Cost Allocation Is a Very Important Thing - Essay Example

? Cost Allocation Affiliation with more information about affiliation, research grants, conflict of interest and how to contact Cost Allocation 1. What methods of cost allocation were used? Cost allocation is very important as is evident from the fact that various firms use several methods of cost allocation. A cost allocation method should meet the specific criteria of the organization so that the ineligible items needed in cost appropriation can be removed and more appropriate items can be included. A systematic and rational cost allocation method should be adopted in the organization. It has to be determined in the beginning as to which divisions in the hospital can be differentiated as service centers or revenue centers and it should be decided how the service costs will be assigned in the hospital and the correct cost drivers should be chosen as well. The direct allocation of costs may not be a clear reflection of the revenue center’s actual use of service. While Western hospital is charging $555 from the patient, the Academic Hospital is charging from the former, $450 instead of $400, when $400 was the negotiated price. Moreover, Western Hospital has found that an independent laboratory agrees to do the work for $375 as compared to the $400 that the other hospital is charging. This implies that there is no rational cost allocation method that has been adopted by the Academic hospital in fixing its costs. Furthermore, the Academic Hospital was charging $90 for overhead costs, which is applicable in both the cases, whether the amniocentesis laboratory tests were done there or not. The hospital even demanded to charge $60 in case of incurring profit. This is not a correct cost allocation as it is not at all systematic. Since it is a merger, there should be profits for both the firms, then only they can continue the business in a harmonious way. How were cost centers determined? The determination of cost centres in an organization is done through an evaluation of the costs of the organization. “A cost centre is part of an organization that does not produce direct profit and adds to the cost of running a company. Examples of cost centres include research and development departments, marketing departments, help desks and customer service/centres. Although not always demonstrably profitable, a cost centre typically adds to revenue indirectly or fulfils some other corporate mandate” (Cost Center, 2000, para. 1). Cost centre can be a location, individual or an item of equipment (or group of these) of the prices that are determined and can perform the function of cost control. In this problem, the cost centres are determined using the given facts about the departments and functions performed by both the hospitals. An evaluation of both Academic hospital and Western hospital is done to determine the cost centres. As per the details of the problem both hospitals have one cost centres each. But, here, the cost centre of the Western Hospital is considered, as the problem is faced in the case of laboratory services. An accounting of the cost centre helps the organization to check the profitability of individual functional areas and to take appropriate decision that would compensate for losses ans help in the attainment o future gains. Table: 1- Cost of services allocated to cost centres. Cost Centre Service Unit Cost($) Profit($) Laboratory (per test) Amniocentesis 300 450 105 The above table shows the present situation in the Western hospital when the laboratory service is provided by the Academic hospital. But if the same service is taken from outside at a lower cost of $375, then the Western hospital will get an increment of $75 in its profit. How would fixed and variable costing differ in this situation? Cost analysis and the considerate character of cost behavior are very significant for the accountants of the organizations. These issues allow estimating potential costs and stages of manufacture as we observe current costs and productions. Costs are a main factor regarding the decision making process. Fixed costs are production expenses that are not reliant on the stage of goods or services formed by the business. They are time-related, for example, rents or salaries being paid for each month, are frequently referred to as fixed costs. Variable costs are expenses that transform with percentage change in the movement of a business. Variable cost is the calculation of marginal costs in general units produced. It can also be measured through normal costs. Fixed and variable costs make up the two components of total cost. In this problem, fixed and variable cost differ in both the cases of Academic and Western hospitals. Following is the comparison of fixed and variable cost relating to the Academic hospital and Western hospital. a) Fixed Costs: Particular Academic Western Sale or Transfer 450 505 Cost 390 450 Profit 60 55 Combined profit=60+55=125. b) Variable Costs: Particular Western Academic Sale or Transfer 345 505 Cost 390 345 Profit 45 60 Combined profit = 45+60= 105. In this situation, Academic hospital’s fixed costs are lower when compared to the Western hospital. Here, the combined profit is 125. In the case of Variable costs, Western hospital has a higher cost than the Academic hospital. The combined profit, here, is found to be 105. Appendix: How much would the transfer price be under a) full charges? Labour and Supplies = 300 Overheads = 90 Profit= 60 Transfer price = 450 b) Variable costs? Labour and Supplies = 300 Profit = 45 Transfer price = 345 c) Market price? Independent lab charges = 375 Transfer price = 375 d) Negotiated value? Academic cost = 400 Transfer worth = 400 How much profit does each hospital make under each alternative? How much do the combined hospitals make under each alternative? a) Full charges Particular Academic Western Sale/Transfer 450 505 Cost 390 450 Profit 60 55 Combined profit of fixed charges = 60 + 55= 115 b) Variable Charges Particular Academic Western Sale 345 505 Cost 390 345 Profit 45 60 Combined profit of variable charges = 45+60= 105 c) Market Price Particular Academic Western Sale 375 505 Cost 390 375 Profit 15 130 Combined profit = 15+130= 145 Combined profit = 10+105= 115 d) Negotiated price? What happens if Western hospital purchases from an outside lab for $375? Particular Academic Western Sale or Transfer 000 505 Cost 90 375 Profit 90 130 Combined profit= 90+130= 220 Reference List Cost Center, (2000). Search CRM.com. Retrieved July 28, 2011, from http://searchcrm.techtarget.com/definition/cost-center Read More