Chapter 5- Activity Based Costing St. Francis Healthcare and Dialysis Clinic St. Francis Healthcare and Dialysis Clinic (SFHDC) is an independent, nonprofit full-service renal dialysis clinic. The clinic provides two types of treatments. Hemodialysis (HD) requires patients to visit a dialysis clinic three times a week, where they are connected to special, expensive equipment to perform the dialysis. Peritoneal dialysis (PD) allows patients to administer their own treatment daily at home. The clinic monitors PD patients and assists them in ordering supplied consumed during the home treatment. The total and product-line income statement for the clinic is shown below TOTAL HD PD CLINIC INCOME STATEMENT Revenues Number of patients Number of treatments Total revenue 62 20,624 3,006,775 $1,860,287 $1,146,488 164 34,067 102 14,343 Supply costs 664,900 310.695 512,619 975,59598,680 785,825 137,046 Standard supplies (drugs, syringes) Episodic supplies (for special conditions) Total supply costs 152,281 212,015 364,296 611,299 Service costs General overhead (occupancy, administration) Durable equipment (maintenance, depreciation) Nursing services (RNs, LPNs, nursing administrators 883,280 1,806,151 2.781,746 $225,029 equipment technicians) Total service costs Total operating expenses 1,117,463 1,728,762 $131,525 688,688 1,052,984 $93,504 Net income Treatment Level Profit Average charge per treatment $129.70 $55.59 Average cost per treatment Profit per treatment 120.53 $9.17 51.06 $4.53 The existing cost system assigned the traceable supply costs directly to the two types of treatments. The service costs, however, were not analyzed by type of treatment. The total service costs of $1,806,151 were allocated to the treatments using the ration-of-cost-to-charges (RCC) method developed for government cost-based reimbursement programs. With this procedure, since HD t4reatments represented about 61% of total revenues, HD received an allocation of 61% of the $1.8 million service expenses PD HD TOTAL GENERAL OVERHEAD COST DRIVER Square feet Number of patients Number of treatments Estimated kilowatt usage 18,900 102 14,343 11,100 62 20,624 99,405 30,000 164 34,967 662,700 PHASE II Bernadone was uncomfortable with the consensus estimate that nursing and equipment costs should be split 85:15 between HD and PD treatments. In particular, he knew that just the nursing resource category contained a mixture of different types of personnel: registered nurses (RNs), licensed practical nurses (LPNs), nursing administrators and machine operators. He thought it was unlikely that each of these categories would be used in the same proportion y the two different treatments In the next phase of analysis, Thomas disaggregated the nursing service category into four resource overhead, selected an appropriate cost driver for each resource pool. pools and as with general SIZE OF POOL COST DRIVER Full-time equivalents (FTES) NURSING SERVICES RESOURCE POOL Registered nurses Licensed practical nurses Nursing administration and support staff $239,120 404,064 FTEs 115,168 Number of treatments Number of clinic Dialysis machine operators 124,928 treatments TOTAL PD NURSING SERVICES COST DRIVER RNs, FTE LPNs, FTE Total number of dialysis treatments Number of clinic dialysis treatments 19 34,967 14,343 15 14,343 20,624 14,343 Bernadone felt that the 85:15 spilt was still reasonable for the durable equipment use, and, in any case, the relatively small size of this resource expense category probably did not warrant additional study and data collection. For many years, the clinics such as SFHDC received much of their reimbursement on reported costs. Starting in 2015, however, payment mechanisms shifted, and now SFHDC received most of its reimbursement on the basis of a fixed fee not the cost of the service provided. In particular, because HD and PD procedures were categorized by the government as a single category-dialysis treatment-the weekly reimbursement for each patient was the same $389.10. As a consequence, the three HD treatments per week led to a reported revenue per HD treatment of $129.70, and the PD treatments per week led to a reported revenue per PD treatment of $55.59. Both procedures appeared to be profitable, according to the clinic's existing cost and revenue recognition system. Francis Bernadone, the controller of SFHDC was concerned, however, that the procedures currently being used to assign common expenses may not be representative of the underlying use of the common resources by the two different procedures. He wanted to understand their costs better so the SFHDCs managers could make more-informed decisions about extending or contracting products and services and about where to look for process improvements. Bernadone decided to explore whether activity- based costing principles could provide a better idea of the underlying cost and profitability of HD and PD treatments. PHASE I in his initial analysis, Bernadone decided to focus on the General Overhead category. But rather than continue to use the RDD method for allocating equipment and nursing costs, he asked the clinic staff for their judgements about how these costs should be allocated. On the basis of the staff's experience and judgement, they felt that HD treatments used about 85% of their resources and PD about 15%. Bernadone composed the General Overhead category into four resource cost pools. Then for each pool, he chose a cost driver that represented how that resource was used by the two treatments. The summary of the analysis is presented below COST DRIVER GENERAL OVERHEAD RESOURCE COST POOL Facility costs (rent, depreciation) Administration and support staff Communication systems and medical records SIZE OF POOL $233,226 354,682 157,219 Square feet of space Number of patients Number of treatments Estimated kilowatt Utilities Total 40,698 usage Bernadone then went to medical records and other sources to identify the quantities of each cost driver for the two treatment types: REQUIRED cost estimates and treatment profit and loss statements for HD and PtD on gathered during Phase I. What led to any major difference between the 1) Prepare the revised set of and tr RDD method for allocating cost and the Phase I ABC method? Use the information on the distribution of nursing and revised product-line income statements and profit and loss statements for individual treatments. 2) machine operator resources to calculate 3) Analyze the newly produced information and assess its implications for managers at S decisions might managers of the clini c make with this new information that might differ from those made using information from the RCC method only? What improvements, if any, would you make in developing an ABC model for SFHDC? 4) Prepare you case response using the five steps of strategic decision making. through four are relevant since time-series data is not available. Only steps one