What methods of cost allocation were used?
After the merger of Western Hospital and Academic Hospital, their costs were managed jointly; the new facility adopted a transfer pricing and service department costing methods.
After the merger, they operated some departments jointly while others remained independent; laboratory services were offered at Academic Hospital for both facilities and all the costs relating to the department were allocated to the costs heads appropriately and included in the final calculation of the department costs.
When using direct costing method, all costs incurred to provide certain service in a hospital are put into consideration when determining the cost of a costing centre. In the case of Western Hospital and Academic Hospital, the laboratory services had their costs as; direct incremental costs in the form of labour and supplies costs, the cost was charged at Academic Hospital and amounted to $300.
The second costs are overheads that amounted for $90 at Academic Hospital. over and above the costs incurred, Academic Hospital making a profit of $6 per laboratory service. If a laboratory service was offered on behalf of western Hospital, Academic hospital charged the service to the Western Hospital.
How were cost centres determined
Cost are determined using cost drivers and cost centres; in the case of Western Hospital and Academic Hospital, cost centres were determined using direct allocation method; this is where the cost of a service is attributed directly to a certain service; when charging for the service total costs are independently considered.
When determining the cost to charge a patient using the cost centres established, the quoted price is inclusive of the profit margin that a particular section of the whole facility has.
In this case, we have the laboratory service department as one of the cost centres that will be used by both hospitals; when they are determining the cost to quote for customers or to transfer to sister company, they include all the costs incurred when providing the service and add a profit margin.
The hospitals when considered independently can be considered cost centres on their own since at the end of the day, they will have to account for expenses incurred in provision of medical services.
How would fixed and variable costing differ in this situation?
Fixed costs are incurred whether a facility has been used or not; whereas variable costs are dependent on the usage of the facility; in the case of hospital costing, fixed costs include rent, licences, legal fees and general maintenance costs.
Variable costs are overheads like nursing service, doctor fees and medicine packaging costs. The main difference between fixed and variable cost is the certainty of their occurrence, at any one time a hospital facility can be assured that it will incur some fixed costs but variable costs will be dependent to the number of patients requiring the facility service.
Laboratory services department fixed costs after the merger were incurred at the expense of Academic Hospital, the costs only passed to Western Hospital if Western Hospital utilized the service. Laboratory services department variable costs will only be incurred when a patient uses the facility, the costs are transferred to the patients.
Reference
Finkler, S.A., Ward, D.M., & Baker, J.J. (2007). Essentials of Cost Accounting for Health Care Organizations. Sudbury, MA: Joseph and Bartlett Publishers, Inc.