Direct Method Illustration (3)
Posted on August 31, 2009 - Filed Under Finance
Two of the support departments, Administration and Personnel, also use a fairly rough cost driver, salary dollars of the patient services departments, instead of a more precise one. For example, if Radiology has payroll costs that are five times larger than those of Laboratory, Radiology will be charged (allocated) five times as much of the costs incurred by Administration and Personnel. This cost driver is often used, but in reality, it is not very precise or meaningful. Thus, the allocated costs probably do not truly represent the
relative amounts of utilization of these overhead services.
Housekeeping, perhaps, has chosen the best cost driver—namely, the number of labor hours of housekeeping services consumed. In many organizations, housekeeping costs are allocated on the basis of square footage, which uses the logic that the amount of space occupied by a department accurately
reflects housekeeping efforts and hence costs. This assumption may or may not be valid, however. In effect, large space departments may be subsidizing small space departments, such as emergency services, where space may be limited but the intensity of work requires a significant amount of housekeeping services.
To account for such situations at Kensington Hospital, Housekeeping is using a better cost driver—one that is more closely aligned to the actual resources expended in providing services to the patient services departments.
Similar to most situations, the development and use of the best cost driver is a cost-benefit issue. Housekeeping must now devote resources to track where their workers spend their time, an effort that would not be required if the cost driver were square footage. The benefit, of course, is a cost driver that makes it easier for Kensington’s senior managers to hold department heads responsible for both direct and indirect costs. Now, if the head of Radiology does not like the amount of housekeeping costs that are
being charged to the department, he or she can do something about it: use less Housekeeping services. Under an inferior cost driver, such as square footage, there is little that patient services department heads can do if they do not like the Housekeeping allocation. In most cases, reduction of square footage is
not a very practical way to deal with excessive housekeeping costs.
Taken From : HEALTHCARE FINANCE
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[…] currently $1,600,000, will fall as these services are more efficiently utilized. In reality, the secondary benefit of moving from a rough cost driver, such as square footage, to a more precise cost driver, such as […]