Question

Tacoma Hospital has three support departments and four patient services departments. The direct costs to each of the support departments are as follows:

Tacoma Hospital has three support departments and four patient services departments. The direct costs to each of the support departments are as follows:

	Direct Costs	Cost Driver
General Administration	$2,000,000	Salary Dollars
Facilities	$5,000,000	Housekeeping Labor Hours
Financial Services	$3,000,000	Patient Services Revenue
Total	$10,000,000

The patient services revenue, salary dollars, and housekeeping labor hours for each department are as follows:

	Revenue	Salary Dollars	Housekeeping Labor Hours
General Administration		$1,500,000	2,000
Facilities		$3,000,000	5,000
Financial Services		$2,000,000	3,000
Routine Care	$30,000,000	$12,000,000	150,000
Intensive Care	$4,000,000	$5,000,000	30,000
Diagnostic Services	$6,000,000	$6,000,000	15,000
Other Services	$10,000,000	$7,000,000	25,000

Assume that the hospital uses the step-down method for cost allocation (see pages 230 0 232), with salary dollars as the cost driver for general administration, housekeeping labor hours as the cost driver for facilities, and patient services revenue as the cost driver for financial services. Assume also that the general administration department provides the most services to other support departments, followed closely by the facilities department. The financial services department provides the least services to the other support departments.

a. Use an allocation table to allocate the hospital’s overhead costs to the patient services departments.

b. Is the direct method or the step-down method better for cost allocation within Tacoma Hospital’s? Please explain.

Answer 1

a. Overhead Allocation Table:Step-down Method

	Basis of Allocation	General Administration	Facilities	Financial Services	Routing Care	Intensive Care	Diagnostic Services	Other Services
Overhead Costs before Alllocation		$ 2,000,000	$ 5,000,000	$ 3,000,000
Allocation of General Administration Overhead	Salary Dollars	(2,000,000)	171,429	114,286	685,714	285,714	342,857	400,000
Allocation of Facilities Overhead	Housekeeping Labor Hours	-	(5,171,429)	69,571	3,478,540	695,708	347,854	579,756
Allocation of Financial Services Overhead	Patients Services Revenue	-	-	(3,183,857)	1,910,314	254,709	382,063	636,771
				-
Totals		0	0	0	6,074,568	1,236,131	1,072,774	1,616,527

b. The step-down method seems to be more appropriate as general administration provides services to both the facilities and financial services departments. Further, the financial services department too avails services of the facilities department. Therefore, the step-down method would be more appropriate than the direct method in allocating support department costs.