To calculate the total cost of each procedure, the MIC traces the Direct Labor (DL) component of the procedure, and adds an allocation of overhead based on the DL $ of each type of service. Overhead costs are allocated as a function of DL $ through the calculation of a burden rate per direct labor dollar consumed by a specific service (Exhibit 2). This consumption of DL $ by individual services is indicated in Exhibit 3.

• Direct Labor activities include all activities specifically pertinent to the administration of individual services. This includes the wages of employees preparing the patient, calibrating the equipment, administering the service, as well as performing general upkeep of the equipment.
• Overhead encompasses all other costs associated with running the facility, including maintenance of the physical facility, general testing on equipment and supplies, energy and water costs, year-round landscaping, and outsourced, specialized maintenance of equipment to comply with current US health standards.

Becks invited his most senior management accountant Crest, suggesting the following:

In its current method, the MIC groups all overhead costs together and then allocates based on DL$. This ignores the differences in the equipment necessary for each test and the specialized maintenance and upkeep needed for each piece of equipment. Equipment related overhead is the largest contributor to overhead and differs widely across tests. We currently do not have a good understanding of this overhead component. I propose the MIC break down overhead costs in two core components, Direct Labor Related Overhead and Equipment Related Overhead. Equipment Related Overhead should then be allocated to each test by their use of equipment time per year. 

With additional research, Crest identifies the part of overhead that was equipment related and the yearly use of each piece of equipment by the 4 services (Exhibit 4). Ms. Posh reviews Crest’s findings and proposes

“I propose that MIC break down the overhead costs even further than it was proposed by Crest. Equipment costs are not just a function of total use. Some machines are notably more high-tech than others and hence are more expensive, and require extra attention to meet federal regulations. By further breaking down equipment run time into high-tech and low-tech, we will be able to gain an even better understanding of the true costs of each test.”

Ms. Posh collects additional information to further break down the use of each piece of equipment per year into use of High-tech and Low-tech equipment and disaggregates the Equipment Related Overhead in High Tech Equipment Related Overhead and Low Tech Related Overhead (Exhibit 5).

After reviewing both Crest’s and Ms. Posh’s findings, Becks is not convinced that either solution would resolve the issue at hand. .

“Both new cost-system allocations lead to results differing substantially from our current cost system, and since we base our prices on full costs of the tests provided, the importance of properly allocating overhead cannot be understated. We cannot act on a whim and change our prices dramatically without being sure these new calculations are accurate.

Exhibit 1  VMD Medical Imaging Center 2017 Summary Financial Results

Revenues	$3,520,018
Direct Labor	$1,375,571
Overhead	$1,982,428
Total Expenses	$3,357,999
Profit	$162,019

 

Exhibit 2  Calculation of Burden Rate at VMD IMC

Overhead	$1,982,428
Direct Labor	$1,375,571
Burden Rate	144.1167%

 

Exhibit 3  VMD MIC Direct Labor Cost Breakdown by Service

Service	Direct Labor ($)
Projectional Radiographs	$417,073
Fluoroscopies	$414,047
Computerized Axial Tomography (CAT) Scan	$270,850
Magnetic Resonance Imaging (MRI) Scan	$273,601
Total	$1,375,571

 

Exhibit 4 & 5 - 

 

Exhibit 4
	A: Breakdown of Overhead Expenses
Type of Overhead Cost	Cost
Direct Labor Related Overhead	721392
Equipment Related Overhead	1261036
Total Overhead	1982428
B: Utilization of Equipment by Service
	Run Time Hours / Year
Services
Projectional Radiographs	1060
Fluoroscopies	1312
Computerized Axial Tomography (CAT) Scan	1394
Magnetic Resonance Imaging (MRI) Scan	2515
			Exhibit 5    Additional Information Required for Cost System Proposed by Consultant

 

Question

a) Based on the information provided in Exhibit 4, calculate the cost allocation rates under the two-pool costing system.
The cost allocation rate for labor-related O/H is:
The cost allocation rate for equipment-related O/H is:

b) Based on the information provided in Exhibit 4 and your answers for Question a), allocate the overhead costs to each of the services provided by VMD based on the two-pool costing system

service	DL $ Per Service	Labor-O/H	Equipment-O/H	Total Costs
Projectional Radiographs	417073	?	?	?
Fluoroscopies	414047	?	?	?
CAT Scans	270850	?	?	?
MRI Scans	273601	?	?	?
Total	1375571	?	?	?