As trivial as the selection of an accounting method may sound, it is not inconsequential. Rather, it can significantly affect the value of a life care plan, which means it can have significant, real world implications on an injured individual’s ability to afford future medical care.
Accounting Methods in Life Care Planning
According to the American Academy of Physician Life Care Planners, the primary objectives of a life care planner are to:
- Accomplish the clinical objectives of life care planning, by
- Answering the Basic Questions of Life Care planning
The Basic Questions of Life Care Planning are:
- What are a subject’s diagnostic conditions?
- What medically related goods and services do a subject’s diagnostic conditions require?
- How much will the medically related goods and services cost over time?
When a life care planner selects an accounting method (knowingly or unknowingly), he/she makes one of the primary decisions in respect to how he/she will answer the third Basic Question of Life Care Planning.
There are two principal accounting methods employed in the field of life care planning: 1) the accrual method, and 2) the cash method.
Accrual v. Cash Accounting: Different Methods, Different Measurements, Different Results
Both accrual and cash accounting are valid methods by which to measure the value of future medical requirements in a life care plan. They do not, however, measure the same thing.
Accrual accounting measures the economic utility that accrues to the subject of a life care plan over time, i.e., with accrual accounting, the values of a life care plan’s future medical requirements (medically related goods and services) are accounted for in the periods in which the utility of the requirements is realized by the subject.
Cash accounting measures how much it will cost a subject to acquire the future medical requirements in a life care plan within the specific periods in which the requirements are forecast.
Life Care Planning Cost Analyses: Understanding the Basics
A properly defined future medical requirement contains six independent variables:
- Start date
- Unit Cost
- Item: Wheelchair
- Start Date: Age 51
- Quantity: 1
- Interval: 5 years
- Duration: 17 years
- Unit cost: $100
When expressed in the form of a sentence, this future medical requirement is expressed as: “Starting at age 51, 1 wheelchair every 5 years for 17 years. Unit cost: $100.”
When attempting to quantify the preceding requirement in monetary terms, relevant questions arise: How does one measure it mathematically? What accounting method should be used? What’s the difference? Is there a difference?
The answer is yes; there’s a significant difference.
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The Accrual Method Example
To calculate the value of “starting at age 51, 1 wheelchair every 5 years for 17 years. Unit cost: $100” using the accrual method, the life care planner simply divides duration by interval, and multiplies by unit cost.
- (Duration ÷ Interval) x Unit Cost
- (17 ÷ 5) x $100
- 3.4 x $100
In the preceding example, 1 wheelchair over the course of 17 years, equals 3.4 wheelchairs. 3.4 wheelchairs times $100 equals $340. Most people will agree; in practical reality, you can’t purchase three and two-fifths wheelchairs.
If that’s true, what’s being measured to produce a result of 3.4 wheelchairs? Answer: accrual accounting, which measures the economic utility of a good or service (“the wheelchair”) that accrues to the subject of the life care plan each year throughout a specified duration.
Accrual Method Expressed Discretely
Accrual Method Expressed Incrementally
As the preceding table demonstrates, the subject accrues one-fifth (0.2%) of the economic utility of a wheelchair every year, so after five years the subject has accrued the economic utility of five-fifths (100%) of one wheelchair. In the preceding examples, by the end of the 17 year duration, the subject has accrued the economic utility of 3.4 (three and two-fifths) wheelchairs.
This is the method by which most life care planners formulate the value of a life care plan, and it’s a valid way of measuring economic utility over time; but it does not measure how much it will cost the subject of a life care plan to acquire the future medical requirements within a life care plan. That is to say, the accrual method does not answer the third Basic Question of Life Care Planning in a manner that’s truly relevant to the context of personal injury torts.
In the real world, you cannot purchase one-fifth of a wheelchair. In the real world, people buy whole wheelchairs; and measuring whole units in the manner in which people purchase them requires the application of a different accounting method, cash accounting.
The Cash Method Example
To calculate the value of the future medical requirement “Starting at age 51, 1 wheelchair every 5 years for 17 years. Unit cost: $100” using the cash method, a life care planner must map cash flows (expenditures) throughout a specified duration. Examples:
Cash Method Expressed Discretely
Cash Method Expressed Incrementally
As the preceding table demonstrates, when a subject requires “1 wheelchair, every 5 years for 17 years”, a subject must acquire an entire wheelchair in Year 1, another in Year 6, another in Year 11, and another in Year 16, for a total of 4 wheelchairs (units) within a 17-year duration.
This results in 4 units x $100 = $400
Accounting Method Selection: Outcome and Real-world Implications
So, what’s the value of the future medical requirement: “Starting at age 51, 1 wheelchair every 5 years for 17 years. Unit cost: $100”? As the preceding examples demonstrate, it depends on which accounting method is used.
- Accrual Accounting Result: $340
- Cash Accounting Result: $400
- Difference: $60, or 15%
In other words, to acquire the wheelchairs in the preceding examples, the subject of a life care plan would need $60 more than the $340 total formulated by the life care planner who employs accrual accounting. That is to say, the subject in this example will have a $60 deficit, and therefore not be able to afford the items specified within the life care plan.
Not only is this problematic to the injured individual who is unable to afford their require care, it is also potentially problematic to the life care planner (the designated expert), as admissibility standards in the United States require experts (including life care planners) to offer their opinions within a reasonable degree of probability.
As the preceding examples demonstrate, the application of the accrual accounting method does not answer the third Basic Question of Life Care Planning in a manner that is relevant to the context of personal injury torts. The third Basic question of life care planning in the context of personal injury torts asks “how much money [expressed in nominal value] will an injured person need to be able to afford the medically related goods and services specified within their life care plan”. In many instances, the accrual method does not address this question reliably, i.e., within a reasonable degree of financial probability.
For purposes of simplicity, the preceding examples do not address factors such as inflation, or money’s capacity to earn interest. It should be noted however, in the current inflation/interest rate environment (2022), a formulation of present value will likely compound a subject’s accrual-derived financial deficit.
Why is Accrual Accounting Used by Most Life Care Planners?
The short answer is, most life care planners are unaware of accrual and cash accounting concepts, and they unknowingly apply accrual accounting because it’s simply more intuitive than cash accounting. It is simply easier to divide interval into duration and multiply by unit cost than it is to map cash flows.
A life care plan can be a powerful case management tool, and it is also an excellent tool for elder care and discharge planning. When a life care plan is being used in the context of personal injury torts, then more-often-than-not the life care planner is serving as a designated “damages valuation expert”, and as a valuation expert, the life care planner should be aware of basic accrual v. cash accounting concepts. Ask the next life care planner you meet which accounting method they use, and do not be surprised when they do not understand what you’re asking.