Rio Grande Medical Center Cost Allocation Concepts HCM 681 Introduction to the Financial Management of Healthcare Organizations 1. Is it “fair” for the Dialysis Center to suffer in profitability, and hence for the department head to possibly lose his bonus, just because the Outpatient Clinic needs additional space? The building of the new facility is not expected to affect revenue, direct cost and patient volume. The Dialysis Center will provide the same services for its patients, but with different location of the facility.
There is no reason for the personnel of the facility to be penalized financially, since the decision for the relocation of the building was taken due to recent growth in volume of the Outpatient Clinic. However the Dialysis Center will have better advantage and potential increase of the volume of patients, better parking location for patients and service employees and lower amortization cost of the building in the future. The new center has the potential to increase its revenue, net of direct costs, with more than $100,000 increase in facility allocation.
The new building with its new location can be a base for a new marketing campaign that might attract new patients by providing conveniences and increasing utilization. The move of the facility in a new building with better location would give a long term advantage for the center compare to its competitors with similar services. 2. In the past, the medical center aggregated all facility costs and then allocated the total amount on the basis of square footage.
This methodology assigned an average cost rate to each patient service department, regardless of whether its space is new or old, or prime or poor. The proposed allocation for the Dialysis Center, on the other hand, requires it to bear the true facility costs of its new space. What are the advantages and disadvantages of the new methodology? Do you support the new allocation scheme? When choosing cost driver it is best to pick up driver that best matches the actual utilization of the overhead service provided.
It seems appropriate if the facility costs are assigned and represent the true costs of the facility each patient service uses. As example from the case activities in newer space will be charged higher rate than activities housed in similar older spaces. In the case of the Dialysis Center it is easy to estimate the exact cost for the facility, since it is new and has been just built. If the facility was in a old building than it would have been much harder to estimate the actual facility costs. it is possible to estimate the actual annual facilities costs for the new Dialysis Center, something that is not possible for units located within the hospital complex”( Rio Grande Medical Center) From the case we know that the move of the facility from the main medical complex was necessary due to “the Outpatient Clinic has created a need for 25 percent more space than is currently assigned” (Rio Grande Medical Center) and it would be very helpful if some of the departments bear the burden of the move and the higher cost associated with it.
The case restricts any cost associated with the move to be shared with the Outpatient Clinic, but by spreading the cost inherent in the new space to all patient services this would help the Dialysis Center with the financial burden of building a new facility. “In the past, facilities costs were aggregated, so all departments were charged a cost based on the average embedded (historical) cost regardless of the actual age (or value) of the space occupied. Thus, a basement room with no windows was allocated the same facilities costs (per square foot) as was the fifth floor executive suite.
Because many department heads thought this approach to be unfair” (Rio Grande Medical Center) It would be much fair if allocated costs are incrementally increased or decreased based on individual departments and the quality of space that they occupy. If this is done arbitrarily the amount allocated would remain unchanged. 3. If the new allocation method for facility costs is implemented, what should be the facility allocation to the Dialysis Center in 20 years, when the loan (which is the basis for the higher cost allocation) has been paid off and there are no longer any actual facility costs?
After twenty years the true allocation facility cost for the Dialysis Center should be zero, since the facility would be paid off and should have only minimal allocating facility costs such as opportunity costs and costs of using the center. If after the twenty years the building is not occupied it can be used from other medical centers or it could be rented out or sold. It is difficult to try to determine the opportunity costs for space occupied by all activities.
The current system of facility allocation assigns equal opportunity cost across all activities and services and avoids the problem inherited in the new method. 4. Explain how the revenue from medical (pharmacy) supplies is currently handled for profit and loss reporting purposes. Is there a problem with the current system? Is there a better way of reporting this revenue? If so, what is it? With the current systems of accounting for profit and losses the Dialysis Center records the pharmaceutical used in patient services as revenue and then records the same amount as an expense.
Because general overhead is allocated on department patient service revenue the record in the system increases the general overhead allocation of the Dialysis Center. A solution to the problem is if the Dialysis Center receives credit for the pharmacy revenue which is a profit for the hospital . If this approach is used some of the profit will stay with the Dialysis Center by assigning price for the drugs used minus the payment received from patients for the service. The remaining profit would accrue to the Pharmacy Department since their cost of the pharmacy supplies would be less than the revenue booked on the supplies.
This would provide justification for the allocation of the overhead costs on pharmacy supplies revenue. 5. When all issues related to the decision are considered, what is your recommendation regarding the final allocation amounts? As Alternative allocation scheme the following information can be taken from the case. The Dialysis Center revenue would fall to $1,900,000 when the pharmacy charge is taken out. $2,700,000-$800,000=$1,900,000 If there is no change of the allocation rate as 10% revenue, the new general overhead allocation would be: 0. 0 X $1,900,000=$190,000 The reduction in general overhead allocation to the Dialysis Center of: $270,000 – $190,000 =$80,000 Must be offset by increase of general allocation to the Outpatient Clinic: $2,000,000 + $80,000= $2,080,000 The facility costs within the outpatient clinic would be: $400,000 + $1,500,000= $1,900,000 The total square footage for all departments is 120,000 and the new allocation rate is: $1,900,000/ 120,000= $15. 8333 per square foot Allocation for the Outpatient clinic: $15. 8333X 100,000sq. t. = $1,583,333 Allocation for the Dialysis Center: $15. 8333 x 20,000sq. ft. = $316,667 | Without Expansion| | With Expansion| | | | | Initial Allocation| Alternative Allocation| Revenue / Direct Cost| DC| OC| DC| OC| DC| OC| Total Revenues| $2,700,000| $160,001,000| $2,700,000| $20,000,000| $1,900,000| $2,700,000| Direct Expenses| 2,100,000| 9,833,155| 2,100,000| 12,291,444| 1,300,000| 12,291,444| Contribution margin| $600,000| $6,166,845| $600,000| $7,708,556| $600,000| $7,708,556| Percent of Revenues| 22. 0%| 38. 50%| 22. 20%| 38. 50%| 31. 60%| 38. 50%| | | | | | | | Indirect Costs| | | | | | Facilities Costs| $300,000| $1,200,000| $400,000| $1,500,000| $316,667| $1,583,333| General overhead| 270,000| 1,600,000| 270,000| 2,000,000| 190,000| 2,080,000| Total Overhead| $570,000| $2,800,000| $670,000| $3,500,000| $506,667| $3. 663,333| Net Profit| $30,000| $3,366,845| ($70,000)| $4,208,556| $93,333| $4,045,223| Percent of revenue| 1. 10%| 21. 00%| (2. 60)%| 21. 00%| 4. 90%| 20. 20%| Facilities cost Allocation| | | | |
Square footage| 20,000| 80,000| 20,000| 100,000| 20,000| 100,000| Facilities costs per square foot| $15. 00| $15. 00| $20. 00| $15. 00| $15. 33| $15. 33| Other Overhead Allocation 😐 | | | | General overhead costs as a % of revenue| 10. 00%| 10. 00%| 10. 00%| 10. 00%| 10. 00%| 10. 40%| From the following allocation scheme it can be concluded that if the Outpatient Clinic share the allocation costs the profitability reduction will be minimal for the clinic from 21. 0% to 20. 2% The profitability for the Dialysis Center would improves from negative 2. % of revenue to a positive 4. 9% of revenue. The whole organization should share the increased facilities cost of the new building. It would me more fairly if it is used reallocation scheme for all patient service departments instead of confining changes to only outpatient services. More complex examination of the allocation for the general overhead and whether more cost pools should be used . The Dialysis Center can receive benefits for the pharmacy drugs sold and used by the patients, which would show more profitability for the center.
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