Q6.1
Direct costs are those costs that are unique and exclusive to the unit and, as such,
often are relatively easy to measure. For example, the direct costs of a clinical
department, say, routine care, would include the labor costs for department personnel,
the costs of equipment and supplies used by the department, and so on. In contrast,
indirect, or
overhead,
costs are inherently difficult to measure because these costs
result from the sharing of resources by two or more units. To illustrate, a clinical
department shares the physical space of the entire organization as well as infrastructure
services, so the department must share in the costs of physical plant, utilities,
information systems, housekeeping, maintenance, medical records, general
administration, and so on.
Q6.3
a. The three primary methods of traditional cost allocation are (1) the direct method,
(2) the reciprocal method, and (3) the step-down method. Regardless of the method,
all of the support costs within an organization ultimately are allocated from support
departments to the departments that generate revenues for the organization, and
hence create the need for the support services.
b. The key differences among the methods are how support services provided by one
department are allocated to other support departments. The
direct method totally
ignores services provided by one support department to another; the
reciprocal method
recognizes all of the intra-support department services; and the
step-down method
represents a compromise that recognizes some, but not all, of the intra-support
department services.
Q6.4
a. A
cost pool is any grouping of overhead (indirect) costs that must be allocated. An
example is the costs associated with the housekeeping.
b. A
cost driver is the criterion upon which the allocation is made. For example, a
hospital may allocate housekeeping costs to its other departments on the basis of the
size of each department’s physical space. In this situation, the number of square feet of
occupied space would be the cost driver.
c. The
allocation rate is obtained by dividing the cost pool by the cost driver
. For
example, in the housekeeping illustration, the allocation rate is total housekeeping costs
divided by the total space (square footage) occupied by the departments receiving the
allocation. This procedure results in an allocation rate measured in dollar cost per
square foot of space utilized. The development of meaningful allocation rates enhances
the ability of managers to make judgments concerning price negotiations, service
profitability, and cost reduction.This study source was downloaded by 100000843799451 from CourseHero.com on 11-18-2022 17:08:05 GMT -06:00
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P6.3 a. Here are the allocation rates:
General Administration
$2,000,000/$50,000,000 = 0.04 per dollar of patient services revenue.
Facilities
$5,000,000/600,000 = $8.3333 per square foot.
Financial Services
$3,000,000/$50,000,000 = 0.06 per dollar of patient services revenue.
Note that these rates are based solely on utilization of support services by the patient
services departments.
b. Here is the allocation table:
Patient Services Department
Routine Intensive Diagnostic Other
Support Department Care Care Services Services Total
General Admin (0.04) $1,200,000 $160,000 $ 240,000 $ 400,000 $ 2,000,000
Facilities ($8.3333) 3,333,333 333,333 500,000 833,333 5,000,000
Financial Services (0.06) 1,800,000 240,000 360,000 600,000 3,000,000
Total indirect costs $6,333,333 $733,333 $1,100,000 $1,833,333 $10,000,000
For Routine Care:
General Admin: 0.04 X $30,000,000 = $1,200,000
Facilities: $8.3333 X 400,000 = $3,333,333
Financial Services: 0.06 X $30,000,000 = $1,800,000
P6.4 a.
General Administration
$2,000,000/$30,000,000 = 0.06667 per dollar of salaries.
Facilities
$5,000,000/220,000 = $22.73 per housekeeping hour.
Financial Services
$3,000,000/$50,000,000 = 0.06 per dollar of patient services revenue.
Note that these rates are based solely on utilization of support services by the patient
services departments.
b. Here is the allocation table:
Patient Services Department
Routine Intensive Diagnostic Other
Support Department Care Care Services Services Total
General Admin (0.067) $ 800,000 $ 333,333 $ 400,000 $ 466,667 $ 2,000,000
Facilities ($22.73) 3,409,091 681,818 340,909 568,182 5,000,000
Financial Services (0.06) 1,800,000 240,000 360,000 600,000 3,000,000
Total indirect costs $6,009,091 $1,255,151 $1,100,909 $1,634,849 $10,000,000This study source was downloaded by 100000843799451 from CourseHero.com on 11-18-2022 17:08:05 GMT -06:00
https://www.coursehero.com/file/16762860/CHAPTER-6-HOMEWORKpd/
For Routine Care:
General Admin: 0.0667 X $12,000,000 = $ 800,000
Facilities: $22.73 X 150,000 = $3,409,091
Financial Services: 0.06 X $30,000,000 = $1,800,000
c. The change in two of the three cost drivers had almost no impact on the amount of
overhead allocated to Diagnostic Services. However, Routine Care had
$6,333,333 –$6,009,091 = $324,242 reduction in overhead allocation; Intensive
Care had a large (proportionally) $521,818 increase; and Other Services had a
$198,484 decrease.
d. This is a difficult question to answer without knowing more about the hospital’s
situation. However, it is likely that General Administration costs are more closely tied to
salaries than to revenues and that Facilities costs (at least if dominated by
housekeeping) are more closely tied to housekeeping labor hours than to square feet.
Furthermore, reductions in both salaries and labor hours would have a positive impact
on overall costs. Thus, it appears that the new (Problem 6.4) cost drivers are better
than the old (Problem 6.3).
P6.5 a. Here is the allocation assuming the step-down method:
Initial Allocation of General Administration
Cost pool = $2,000,000.
Salary Dollars = $36,500,000 – $1,500,000 = $35,000,000
Allocation rate = $2,000,000/$35,000,000 = 0.057143 per dollar of salaries.
Allocation to Facilities = 0.057143 x $3,000,000 = $171,429.
Allocation to Financial Services = 0.057143 x $2,000,000 = $114,286.
Subsequent Allocation of Facilities
Cost pool = $5,000,000 + $171,429 = $5,171,429.
Allocation rate = $5,171,429/223,000 = $23.19 per labor hour.
Allocation to Financial Services = $23.19 x 3,000 = $69,571.
Subsequent Allocation of Financial Services
Cost pool = $3,000,000 + $114,286 + $69,571 = $3,183,857.
Allocation rate = $3,183,857/$50,000,000 = 0.063677 per dollar of revenue.
Patient Services Department
Routine Intensive Diagnostic Other
Support Department Care Care Services Services Total
General Admin (0.0571) $ 685,714 $ 285,714 $ 342,857 $ 400,000 $ 1,714,285
Facilities ($23.19) 3,478,540 695,708 347,854 579,757 5,101,859
Financial Services (0.0637) 1,910,314 254,709 382,063 636,771 3,181,857
Total indirect costs $6,074,568 $1,236,131 $1,072,774 $1,616,528 $10,000,000This study source was downloaded by 100000843799451 from CourseHero.com on 11-18-2022 17:08:05 GMT -06:00
https://www.coursehero.com/file/16762860/CHAPTER-6-HOMEWORKpd/
For Routine Care:
General Admin: 0.0571 X $12,000,000 = $ 685,714
Facilities: $23.19 X 150,000 = $3,478,540
Financial Services: 0.0637 X $30,000,000 = $1,910,314
b. The change to the step-down method has several effects. First, the allocation from
General Administration to the patient services departments are lower because some of
this overhead pool was allocated to the other two overhead departments. However, the
allocations from Facilities to the patient services departments are larger because more
overhead went into its cost pool from General Administration than went out of the pool
to Financial Services. Finally, the allocations from Financial Services to the patient
services departments are larger because its pool is larger. However, the aggregate
overhead allocation to each patient services department does not differ by a large
amount from the allocation under the direct method.
c. In theory, the step-down method is better because it recognizes that support
departments themselves use overhead services. However, the small magnitude of the
difference from the direct method, at least in this situation, leads to the question of
whether the extra work is worth the effort.
