Question

1 Approved Answer

Posted on Jul 15, 2024

3. Now consider the sensitivity of the results to changes in the values of the overhead cost pools. Repeat question two, but now use the

3. Now consider the sensitivity of the results to changes in the values of the overhead cost pools. Repeat question two, but now use the overhead cost pool amounts from the first section of Exhibit 7.3 along with the base case allocation percentages contained in Exhibit 7.2. (Note that there are two different overhead cost pool amounts [calculation 1 and calculation 2].)

Percentage of Services Provided by Administration Facilities Finance Services Provided to - 5% 5% Administration Facilities Finance 5 10% 10 10 Adult Medicine Obstetrics Pediatrics 35 20 25 55 10 20 50 25 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%. Sensitivity to Changes in Relative Overhead Costs: New Direct Expenses for Calculation 1 Administration Facilities Finance Total overhead expenses $4,400,000 1,000,000 1,800,000 $7,200,000 New Direct Expenses for Calculation 2 Administration Facilities Finance Total overhead expenses $1,000,000 1,800,000 4,400,000 $7,200,000 Sensitivity to Allocation Percentages: Percentage of Services provided by Administration Facilities Finance Services Provided to 25% 20% Administration Facilities Finance 20 30% 30 25 33 Adult Medicine Obstetrics Pediatrics 18 10 12 32 6 12 17 10 Total 100% 100% 100% Percentage to support departments 60% 50% 40% Percentage to patient service departments 40% 50% 60% Revenues Profit and Loss Statements: Direct Method: Adult Medicine Obstetrics Pediatrics Total revenues $ 12,000,000 6,000,000 2.000.000 $ 20,000,000 Revenues Direct costs Indirect costs Total costs Pretax profit A. Medicine Obstetrics Pediatrics Aggregate $ 12,000,000 $ 6,000,000 $2,000,000 20,000,000 $ 6,000,000 $3,600,000 $ 1,200,000 $10,800,000 4,284,559 1,267,647 1,647,794 7,200,000 $ 10,284,559 $4,867,647 $ 2,847,794 '$ 18,000,000 $ 1,715,441 $ 1,132,353 (847,794) $ 2,000,000 Direct Costs: Step-Down Method: $ 6,000,000 3,600,000 1,200,000 $ 10,800,000 Patient Services Departments: Adult Medicine Obstetrics Pediatrics Subtotal Support Departments: Administration Facilities Finance Subtotal Total costs Revenues Direct costs Indirect costs Total costs Pretax profit A. Medicine Obstetrics Pediatrics Aggregate $ 12,000,000 $ 6,000,000 $2,000,000 $20,000,000 $ 6,000,000 $3,600,000 $1,200,000 $10,800,000 4,273,977 1,333,041 1,592,982 7,200,000 $ 10,273,977 $ 4,933,041 $ 2,792,982 $ 18,000,000 $ 1,726,023 $ 1,066,959 $ (792,982) $ 2,000,000 1.000.000 4,400,000 1,800,000 $ 7,200,000 $ 18,000,000 Allocation Matrix: Double Apportionment Method: A. Medicine Obstetrics Pediatrics Aggregate Revenues $ 12,000,000 $ 6,000,000 $ 2,000,000 $20,000,000 Direct costs $ 6,000,000 $3,600,000 $1,200,000 $10,800,000 Indirect costs 4,236,594 1,340,336 1,623,070 7,200,000 Total costs $ 10,236,594 $4,940,336 $ 2,823,070 $ 18,000,000 Pretax profit $ 1,763,406 $ 1,059,664 $ (823,070) $ 2.000.000 Services Provided to Percentage of Services Provided by Administration Facilities Finance 5% 5% Reciprocal Method: 5% Administration Facilities Finance Adult Medicine Obstetrics Pediatrics Total 10% 10% 35% 20% 10% 55% 10% 20% 100% 50% 25% 15% 100% Revenues Direct costs Indirect costs Total costs Pretax profit A. Medicine Obstetrics Pediatrics Aggregate $ 12,000,000 $ 6,000,000 $ 2,000,000 $ 20,000,000 $ 6,000,000 $3,600,000 $ 1,200,000 $ 10,800,000 4,234,315 1,336,297 1,629,388 7,200,000 $ 10,234,315 $ 4,936,297 $ 2,829,388 $ 18,000,000 $ 1,765,685 $ 1,063,703 $ (829,388) $ 2,000,000 25% 100% Percentage of Services Provided by Administration Facilities Finance Services Provided to - 5% 5% Administration Facilities Finance 5 10% 10 10 Adult Medicine Obstetrics Pediatrics 35 20 25 55 10 20 50 25 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%. Sensitivity to Changes in Relative Overhead Costs: New Direct Expenses for Calculation 1 Administration Facilities Finance Total overhead expenses $4,400,000 1,000,000 1,800,000 $7,200,000 New Direct Expenses for Calculation 2 Administration Facilities Finance Total overhead expenses $1,000,000 1,800,000 4,400,000 $7,200,000 Sensitivity to Allocation Percentages: Percentage of Services provided by Administration Facilities Finance Services Provided to 25% 20% Administration Facilities Finance 20 30% 30 25 33 Adult Medicine Obstetrics Pediatrics 18 10 12 32 6 12 17 10 Total 100% 100% 100% Percentage to support departments 60% 50% 40% Percentage to patient service departments 40% 50% 60% Revenues Profit and Loss Statements: Direct Method: Adult Medicine Obstetrics Pediatrics Total revenues $ 12,000,000 6,000,000 2.000.000 $ 20,000,000 Revenues Direct costs Indirect costs Total costs Pretax profit A. Medicine Obstetrics Pediatrics Aggregate $ 12,000,000 $ 6,000,000 $2,000,000 20,000,000 $ 6,000,000 $3,600,000 $ 1,200,000 $10,800,000 4,284,559 1,267,647 1,647,794 7,200,000 $ 10,284,559 $4,867,647 $ 2,847,794 '$ 18,000,000 $ 1,715,441 $ 1,132,353 (847,794) $ 2,000,000 Direct Costs: Step-Down Method: $ 6,000,000 3,600,000 1,200,000 $ 10,800,000 Patient Services Departments: Adult Medicine Obstetrics Pediatrics Subtotal Support Departments: Administration Facilities Finance Subtotal Total costs Revenues Direct costs Indirect costs Total costs Pretax profit A. Medicine Obstetrics Pediatrics Aggregate $ 12,000,000 $ 6,000,000 $2,000,000 $20,000,000 $ 6,000,000 $3,600,000 $1,200,000 $10,800,000 4,273,977 1,333,041 1,592,982 7,200,000 $ 10,273,977 $ 4,933,041 $ 2,792,982 $ 18,000,000 $ 1,726,023 $ 1,066,959 $ (792,982) $ 2,000,000 1.000.000 4,400,000 1,800,000 $ 7,200,000 $ 18,000,000 Allocation Matrix: Double Apportionment Method: A. Medicine Obstetrics Pediatrics Aggregate Revenues $ 12,000,000 $ 6,000,000 $ 2,000,000 $20,000,000 Direct costs $ 6,000,000 $3,600,000 $1,200,000 $10,800,000 Indirect costs 4,236,594 1,340,336 1,623,070 7,200,000 Total costs $ 10,236,594 $4,940,336 $ 2,823,070 $ 18,000,000 Pretax profit $ 1,763,406 $ 1,059,664 $ (823,070) $ 2.000.000 Services Provided to Percentage of Services Provided by Administration Facilities Finance 5% 5% Reciprocal Method: 5% Administration Facilities Finance Adult Medicine Obstetrics Pediatrics Total 10% 10% 35% 20% 10% 55% 10% 20% 100% 50% 25% 15% 100% Revenues Direct costs Indirect costs Total costs Pretax profit A. Medicine Obstetrics Pediatrics Aggregate $ 12,000,000 $ 6,000,000 $ 2,000,000 $ 20,000,000 $ 6,000,000 $3,600,000 $ 1,200,000 $ 10,800,000 4,234,315 1,336,297 1,629,388 7,200,000 $ 10,234,315 $ 4,936,297 $ 2,829,388 $ 18,000,000 $ 1,765,685 $ 1,063,703 $ (829,388) $ 2,000,000 25% 100%