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.
1. 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).
2. 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).
3. 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).
4. 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).
5. 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). b 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.
