- What Are The Allocations To Each Patient Services Department And Resulting 6 Profitability Under The Four Allocation M 1 (223.42 KiB) Viewed 42 times
As part of a much-needed overhaul of the cost allocation process, Eagan contracted with a major accounting firm to estimate the amount of services provided by the support departments to each other and to each patient service department. The intent of the study was to provide data that would help Eagan develop a better cost allocation system to replace the outdated, arbitrary system currently in use. The results of this 1 study are shown in exhibit 7.2. Although expressed as percentages of the total dollar amount of support provided to other departments (instead of the more typical cost allocation rates), the data in exhibit 7.2 are based on an extensive study using sound managerial accounting techniques. Thus, both senior management and department heads at Eagan are comfortable with the resulting allocation percentages. (Hint: To ensure that you apply the percentages properly in your analysis, pay attention to Note 2 at the bottom of exhibit 7.2.)
Percentage of Services Provided by EXHIBIT 7.2 Eagan Family Practice: Allocation Percentages Services Provided to Administration Facilities Finance 5% 5% Administration Facilities Finance 10% 5 10 10 Adult Medicine 35 55 50 Obstetrics 20 10 25 Pediatrics 25 20 15 Total 100% 100% 100% Percentage to support departments 20% 15% 10% Percentage to patient service departments 80% 85% 90% Notes: 1. The allocation percentages are based on a two-year analysis of the actual services provided by the support departments to other departments. 2. To use the percentages to perform an allocation, they may have to be adjusted to ensure that the entire amount of the cost pool is allocated. To illustrate, in the direct method, all of Administration's costs ($500,000) have to be allocated directly in a single allocation to the three patient service departments. If the raw percentages were used, only 35% + 20% + 25% = 80% of the cost pool would be allocated, so the allocation percentages have to be adjusted so that 80 percent represents the entire allocation (100 percent). Thus, instead of a 35 percent allocation to Adult Medicine, its adjusted allocation is 35%/80% = 43.75%. In a similar manner, the adjusted allocation to Obstetrics is 20%/80% = 25%, while the adjusted allocation to Pediatrics is 25%/80% = 31.25%. When done correctly, the adjusted percentages must sum to 100%: 43.75% + 25% + 31.25% = 100%. The second step in the cost allocation process improvement initiative is to choose the allocation method. Four allocation methods are under consideration: direct, step-down, double apportionment, and reciprocal. Jerry Silverman, Eagan's chief financial officer, has asked Ashley Matson, the administrative resident at Eagan, to conduct a study and
make a recommendation on the best allocation method. This task can be approached in several ways, but Ashley has decided to examine by doing. She plans to use the data in exhibits 7.1 and 7.2 to determine the overhead cost allocations under each allocation method. Afterward, she can compare and contrast the results. Of course, the final decision cannot be made without considering the costs involved in implementing each allocation method. When Ashley asked Jerry about the costs inherent in each allocation method, Jerry said, "I don't know! Assume that the direct method is the least costly, the reciprocal method is the most costly, and the other two fall somewhere in between." He also expects Ashley to make some judgments on the relative profitability of the patient services departments under the recommended allocation system. Ashley began her analysis by reviewing the allocation methods presented in her old healthcare finance textbook. She had no problem remembering basic cost allocation concepts, but she did hit two snags. The first problem was that the textbook did not describe the double apportionment method. However, after a little research, Ashley discovered that the double apportionment method is a slightly more complicated version of the step-down method. In the first apportionment, support provided by each service department to the other service departments as well as to the patient services departments is recognized. Because some costs remain in the support departments after the first apportionment, a second apportionment, which applies the step-down method, moves all remaining support department costs to the patient services departments. Thus, in the double apportionment method, service department support to all other service departments is recognized, whereas, in the pure step-down method, service department support is recognized only to "downstream" service departments. Here's how Ashley assumed that the double apportionment method would be applied to Eagan. (There are alternative ways in which this allocation method can be applied.) First, direct Administration costs would be allocated to the other five departments (two support and three patient services). Second, direct Facilities costs would be allocated to all other departments (including Administration and Finance). Third, direct Finance costs would be allocated to all other departments (including Administration and Facilities). After these three allocations are completed, the first apportionment is finished. Some costs remain in the support departments—the intra-support department allocations from the first apportionment—so a second apportionment is necessary. The second apportionment is conducted using the step-down method as it is normally applied, except that the application of the first apportionment means that the starting cost pool values are much lower.