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Cost Behavior and Allocaton in Health Care Essay

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Updated: May 10th, 2022

Health care is a very important structure in the life of a human beings and, without a proper health care system, life can be a hollow existence. Proper health care should not be privileged to people rather it should be affordable. When the determination of the payment of hospital services is made in America, they must be a change to be adapted. For instance, in 1965- 1983, payment was based on hospitals’ total cost but, from 1984, payment was based on patient’s diagnosis on an episode which is a variable cost base. Due to this, the ratio of variable cost to total cost increased after 1983 (Kallapur and Eldenburg 2005).

Before the management of cost, it is vital to understand why the cost is being incurred. For example, a total cost must be broken down to variable cost and fixed cost TC=FC+VC. Total cost is patient related costs and non patient related cost. The variable cost is the cost which does change directly with the level of activity such as medication dispensed from the pharmacy. The cost drive in variable cost includes standard cost of x-ray, laundry and linen cost, etc. Fixed cost is the constant cost which is not influenced by the level of activity in the hospital that is salary of the directors in the pharmacy. Another cost has both the element of both fixed and variable cost, normally, are called mixed cost.

Mostly, in the hospital cost, 84% is a fixed cost while only 16% is variable mainly due to the capital expenditure and construction costs. This is the complexity, when the fixed cost is high, it is essential to have a high level of activities that generates revenue so as to cover the fixed costs and boost the profits. Once fixed cost is covered, everything beyond that point is profitable (Egger 2000).

Cost classification is a process of grouping cost according to their class and similarities. This helps in the establishment of the cost centers. This classification includes the following.

Identify basis

Cost is divided into three groups material, labor and expenses basis. This cost helps in establishment of total cost and the way it is incurred. Work in progress is also established through this basis

Function basics

Include production, administration and selling and distribution basis. They help in the establishment cost of the general running of the organization

Time basis

This includes the historical cost that are ascertained are they have occurred. This cost is available when the production of an item has been done already. The other one is predetermined cost which is determined through the scientific way. This becomes the standard cost after then it is compared with the actual cost.

Normally basis

In this category they are classified into:

  • Normal costs, which are incurred on the normal level of output usually the production cost.
  • Abnormal cost, a cost which does not incur normally on a given level of output.

Cost allocation is the process of identifying and assigning costs to various departments within the organization. It is the management accounting tool that is used to measure the income of the firm, control cost and boost the morale of the employees. Furthermore cost allocation is also an important tool in decision making and helps the organization to meet its goals. The other importance of cost allocation includes teh following:

  • Accurately assigning of cost within the organization in order to establish exactly the cost that was incurred within the departments.
  • Keeping a proper record of expenses and tracking them for better planning.

References

Egger, Ed. (2000). Market Memo: Hospital Should Look at Radiology as a Profit Center. Health Care Strategic Management, 18(2), 1-3.

Kallapur, S., & Eldenburg, L. (2005). Uncertainty, Real Options and Cost Behavior. Evidence from Washington State Hospitals. Journal of Accounting Research, 5, 735-752.

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