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Example 6A: Direct and Indirect Costs

Review the chapter text regarding direct and indirect costs. In particular, review the example of ambulance direct costs (Exhibit 6–1) and indirect costs (Exhibit 6–2). Remember that indirect costs are shared and are sometimes called joint costs or common costs. Because such costs are shared they must be allocated. Also, remember that one test of a direct cost is to ask: “If the operating unit (such as a department) did not exist, would this cost not be in existence?”

Practice Exercise 6–I: Identifying Direct and Indirect Costs

Make a worksheet with two columns: Direct Cost and Indirect Cost. Place each of the following items in the appropriate column:

• • Managed care marketing expense
• • Real estate taxes
• • Liability insurance
• • Clinic telephone expense
• • Utilities (for the entire facility)
• • Emergency room medical supplies

Assignment Exercise 6–1: Allocating Indirect Costs

Study Table 6–1, Table 6–2, and review the chapter text describing how the indirect cost is allocated. This assignment will change the allocation bases input for (A) Number of Visits (Volume), (B) Proportion of Direct Costs, and (C) Number of Computers in Service.

Practice Exercise 6–II: Responsibility Centers

The Metropolis Health System has one director who supervises the areas of Security, Communications, and Ambulance Services. This director also supervises the medical records relevant to Ambulance Services, the educational training for Security and Ambulance Services personnel, and the human resources for Security, Communications, and Ambulance Services personnel.

Assignment Exercise 6–2: Responsibility Centers

Choose among the Case Study in Chapter 27, the clinic in Mini-Case Study 2, or the Metropolis Health System information as contained in its Case Study and the Appendix that contains its financial statements. Designate the responsibility centers and the support centers for the organization selected. Prepare a rationale for the structure you have designed.

Example 7A: Fixed, Variable, and Semivariable Distinction

Review the chapter text for the distinction between fixed, variable, and semivariable costs. Pay particular attention to the accompanying Figures 7–1 through 7–5.

Practice Exercise 7–I: Analyzing Mixed Costs

The Metropolis Health System (MHS) has a system-wide training course for nurse aides. The course requires a packet of materials that MHS calls the training pack. Due to turnover and because the course is system-wide, there is a monthly demand for new packs. In addition, the local community college also obtains the training packs used in their credit courses from MHS.

The education coordinator needs to know how much of the cost is fixed and how much of the cost is variable for these training packs. She decides to use the high–low method of computation.

Assignment Exercise 7–1: Analyzing Mixed Costs

The education coordinator decides that the community college packs may be unduly influencing the high–low computation. She decides to rerun the results, omitting the community college volume.

Example 7B: Contribution Margin

Computation of a contribution margin is simplified if the fixed and variable expense has already been determined. Examine Table 7–1, which contains Operating Room fixed and variable costs. We can see that the total costs are $1,217,756. Of this amount, $600,822 is designated as variable cost and $616,934 is designated as fixed ($529,556 1 $87,378 = $616,934). For purposes of our example, assume the Operating Room revenue amounts to $1,260,000. The contribution margin is computed as follows:

Thus, $659,178 is available to contribute to fixed costs and to profit. (In this example fixed costs amount to $616,934, so there is an amount left to contribute toward profit.)

Practice Exercise 7–II: Calculating the Contribution Margin

Greenside Clinic has revenue totaling $3,500,000. The clinic has costs totaling $3,450,000. Of this amount, 40% is variable cost and 60% is fixed cost.

Assignment Exercise 7–2: Calculating the Contribution Margin

The Mental Health program for the Community Center has just completed its fiscal year end. The program director determines that his program has revenue for the year of $1,210,000. He believes his variable expense amounts to $205,000 and he knows his fixed expense amounts to $1,100,000.