Direct costs are defined as costs that can be traced directly to a department, product, or service
(Nowicki, 2021). In direct costs, also often called overhead costs are defined as costs that cannot be
traced directly to a department, product, or service. Examples of direct costs are medical supplies,
salaries, and meals provided to patients. Examples or indirect costs are rent, utilities, indirect salaries,
legal fees, and equipment depreciation (NIH, 2020).
Financial managers use financial resources and cost classification to allocate expenses as either an
indirect or direct cost when determining patient charges. Nowicki (2021) states that cost allocation is
the process of assigning indirect costs, and some direct costs to departments that generate charges.
They do this by following a five-step prerequisite process.
Organizational Chart- this chart and commensurate chart of accounts identifies who is responsible for
each functional area/department and the cost center and revenue center that corresponds to the chart
(Nowicki, 2021). All departments are a cost center but only departments that generate money are
revenue centers (Nowicki, 2021). d
Revenue Center Identification-The next step is dividing cost centers by whether they generate
revenue and if a cost center does not generate revenue, then their costs need to be allocated to a cost
center this is revenue producing (Nowicki, 2021).
Accounting System-organizations must have an accounting system that quickly and accurately assigs
costs and charged to the identified cost and revenue centers (Nowicki, 2021).
Workload Statistics-organizations must have a comprehensive information system that generates
accurate, non-financial statistics for all departments that best reflects the departments workload
statistics and the work performed in each department (Nowicki, 2021).
Cost Allocation Methods-organizations must determine their cost allocation method (Nowicki, 2021).
Methods include Direct Apportionment-this method moves costs from non-revenue generating
departments to ones that generate revenue (Nowicki, 2021). Step Down Apportionment-this method
allocates costs and moves them from one non-revenue generating cost center to another and then to a
revenue generating cost center (Nowicki, 2021). Double Appointment-this method does the same as
the step-down method but adds another step of moving the allocated costs to another revenue
generating costs center and then allocates costs from non-generating costs centers to revenue
generating cost centers (Nowicki, 2021). Multiple Apportionment-this method is also called algebraic
apportionment and is a twostep method that makes multiple apportionments within the first step
(Nowicki, 2021).
Utilization rates measure efficiency and productivity. Organizations should have targeted utilizations
rates to help with measuring profitability and growth (Leeuwen, 2021). d Positive or higher utilization
rates lead to both increased revenue and profitability.
Reference
Office of Management. (2020, December 13). Indirect Cost: Definition and Example | Nih.Gov.
Leeuwen, M. (2021, October 28). Why Employee Utilization Rates are the Key to Driving
Profitability. VOGSY. https://www.vogsy.com/blog/utilization-rate-profitability/
Nowicki, M. (2021). Introduction to the Financial Management of Healthcare Organizations, Eighth
Edition (Gateway to Healthcare Management) (7th ed.). Gateway to Healthcare Management.
