Cost Drivers
Posted on August 10, 2009 - Filed Under Finance
Perhaps the most important step in the cost allocation process is the identification of proper cost drivers. Traditionally, overhead costs were aggregated across all support departments and then divided by a rough measure of organizational output, resulting in an allocation rate of some dollar amount of generic overhead per unit of output. For example, the total inpatient overhead costs of a hospital might be divided by total inpatient days, giving an allocation rate of so many dollars per patient day, which was called the per diem overhead rate. If a hospital had 72,000 patient days in 2004, and total inpatient overhead costs were $36 million, the overhead allocation rate would
be $36,000,000 / 72,000 = $500 per patient day (per diem). Regardless of the type of patients treated within an inpatient services department (adult versus child, trauma versus illness, acute versus critical care, and so on), the $500 per diem allocation rate would be applied to determine the indirect cost
allocation for that department.
However, it is clear that not all overhead costs are tied to the number of patient days. For example, overhead costs associated with admission, discharge, and billing are typically not related to the number of patient days but to the number of admissions. Thus, tying all overhead costs to a single
cost driver improperly allocates such costs, which distorts reported costs for patient services, and hence raises concerns about the effectiveness of decisions based on such costs. In state-of-the-art cost management systems, the various types of overhead costs are separated into different cost pools and the most appropriate cost driver for each pool is identified.
The basis for identifying cost drivers is the extent to which costs from a pool actually vary as the value of the driver changes. For example, does a department with 10,000 square feet of space use twice the amount of housekeeping services as a department with only 5,000 square feet of space?
The better the relationship (correlation) between actual resource expenditures at each sub-unit and the cost driver, the better the cost driver and hence the better the resulting cost allocations.
Taken From : HEALTHCARE FINANCE
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