To make an intelligent comparison of an in-house laundry with outside rental service, you should be aware of all costs involved. Hospitals readily recognize certain direct costs such as laundry labor and supervision, washing supplies and linen replacement costs.
These, however, represent only part of the total cost of operations. Other costs are frequently overlooked and must be allocated to the in-house laundry, such as: fuel, electricity, housekeeping, office and administration. Through methodical cost accounting procedures, all of the direct and allocable costs relating to the laundry operation are accumulated and ultimately reduced to linen cost per lb. and per patient day-the familiar units of linen cost in the hospital.
In comparing costs of in-house vs. outside linen supply service, a test period of two to four weeks should be identified. Item counts of clean linen produced by the hospital laundry should be made. Caution should be taken that re-washed or rejected items should not be counted twice. Counts of clean linen used by the healthcare facility should also be made and compared with production counts to verify the accuracy of production figures. The average weight of each item processed should be determined by individually weighing, for each item, a bundle of 10 pieces of clean linen. The total pounds processed during the survey period can be calculated by multiplying the number of pieces of each item processed by its clean weight and totaling the resulting figures. The census for each day during the survey period should be obtained and compared with the average annual daily census. This comparison will indicate whether the survey period is typical of the entire year, and consequently, if the quantity of linens produced is typical. In periods of high activity, laundry costs per pound will be lower than average since fixed costs will be spread over more units. Conversely, costs per pound will be higher in periods of low activity.
There are a number of reasons why a hospital might swap its in-house laundry for an outside service. These include:
- The healthcare provider does not make a capital outlay for linen
- Unseen costs disappear with awareness in applicable charges
- An ample supply of linens and specialty items becomes increasingly available
- A profit center from hospital space is currently occupied by a cost center, namely a laundry
- Funds are tied up in laundry equipment and linens available for other uses
- A linen service provider understands textiles and is attuned to purchasing the correct types of textiles to meet specific needs
- A single linen service supplier has greater purchasing power for linen items than several hospitals
The first step in determining the full cost of operating the laundry is to set up a worksheet listing all the expenses that will be incurred for the test period. This includes expenses charged directly to the laundry or accumulated in a separate account to be later allocated to the laundry. A sort test period may result in distortions, with regard to some individual expenses. For example, repairs may be unusually high throughout the test period, or certain administrative costs may be unusually low. To reflect normal costs, compare each expense (particularly those allocable) for the period with year-to-date figures and/or most recent fiscal year, to determine if these are truly representative for the period.
The American Hospital Association Chart of Accounts for Hospitals identifies the various cost centers and expenses by the following classifications:
- Revenue producing.
- Non-revenue producing, including laundry and linen service (account numbers 8111 and 8112, respectively).
Natural Classification of expenses
- Consists of direct and allocable expenses that are chargeable to the appropriate responsibility centers. They are identified by two digits preceded by a decimal point (e.g. labor .07, supervision .01, supplies .35 to .44, fuel .79, electricity .78, depreciation of equipment .69, etc.).
- The costs of some non-revenue producing centers such as plant operations, housekeeping, and administrative services are allocable to other centers that include laundry and linen service.
Establishing direct costs
Direct costs are expenses that can be directly identified with the laundry and are immediately charged to laundry and linen service when incurred. The following are direct cost expenses:
- Laundry salaries and wages
This account contains the cost of direct production wages of laundry personnel and is included in the hospital chart of accounts under the code 8111.07 (environment and food service employees). All personnel working in the laundry, even part-time, are included in the labor accounts in this category.
- Laundry managers and supervisors
Salaries of laundry managers and supervisors who are directly responsible for the operation of the laundry are included in this account (8111.01). If they share their time with other hospital departments, their salaries should be allocated in accordance with time spent.
- Laundry vacation, holiday and sick pay
Vacation, holiday, and sick wages paid and charged to this account (8110.10) should be reversed and replaced by the pro-rata portion of the annual cost. This is calculated by: determining the number of vacation, holiday and sick days a year allowed to each employee in the laundry and linen departments, then dividing by the average number of working days for each employee. The result is the percentage of direct wages chargeable to vacation, holiday and sick pay. Apply the percentage to the laundry and linen direct wages.
- Laundry Supplies
There are 10 account numbers, .35 through .44, for specialized supplies and materials that are indigenous to a particular department. The hospital assigns one or more of these to laundry production supplies such as soap and chemicals. If the purchase of supplies is abnormally high or low for the test period, adjustments need to be made to reflect normal cost. This is computed as: start with the expense in the most recent fiscal year, divide the annual cost by 52, and multiply the result by the number of weeks in the test period. Other direct laundry expenses and materials are computed in a similar way.
- Linen Service Salaries and Wages
This account, 8112.07, includes salaries and wages paid to seamstresses, linen room employees and distribution personnel. It is handled in the same way as laundry salaries and wages.
- Linen Service Vacation, Holiday, and Sick Pay
The procedure with this account, 8112.10, is handled the same as laundry vacation, holiday and sick pay.
- Linen Service Supplies
Linen Service Supplies, 8112.35, is the same as for laundry supplies.
- Linen Replacement Purchase 8112.35 through .44
The Chart of Accounts provides account .35 through .44 for specialized departmental supplies associated with a particular department. One of these suffix numbers can be applied to linen purchases. Purchase of linen is accumulated, and generally represents replacement for linen that is lost or discarded due to wear and tear. Costs incurred for a short test period may not be a fair representation of actual costs over a longer period such as one year.
A hospital may, for example, purchase a large quantity of linen during one month to replenish depleted stock, or take advantage of favorable purchase prices in the market. To determine a representative cost for the survey period, calculate the average cost based on linen purchases over an extended period, say the past two or three years. To illustrate, the linen expense for three years-156 weeks x number of weeks in survey = the tentative average cost for the survey period. If the cost of merchandise has been increasing, it may be more accurate to increase the tentative cost by a factor of 5% - 15% to provide for the increase of linen cost. In commercial businesses where sales volume is a measure of activity, the textile supplier can estimate the cost of linen replacement by using the percentage of linen cost to sales, which provide for variations in activity level. Since the hospital linen and laundry activity cannot be related to a sales figure, an alternative indicator may be used (i.e. patient days). Hospital linen usage changes may appreciate due to an accumulation of decrease in the number of hospital beds or census. It is then recommended that the cost of linen replacement be calculated on the cost per patient day using the past two or three years experience as a basis, and adjusting for increase in the price of linen.
Allocable costs are not as readily recognizable as part of the cost of operations by those not actually involved in cost accounting. The principal distinction between direct and allocable costs is not in the nature of these costs but in the accounting treatment. Allocable costs may have to await the application of the appropriate formula before being charged back. A further distinction can be made in that most direct costs are variable in nature and will fluctuate with the level of activity or production of the laundry.
The allocable costs, on the other hand, are comprised of both variable and fixed costs. For example, payroll fringes, water, fuel, and electricity are allocable costs which are predominantly variable, while repairs and maintenance, insurance, office, and administrative costs are generally considered fixed expenses. Even expenses such as interest must be identified as having a direct bearing on cost of operations. This becomes meaningful in considering the hospital's investment in laundry equipment and linens- funds which might otherwise be available for income-producing investments or reduction of interest-bearing obligations.
Employee benefits (account 8710)
The following procedures should be used to find the expense to be allocated to the laundry linen services:
- Obtain the figure for the total wages and salaries paid by the hospital in the most recent full year.
- List the detail of expenses and amounts for the year included in the employee benefits account (FICA, unemployment insurance, etc.).
- Adjust each of the expense items for increase in rates in the current year. For example, if the FICA rate increased by 5% over the prior, increase the FICA expense by 5%.
- Divide the total of employee benefits for the prior year (adjusted for rate changes obtained in step three) by the total hospital salaries and wages for the year in step one) This calculation will give you the percentage of employee benefits to total salaries and wages.
- Multiply all laundry and linen wages (including supervision and vacation, holiday, and sick pay) by the percentage obtained in step four to arrive at the portion of employee benefits to be allocated to the laundry and linen service.
Gas and/or oil (accounts 8071.79 and 8071.81)
An appropriate formula for allocating fuel to the laundry provides the ratio of steam used by the laundry to total steam produced by the boiler. The equation is:
Total Cost of gas/oil allocated to laundry
Lbs. of steam used by laundry per week Lbs. of steam produced by boiler per week
Total Cost of gas/oil for study period
Water and sewage (account 8071.80)
Water and sewage can be estimated with reasonable accuracy on the basis that it takes about three and a half to four gallons of water to process hospital linens. The cost of water allocable to laundry is computed as follows:
- Calculate the gals. of water used by multiplying the lbs./ of line processed (clean weight) during the survey period by four (assuming four gallons of water per lb.).
- Obtain the cost of water and sewage per gal. of water used by dividing the charge on a recent water and sewage bill by the gal lons of water purchased. If the bill is in cubic feet of water, con vert to gallons by using 7.48 gallons per cu. ft.
- Multiply the gallons of water used in step one by the cost per gal lon in step two to arrive at total cost of water and sewage during the survey period.
If the hospital maintains a separate meter for the laundry department, the actual water and sewage cost should be used instead of the above allocation.
Electricity (account 8071.78)
The cost of electricity allocable to the laundry can be determined with a fair degree of accuracy on the basis of kilowatt hours (KWH).
- List the equipment used in the laundry and the rated motor horse power (MHP) for each. The rated HP may be obtained from the motor name-plate or from the equipment manufacturer.
- Convert the MHP to kilowatts by multiplying the MHP by 60% to 80%, depending on the electricity load, and divide by 1.34 (one kilowatt equals 1.34 MHP).
- Multiply the kilowatts of each piece of equipment by the number of hours used during the survey period to obtain the total KWH.
- Determine the rate per KWH from the hospital's recent electric bill; multiply the total KWH, in step three, by the rate per KWH to determine the cost of electricity to be allocated to the laundry. As under water cost, if a separate electric meter is installed in the laundry, the cost should be computed from the actual bill rather than the allocation method described above.
Depreciation and amortization
The accounts 8511.67, .68, .69, .70 apply respectively to buildings and improvement, leasehold improvements, and fixed equipment and movable equipment.
Depreciation and amortization of buildings and leasehold improvements are allocated on the basis of sq. ft. of area occupied by the laundry and linen facilities, relative to total sq. ft. of the hospital. The depreciation of the most recent fiscal year should be the starting point. These figures should be adjusted for any acquisitions or improvements in the current year. Divide the sq. ft. of the linen/laundry area by total sq. ft. of the entire hospital to find the proportion to be allocated. Multiply this percentage by the total annual depreciation; divide by 52 and then multiply by the number of weeks in the survey to arrive at the amount to be charged to the laundry and linen service for the study period. Depreciation of equipment is generally allocated on the basis of the relative value of the laundry equipment to the total hospital equipment. This method may prove to be impractical unless the hospital maintains detailed records of the cost of all equipment. Even if records are maintained, if the laundry equipment is old and purchased before current market prices, the depreciation may be abnormally low.
Further, if the laundry equipment is comparatively older than other hospital equipment, the allocated portion of depreciation will be distorted. A more realistic approach would be to independently compute the machinery depreciation for the laundry on the basis of current values and estimated useful lives. This procedure entails listing all major pieces of equipment in the laundry and linen department, and entering their current prices (which can be obtained from the manufacturer). Since it is unreasonable to assume that all equipment in a laundry is new and purchased at current prices, it would be fair to reduce the current price value by a factor of say about 25% to 50%. The following useful lives are recommended by The American Hospital Association in its publication, Estimated Useful Lives of Depreciable Hospital Assets:
Other operating costs
The following expenses should be allocated on the same basis as fuel:
- Plant engineer wages
- Payroll fringes of plant engineer's wages
- Boiler and power plant repairs
- Boiler insurance
- Depreciation boiler and power plant
The following expenses should be allocated on the same basis as that of building depreciation (area of sq. ft.):
- Real estate taxes
- Property rentals: If fair rental is used in lieu of building depreciation, these costs should not be allocated to the laundry since they are presumed to be included in the rental
- Building repairs and maintenance wages
- Payroll fringes on building maintenance wages
- Insurance on buildings
If the hospital keeps separate records of building repairs and employee hours attributable to the laundry, this data should be charged directly to the laundry. General building repairs and maintenance, or those not identified with any specific department, should be allocated on the basis of area in sq. ft. The following expenses should be allocated on the same basis as that of equipment depreciation (value of equipment):
- Equipment repairs
- Mechanics' wages
- Payroll fringes on mechanics' wages
- Insurance on equipment
If the hospital keeps records of laundry repairs, maintenance and hours, which mechanics spend on laundry equipment maintenance, then this data should be charged directly to the laundry. General repairs and maintenance not specifically identified with departments should be allocated on equipment value.
Office, fiscal and administrative services
Costs of these categories are reflected in a number of responsibility cost-centers from accounts 8210 to 8410. The most appropriate basis for allocation of these costs is payroll. The allocation procedure is as follows:
Divide laundry and linen wages (including supervision) for the most recent fiscal year by the hospital's total salaries and wages to find the percentage for allocation.
Accumulate all the allocable office, fiscal and administrative costs for the year and multiply the percentage from step one.
Divide the amount obtained in step two by 52 weeks. Multiply by the number of weeks in the survey. Result is cost allocable to the laundry and linen services.
Interest (account 8690)
Interest is the cost of money committed to investments. As previously noted, if not for the laundry the hospital would have more funds available to either reduce its interest-bearing debt, or to invest in income-producing securities or facilities. To compute the portion of interest expense allocable, it is necessary to first estimate the value of the investment in laundry equipment and linen.
One method of determining these values is to take physical inventory of both equipment and linen and pricing the items at current values. Since it would be reasonable to assume that the equipment and linen in use are 50% depreciated, the valuation should be at 50% of new cost. This would not apply to new linen, which should be valued at 100%.
It may not be feasible to inventory linen in circulation; and if the hospital does not maintain records of linen-in-service, the textile supplier may have to estimate its value by drawing on his experience. He may find that the ratio of linen-in-service to number of patient days or hospital beds, based on his rental business, produces a reasonable inventory figure. Or he may choose to use the ratio of linen lbs. processed per week to linen-in-service as a test. If these alternate means are used, the value ascertained is already presumed to be reduced by 50% depreciation.
Once the value of equipment and linen is determined, the annual interest cost is computed by multiplying the value by a fair current rate of interest. The pro-rata interest for the survey period is computed by dividing the annual interest by 52 weeks and multiplying the result by the number of weeks in the survey.
These are the major factors that determine hospital linen and laundry costs. Other costs are outlined in TRSA's publication, Hospital Textile Cost Manual (#71400). TRSA also offers the Hospital Cost Calculator (#71908) that automates the calculations mentioned. For more information about these and other TRSA resources, call 800/868-8772
Quick Rinse - News From Around The World
Laundry to Reduce Air Emmissions and Fund Cleaner Burning Wood Stove Purchases
BOSTON, Mass. — Alltex Uniform Rental Service, an industrial laundry in Manchester, N.H. has agreed to settle claims by the US Environmental Protection Agency that it violated the Clean Air Act by paying a civil penalty of $65,000. They will also be undertaking a Supplemental Environmental Project with a value of at least $220,000 to replace old, polluting wood stoves in southern New Hampshire with new, cleaner models. Additionally, the company will install equipment at its facility to remove approximately 20 tons per year of emissions of volatile organic compounds (“VOCs”). G&K Services is the parent company of Alltex Uniform Rental Service Inc. The EPA action grew out of an EPA inspection of the facility in July 2008.