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Management suspected the existing cost allocation system was inaccurate in measuring the true cost of providing the respective services; it had been developed in

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Management suspected the existing cost allocation system was inaccurate in measuring the true cost of providing the respective services; it had been developed in response to Medicare reporting requirements. It allocated costs between HD and PD based on the ratio of cost to charges (RCC). In other words, RCC allocates indirect costs in proportion to revenues. To illustrate, consider the allocation of $883,280 of indirect nursing services costs, which are allocated to the two treatment groups in relation to the revenue generated by each group. Given that the clinic generated total revenue of $3,006,775, an allocation rate of 0.2937633 per revenue dollar was established ($883,280 $3,006,775). This rate was multiplied by the proportionate share of revenue generated by each service category to produce the following allocation. Type of Service Service Revenue Allocation Rate Allocated Cost HD $1,860,287 PD Total 1,146,488 $3,006,775 x 0.2937633 0.2937633 $546,484 336,796 x 0.2937633 $883,280 To better assess the cost of providing each type of service, the clinic initiated an activity-based costing (ABC) system. The ABC approach divided the nursing service cost into four separate cost pools. A separate cost driver (allocation base) was identified for each cost pool. The cost pools and their respective cost drivers follow.

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