1. Briefly describe the differences in the four allocation methods discussed in the case. From your standpoint, which of the four methods is conceptually the most reasonable? Why?
Direct allocation: each support department costs are allocated directly to the service departments that use the services. The direct allocation method is relatively simple to apply. None of the costs of providing support services is allocated to other support departments. Only the direct costs of the support departments are allocated to the patient services departments because no indirect costs have been created by intrasupport department allocations. This method is the least costly of the four.
This method captures all of the intrasupport department relationships, therefore no information is ignored and no biases influence the cost allocation process. This method does rely on the simultaneous solution of a series of equations representing the utilization of intrasupport department services. This method is complex and is known to be difficult to explain to department managers. This method is the most costly of the four.
From my standpoint, the direct allocation method is the most reasonable. It is relatively simple to apply, the least costly and a timely process.
2. What are the allocations to each patient services department, and resulting profitability, under the four allocation methods using the base case cost amounts (Exhibit 4.1) and allocation rates (Exhibit 4.2)? Which do you think is best? Why?
It appears that the numbers are not that different, and because you have graciously provided the completed excel sheet, I can be confident it wasn’t my error!! Thank you! In each allocation method, one dept makes money and the others lose money. I would still stay with the direct allocation method – emphasizing that it is the most simple to determine. The more complex the process, the more likely it is that additional expenses will occur to support the process.
3. Calc 1,2. What happens to the profitability of each clinical service department (AM, OB, PEDS) under each scenario? Why?
Regardless of where the highest direct costs are, adult medicine is the most profitable in the base case, calculation 1 and calculation 2. Adult medicine produces the most revenue and therefore will always have the highest profitability – regardless of...
