A dialysis clinic provides two types of treatment for its patients. Hemodialysis (HD), an in-house treatment, requires
Question:
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.
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.
Required
a. Organize the class into four sections and divide the sections into groups of four or five students each. Assign Task 1 to the first section of groups, Task 2 to the second section, Task 3 to the third section, and Task 4 to the fourth section.
Group Tasks
(1) Allocate the RN cost pool between the HD and PD service centers.
(2) Allocate the LPN cost pool between the HD and PD service centers.
(3) Allocate the nursing administration and support staff cost pool between the HD and PD service centers.
(4) Allocate the dialysis machine operations cost pool between the HD and PD service centers.
b. Have the class determine the total cost to allocate to the two service centers in the following manner. Select a representative from each section and have the selected person go to the board. Each representative should supply the allocated cost for the cost pool assigned by her respective section. The instructor should total the amounts and compare the ABC cost allocations with those developed through the traditional RCC system.
c. The instructor should lead the class in a discussion that addresses the following questions.
(1) Assuming that the ABC system provides a more accurate measure of cost, which
Service center (HD or PD) is overcosted by the traditional allocation system and which is
undercosted?
(2) What is the potential impact on pricing and profitability for both service centers?
(3) How could management respond to the conditions described in the problem?
Step by Step Answer:
Fundamental Managerial Accounting Concepts
ISBN: 978-1259569197
8th edition
Authors: Thomas Edmonds, Christopher Edmonds, Bor Yi Tsay, Philip Olds