Do you know your operating costs? Could you easily recite the percentage of gross income normals for drugs used or vended, for therapeutic diets, or for flea and heartworm preventives?

In the past several months, we've been startled by some pretty hefty increases in multiple practices we reviewed in detail. Substantial jumps in operational costs, particularly drugs and medical supplies, stood out.

A caveat: When we say increased, we are referring to the practice's comparison with itself over a series of years, not to any so-called industry standard. We compare certain practice expenses as a ratio relationship with the practice revenues generated during the same time period.

The accrual basis of accounting allows, practice management to spot potential problems simply through a review of the profit and loss information. Of course, such analysis depends on reliable bookkeeping systems that allow accurate transaction categorization to the correct accounts in a consistent fashion.

Let's assume the practice bookkeeping systems have abided by operational standards. If so, increasing percentages of gross income for any line-item expense should immediately drive management's closer inspection of the underlying transactional detail.

What if you noted a much higher-than-expected expense percentage for drugs and medical supplies? One logical question would be whether an accidental misclassification of equipment resulted in expensing with other supplies purchased from a distributor.

Even one purchase of a substantially costly piece of equipment could cause ratios to be markedly skewed. Such skewing also occurs when multiple smaller equipment purchases are expensed rather than appropriately recorded as longer-lived assets on the balance sheet.

We recall a practice owner who expressed concern over the fact that her practice's office supply expense was so much higher than that of other colleagues and benchmarking data. Our inspection of QuickBooks data detail quickly isolated the expenditure of several laptop computers and some other accessories as office supply expense. The result was an expense ratio at about double what it would have been otherwise.

If the practice's Board of Directors established clear capitalization protocols, bookkeeper confusion would result in fewer errors. Capitalization protocols define at what dollar amount a particular purchase should be listed on the property schedules as a depreciable asset rather than a "supply" expensed in the same period. In some cases, small items of equipment, such as a hemostat or forceps might be expended as surgical supplies.

Larger bulk purchases of surgical instrumentation to fill out surgery packs would be more appropriately handled as capitalized assets so surgery supply expense is not overstated. Quality surgical instrumentation has a life expectancy spanning far beyond a single-year use, even by the toughest surgeon.

From a managerial perspective, bookkeeper care in classifying all longer-lived equipment as capital assets is the best way to assure fairly accurate interpretation of practice operational results. Profit will be clearly reflected with better consistency of ratios through multiple fiscal periods.

From a fiduciary standpoint, such categorization is also appropriate, to mitigate tax agency difficulties. Flowing equipment acquisitions through expense categories, particularly when some great alternatives exist under current tax law, doesn't make a whole lot of sense. Never-theless, many bookkeepers often don't realize all of the ramifications of inappropriate accounting for assets with useful life expectancies for revenue generation of greater than one year.

A closer look

What should you review next?