Service Department Cost Allocation Problem

Nowadays, a pervasive and important issue concerns healthcare costs and healthcare services. This case will examine the role of allocations on reimbursement amounts at High Desert Hospital. To simplify the case, there are two classes of patients: Plan One patients, whose care is reimbursed by the government and Others, whose care is reimbursed by a private plan. Reimbursement to the XYZ hospital for the care of Plan One patients is 'limited to the costs of treating these Plan One patients." The reimbursement to the XYZ hospital for the care of Others is based on a negotiated total amount that is set once a year based on negotiations with the private plan. (NOTE: these are fictitious plans!)

Hospital services may be divided into two categories: (1) revenue producing departments and (2) non-revenue producing departments. This classification is simple, but useful. The traditional accounting concepts associated with "service department cost allocation' while appropriate to this context, lead to a great deal of confusion in terminology since all of the hospital's departments are considered to be rendering services.

Costs of revenue producing departments are charged to Plan One patients on the basis of actual usage of the departments. These costs are relatively simple to apportion. The costs of non-revenue producing departments are somewhat more difficult to apportion. The approach to finding the appropriate distribution of these costs begins with the establishment of a reasonable basis for allocating non-revenue producing department costs to revenue producing departments. Statistical measures of the relationships between departments must be ascertained. The cost allocation bases listed in Exhibit A have been established by Plan One regulations as acceptable for cost reimbursement purposes. The regulated order of allocation (as listed below) must be used for Plan One reimbursement even though the general rule may call for another order.

REQUIRED:

Develop a spreadsheet (data section and analysis section) to do the following:

- Using the step down method, compute the reimbursement claim for Plan One and the minimum reimbursement that XYZ would accept in its negotiations with the private plan.

- Using the simultaneous or reciprocal method, compute the reimbursement claim for Plan One and the minimum reimbursement that XYZ would accept in its negotiations with the private plan.

- Assess the impact of a doubling of Plan One patients including a consideration of capacity issues.

- Evaluate each allocation method. Discuss the impact of the change in Plan One patients on each method. Make a recommendation as to which allocation method should be chosen. Be sure to include your reasons for choosing the method. Be sure to hand in the cell formulas for your program. Don't forget to clearly identity all assumptions that you are making.

EXHIBIT A Cost Drivers For Allocating Non-revenue Department Costs Non-revenue Cost Center Cost Driver Depreciation - buildings Square feet in each department Depreciation - movable equipment Dollar value of equipment in each department Employee health and welfare Gross salaries in each department Administrative and general Accumulated costs by department Maintenance and repairs Square feet in each department Operation of plant Square feet in each department Laundry and linen service Pounds used in each department Housekeeping Hours of service to each department Dietary Meals served in each department Maintenance of personnel Numbers of departmental employees housed Nursing administration Hours of supervision in each department Central Supply Costs of requisitions processed Pharmacy Costs of drug orders processed Medical records Hours worked for each department Social service Hours worked for each department Nursing school Assigned time by department Inter/resident service Assigned time by department A hospital may then use a simultaneous solution method to the cost allocation problem or it may use the 'step down" method. If the step down method is used the order of departments for allocation is the same order as that in Exhibit A. For example depreciation of buildings is allocated before depreciation of moveable equipment. Cost centers must be established for each of these non-revenue producing costs that are relevant to a particular hospital's operations. In the past year, XYZ hospital reported the following departmental costs: Non-revenue producing: Laundry and linen $ 250,000 Depreciation - buildings 830,000 Employee health and welfare 375,000 Maintenance of personnel 210,000 Central supply 745,000 Revenue producing: Operating room $1,450,000 Radiology 160,000 Laboratory 125,000 Patient rooms 2.800,000 The percentage usage of services by one department from another department are in Exhibit B. The proportional usage of revenue producing department services by Plan One and Others was as follows: Plan One Others Operating Rooms 25% 75% Radiology 20 80 Laboratory 28 Patient Rooms 36 64. High Desert Hospital Service Department Interdepartmental Use Patient Rooms .05 40 EXHIBIT B PERCENTAGE USAGE OF SERVICES AMONG DEPARTMENTS Service Departments Producing Departments To: Laundry and Depreciation Employee Maintenance Central Operating Radiology Laboratory From: Linen Buildings Health & Of Personnel Supply Rooms Welfare Laundry and Linen .10 -0- -0- 30 .10 05 Depreciation Buildings .10 -0- 10 -0- .05 .02 .02 Employee Health & Welfare .15 -0- .05 .03 .25 .05 .04 Maintenance Of Personnel -0- -0- -0- 36 .10 .08 Central Supply .10 -O- -0- 08 .09 .04 .03 .71 .43 .12 34 -- .66 EXHIBIT A Cost Drivers For Allocating Non-revenue Department Costs Non-revenue Cost Center Cost Driver Depreciation - buildings Square feet in each department Depreciation - movable equipment Dollar value of equipment in each department Employee health and welfare Gross salaries in each department Administrative and general Accumulated costs by department Maintenance and repairs Square feet in each department Operation of plant Square feet in each department Laundry and linen service Pounds used in each department Housekeeping Hours of service to each department Dietary Meals served in each department Maintenance of personnel Numbers of departmental employees housed Nursing administration Hours of supervision in each department Central Supply Costs of requisitions processed Pharmacy Costs of drug orders processed Medical records Hours worked for each department Social service Hours worked for each department Nursing school Assigned time by department Inter/resident service Assigned time by department A hospital may then use a simultaneous solution method to the cost allocation problem or it may use the 'step down" method. If the step down method is used the order of departments for allocation is the same order as that in Exhibit A. For example depreciation of buildings is allocated before depreciation of moveable equipment. Cost centers must be established for each of these non-revenue producing costs that are relevant to a particular hospital's operations. In the past year, XYZ hospital reported the following departmental costs: Non-revenue producing: Laundry and linen $ 250,000 Depreciation - buildings 830,000 Employee health and welfare 375,000 Maintenance of personnel 210,000 Central supply 745,000 Revenue producing: Operating room $1,450,000 Radiology 160,000 Laboratory 125,000 Patient rooms 2.800,000 The percentage usage of services by one department from another department are in Exhibit B. The proportional usage of revenue producing department services by Plan One and Others was as follows: Plan One Others Operating Rooms 25% 75% Radiology 20 80 Laboratory 28 Patient Rooms 36 64. High Desert Hospital Service Department Interdepartmental Use Patient Rooms .05 40 EXHIBIT B PERCENTAGE USAGE OF SERVICES AMONG DEPARTMENTS Service Departments Producing Departments To: Laundry and Depreciation Employee Maintenance Central Operating Radiology Laboratory From: Linen Buildings Health & Of Personnel Supply Rooms Welfare Laundry and Linen .10 -0- -0- 30 .10 05 Depreciation Buildings .10 -0- 10 -0- .05 .02 .02 Employee Health & Welfare .15 -0- .05 .03 .25 .05 .04 Maintenance Of Personnel -0- -0- -0- 36 .10 .08 Central Supply .10 -O- -0- 08 .09 .04 .03 .71 .43 .12 34 -- .66