Managerial Accounting Basics
Cost Allocation
Cost Allocation - Direct Method
The Impact of Cost Structure on Risk
- Reimbursement is tied exclusively to
volume (FFS), then the provider’s
financial risk is minimized if all costs
are variable.
If reimbursement is exclusively
capitated, then the provider’s
financial risk is minimized if all
costs are fixed.
Utilization management: FFS –
increasing # of visits, increases profit;
Capitation – increasing # of visits does
NOT increase profits
Number of members: Capitation –
increasing members, increases profits
Cost Allocation – classified by its relationship to the unit of activity. is to assign
indirect costs to the departments that create the need for such costs, typically the
patient service departments
Types:
Direct – costs unique and exclusive to a subunit
Indirect or overhead – costs associated with shared resources used by the entire
organization
Cost Pool – is the overhead amount to be allocated (Ex – overhead costs of the HR
dept.
Cost Driver – the basis on which the cost pool will be allocated. (This will be given.
Ex: Sq Footage)
- Critical to the cost allocation process
- goal is high correlation with actual overhead consumed
- should promote organization cost reduction
Managerial accounting:
- Uses organizational and subunit data
- Designed for use by managers
- Primarily forward looking
- Does not adhere to external standards
Cost Classifications:
*Fixed – independent of volume-Rent, Salaries
Variable – depends on volume-Supplies, Pharmacies
*no costs are fixed throughout an infinite range of volumes.
Thus, the concept of cost classifications according to volume
must be applied within some “relevant range” of patient
volume.
Cost Definitions:
Full or Total Cost - the sum of all costs associated with the cost
objective. It equals direct cost + indirect cost
Direct Costs – costs for your department, specifically. (MRI
machine for radiology)
Indirect Costs (Overhead) – costs spread across the entire
organization. (Housekeeping or Admin)
Average Cost = TC/# units
AVG Variable Costs=VC/# units
Marginal Costs are the "additional" costs incurred as the result
of providing one more unit of service (incremental costs).
*Marginal costs are equal to Variable costs unless there are
changes in Step-Fixed costs.
Traditional Allocation Process
1. Identify the cost pool – dollar cost of the overhead activity to be allocated.
2. Determine the cost driver – basis on which the overhead costs will be
allocated
3. Calculate the allocation rate – numerical value used to make the allocation
**Allocation rate = [Dollars in cost pool / Total volume of cost driver]**
4. Determine the allocation amount (Multiply above by
Results:
Profit center—a business unit that generates revenues as well as costs; therefore
ddPROFITABILITY can be measured
Cost Center—a business unit that does not generate revenues and hence only its
ddCOSTS can be measured
Allocation Method
1. Direct method - costs of each support department are allocated directly to, and
only to, the patient services departments.
2. Step-down method - some (but not all) of the intra-support department
relationships are recognized.
3. Activity-Based Costing (ABC) – unlike traditional cost allocation (top-down
system), ABC begins with individual activities that comprise the services provided
- Requires more info and is more complex than traditional costing
Forecasted (Projected) Profit and Loss (P&L) Statementuses cost structure information along with the revenue forecast
and projected volume to forecast profitability
Total Contribution Margin-Revenue-VC
Contribution Margin per unit–Rev/# units-VC/#units
Breakeven Analysis – can be used to determine breakeven
volume - volume needed for an organization to be financially
self-sufficient (TR=TC=0 or TR-TC=0)
- Accounting breakeven (zero profit)
- Economic breakeven (with profit)
Total Revenue = Fixed Rev. + (price x quantity) = FR + VR
Total Cost = Fixed cost + (AVG VC x quantity)
P&L Format Breakeven Analysis: Total Rev – Total VC – FC = 0
(breakeven)
Contribution Margin Format: CM x Q = Fixed Costs (no
economic profit)
: CM x Q = Fixed Costs + Profits (economic profit)
Marginal (Incremental Analysis) (CM=240, VC=112.48, Unit=4)
Marginal cost of each visit is the variable cost rate (VCR=Variable
cost/unit=$28.12)
Marginal Revenue (CM/unit) of the new contract is $60, so the CM/unit is $60 $28.12 = $31.82 for each unit
1. Assume a hospital’s Housekeeping Department has direct costs of $100,000
2. The cost driver is the amount of space occupied. User departments in total
occupy 200,000 square feet of space.
3. Allocation rate is $100,000 / 200,000 = $0.50 per sq. ft. of space occupied.
4. If the Critical Care Department occupies 10,000 sq. ft. of space its allocation
would be $5000? (.5*10,000)
Cost Allocation – ABC Method
FFS: Number of
visits times
revenue per
visit
+
=
Minor Exam(MiE)(1500) plus Major Exam(MaE)(500)=Total (2000). Total divided by Annual
Cost(25,000)=Allocation Rate(12.50).
Physical Exam minutes for MiE (60) times total MiE Exams(1500) plus Physical Exam MaE
minutes(120) times total MiE Exams(500)=Total(150,000). Total divided by Physical Exam Annual
Costs(300,000)
Variance Analysis
Capitation:
PMPM times
Member
Months
Budget Variance Analysis – technique
applied to budget data to:
- Identify problem areas
- Enhance control
- Helps managers: prepare budgets for
upcoming year, control results in the
current year, and evaluate the
performance of operating units
Reasons why actual results might
differ from the static (master) budget:
- Sales and other cost-driver activities
were not the same as originally
forecasted.
- Revenue or variable costs per unit of
activity and fixed costs per period
were not as expected.
Which Variances Merit Examination?
Variances greater than the
specified dollar amount
Variances greater than specified
percentages
Variances that persist for some
time period
Combinations of the above
The ones your manager cares
about
Traditional Variance Analysis - Variance can be “Favorable” (F), or “Unfavorable” (U)
Three types of data used:
- The static or budgeted amount is the original budget, unadjusted for realized volume
- The realized, or actual data reflect after-the-fact results.
- The flexible budget is one that has been adjusted to reflect realized volume only; using
all other budget (initial) assumptions. Cost is what changes from actual. Flex=Actual
Volume, Budget Costs
Statement of Cash Flow
STATEMENT OF CASH FLOWS – combines both I/S and B/S data.
Reports transactions over a PERIOD OF TIME;
Operating Activities
Refers to the primary revenue generating activities of a business
Start with net income
Depreciation/amortization expense for the year is a results in a positive
adjustment (increase) on cash flow statement
Any changes to working capital (current assets, current
liabilities) goes in this section
Positive change (increase) in an asset (except CASH) account
result in a negative adjustment (decrease) on cash flow
statement
Positive change (increase) in a liability account result in a
positive adjustment (increase) on cash flow statement
+ loss on sale of equipment or other assets (OR -gain) / + decrease in
Inventory (OR -increase in Inventory) / - increase (OR + decrease) in
A/Receivable / + increase (OR - decrease) in A/Payable / + increase
(OR – decrease)in Accrued Expense / + decrease (- increase) in
Prepaid Expenses/Insurance
Investing Activities
Consider this section to reflect purchases and sales of NON-CURRENT
assets or sales of investments or securities
Refers to changes in regard to investment gains/losses and new
investments or sales of fixed assets
Proceeds from sale of assets or investments results in positive adjustment
on CF statement
Purchase of investments, such as stocks and bonds, results in negative
adjustment to CF
+ Increase (- Decrease) in Notes payable (liability)
Financing Activities
Considers activities associated with all liabilities and stockholders’ equity,
except for current liabilities
Transactions with owners or lenders to provide long-term funds to the
company or return those funds to the owners or lenders
Proceeds from issuance of stock or debt result in positive adjustment on CF
statement
Issuance of dividends results in negative adjustment on CF statement
+ Issuance of bonds - Purchase of Treasury Stock - Redemption of
Bonds - Payment of Dividends