it starts the program, while allocated costs are shares of existing expenses, such as rent and administration, that the center pays whether or not it performs a single knee replacement.

For this program, the variable costs are the implant, other supplies and drugs, nursing and technician time in each phase of care, sterile processing of the instrument trays, and the cold therapy device and equipment sent home with the patient. The incremental fixed costs are a joint program coordinator, two new instrument and power sets, an ultrasound unit for nerve blocks and a patient education class. Extending recovery room hours to 7 p.m. on the two surgery days is a step-fixed cost: it covers up to about 150 cases a year, after which a third day would be needed. The center's finance office also allocates $110,000 of existing overhead to any new service line.

Variable Cost per Case

Labor was costed by following a patient through each step and multiplying the minutes of each staff member by a fully loaded hourly rate, the approach known as time-driven activity-based costing. Keel et al. (2017), reviewing its use in health care, concluded that the method can cost clinical processes efficiently and addresses a key weakness of traditional cost accounting, though they noted its value for bundled payment was not yet demonstrated in the literature. Applied here, it produced $534 of nursing, technician and therapy time per case: an hour of preoperative nursing, 2.2 hours of a circulating nurse and a surgical technologist in the operating room, half an hour of room turnover, two hours of recovery nursing at a one-to-two ratio, a same-day physical therapy evaluation, and discharge teaching with a follow-up call the next morning.

The implant, under a contract the center has negotiated with one vendor, costs $4,100. Other supplies and drugs add $980, sterile processing $140, the cold therapy device and home equipment $120, and linen and miscellaneous items $60. Total variable cost is $5,934 per case.

Revenue and Contribution Margin

The center is paid a single facility fee per case that covers its services and the implant; the surgeon and anesthesiologist bill separately. The surgeons expect 60% of patients to have commercial coverage, for which the center's contracted rate averages $11,800, and 40% to be Medicare Advantage members, for whom the contracted rate averages $8,600. The blended revenue per case is therefore $10,520.

Contribution margin, revenue per case minus variable cost per case, is $4,586. This is the amount each case contributes toward the program's fixed costs and then toward profit. It is a thin cushion relative to revenue, about 44%, because the implant alone consumes 39% of every dollar the center receives.

Break-Even Volume

To find the break-even point, the program's fixed costs are divided by the $4,586 each case contributes. The incremental fixed costs total $197,000 a year: the coordinator at 0.8 of a full-time position, $96,000 with benefits; depreciation on the instrument and power sets, $38,000; depreciation on the ultrasound unit, $12,000; the evening recovery room staffing, $37,000; and the education program, $14,000. Divided by $4,586, the program breaks even at 43 cases a year.

If the $110,000 of allocated overhead is added, fixed costs rise to $307,000 and break-even rises to 67 cases. Both numbers are useful, but they answer different questions. The 43-case figure tells the board whether the center is better off with the program than without it, since the allocated overhead would be paid either way. The 67-case figure tells the board whether the program covers its fair share of the center's shared costs. A program that pays for itself but not for its share of the building can still be worth doing; one that cannot pay for itself never is.

Expected Volume and Patient Selection

The surgeons performed about 150 primary knee replacements last year at the hospital. Not all of those patients are candidates for same-day discharge. Courtney et al. (2017), analyzing a national surgical quality database, found an overall complication rate of 8% after outpatient joint replacement compared with 16% after inpatient surgery, and identified age over 70, malnutrition, cardiac history, smoking and diabetes as risk factors for poor short-term outcomes. The lower rate partly reflects healthier patients being chosen for outpatient surgery, which is exactly why selection matters. Applying the center's proposed criteria to last year's patients left about 105 eligible, and that figure, not 150, is the planning volume.

At 105 cases, the program would earn about $284,500 above its incremental fixed costs and about $174,500 after allocated overhead. The margin of safety, the share by which expected volume exceeds incremental break-even, is about 59%.

Sensitivity and Recommendation

Two assumptions carry the most risk. If the implant contract is not renewed and the center pays $4,900, contribution margin falls to $3,786 and break-even rises to 53 cases. If the payer mix shifts to 40% commercial and 60% Medicare Advantage, blended revenue falls to $9,880 and break-even rises to 50. If both happen, break-even reaches 63 cases, still well below the planning volume of 105.

The analysis supports approving the program, with three conditions: the board should require a signed implant contract of at least three years before the first case, set a review point at 50 cases to confirm actual labor minutes and supply costs against these estimates, and track the share of patients transferred to the hospital overnight, since a high rate would signal that selection criteria are too loose and would add costs this analysis does not include.

References

Centers for Medicare & Medicaid Services. (2019, November 1). CY 2020 Medicare hospital outpatient prospective payment system and ambulatory surgical center payment system final rule (CMS-1717-FC) [Fact sheet]. https://www.cms.gov/newsroom/fact-sheets/cy-2020-medicare-hospital-outpatient-prospective-payment-system-and-ambulatory-surgical-center-0

Courtney, P. M., Boniello, A. J., & Berger, R. A. (2017). Complications following outpatient total joint arthroplasty: An analysis of a national database. The Journal of Arthroplasty, 32(5), 1426-1430. https://doi.org/10.1016/j.arth.2016.11.055

Keel, G., Savage, C., Rafiq, M., & Mazzocato, P. (2017). Time-driven activity-based costing in health care: A systematic review of the literature. Health Policy, 121(7), 755-763. https://doi.org/10.1016/j.healthpol.2017.04.013

Penner, S. J. (2017). Economics and financial management for nurses and nurse leaders (3rd ed.). Springer Publishing.