This is all the information that is available Chapter 5 Act

This is all the information that is available.

Chapter 5 – Activity-Based Costing

St. Francis Healthcare and Dialysis Clinic

St. Francis Healthcare and Dialysis Clinic (SFHDC) is an independent, nonprofit full-service renal dialysis clinic. The clinic provides two types of treatments. Hemodialysis (HD) requires patients to visit a dialysis clinic three times a week, where they are connected to special, expensive equipment to perform the dialysis. Peritoneal dialysis (PD) allows patients to administer their own treatment daily at home. The clinic monitors PD patients and assists them in ordering supplied consumed during the home treatment. The total and product-line income statement for the clinic is shown below:

CLINIC INCOME STATEMENT

TOTAL

HD

PD

Revenues

Number of patients

164

102

62

Number of treatments

34,067

14,343

20,624

Total revenue

$3,006,775

$1,860,287

$1,146,488

Supply costs

Standard supplies (drugs, syringes)

664,900

512,619

152,281

Episodic supplies (for special conditions)

310,695

98,680

212,015

Total supply costs

975,595

611,299

364,296

Service costs

General overhead (occupancy, administration)

785,825

Durable equipment (maintenance, depreciation)

137,046

Nursing services (RNs, LPNs, nursing administrators

equipment technicians)

883,280

Total service costs

1,806,151

1,117,463

688,688

Total operating expenses

2,781,746

1,728,762

1,052,984

Net income

$225,029

$131,525

$93,504

Treatment Level Profit

Average charge per treatment

$129.70

$55.59

Average cost per treatment

120.53

51.06

Profit per treatment

$9.17

$4.53

The existing cost system assigned the traceable supply costs directly to the two types of treatments. The service costs, however, were not analyzed by type of treatment. The total service costs of $1,806,151 were allocated to the treatments using the ration-of-cost-to-charges (RCC) method developed for government cost-based reimbursement programs. With this procedure, since HD t4reatments represented about 61% of total revenues, HD received an allocation of 61% of the $1.8 million service expenses.

For many years, the clinics such as SFHDC received much of their reimbursement on the basis of reported costs. Starting in 2015, however, payment mechanisms shifted, and now SFHDC received most of its reimbursement on the basis of a fixed fee not the cost of the service provided. In particular, because HD and PD procedures were categorized by the government as a single category – dialysis treatment-the weekly reimbursement for each patient was the same $389.10. As a consequence, the three HD treatments per week led to a reported revenue per HD treatment of $129.70, and the seven PD treatments per week led to a reported revenue per PD treatment of $55.59.

Both procedures appeared to be profitable, according to the clinic’s existing cost and revenue recognition system. Francis Bernadone, the controller of SFHDC was concerned, however, that the procedures currently being used to assign common expenses may not be representative of the underlying use of the common resources by the two different procedures. He wanted to understand their costs better so the SFHDC’s managers could make more-informed decisions about extending or contracting products and services and about where to look for process improvements. Bernadone decided to explore whether activity-based costing principles could provide a better idea of the underlying cost and profitability of HD and PD treatments.

PHASE I

In his initial analysis, Bernadone decided to focus on the General Overhead category. But rather than continue to use the RDD method for allocating equipment and nursing costs, he asked the clinic staff for their judgements about how these costs should be allocated. On the basis of the staff’s experience and judgement, they felt that HD treatments used about 85% of their resources and PD about 15%.

Bernadone composed the General Overhead category into four resource cost pools. Then for each pool, he chose a cost driver that represented how that resource was used by the two treatments. The summary of the analysis is presented below:

GENERAL OVERHEAD RESOURCE COST POOL

SIZE OF POOL

COST DRIVER

Facility costs (rent, depreciation)

$233,226

Square feet of space

Administration and support staff

354,682

Number of patients

Communication systems and medical records

157,219

Number of treatments

Utilities

40,698

Estimated kilowatt usage

Total

$785,825

Bernadone then went to medical records and other sources to identify the quantities of each cost driver for the two treatment types:

GENERAL OVERHEAD COST DRIVER

TOTAL

HD

PD

Square feet

30,000

18,900

11,100

Number of patients

164

102

62

Number of treatments

34,967

14,343

20,624

Estimated kilowatt usage

662,700

563,295

99,405

PHASE II

Bernadone was uncomfortable with the consensus estimate that nursing and equipment costs should be split 85:15 between HD and PD treatments. In particular, he knew that just the nursing resource category contained a mixture of different types of personnel: registered nurses (RNs), licensed practical nurses (LPNs), nursing administrators and machine operators. He thought it was unlikely that each of these categories would be used in the same proportion y the two different treatments. In the next phase of analysis, Thomas disaggregated the nursing service category into four resource pools and as with general overhead, selected an appropriate cost driver for each resource pool.

NURSING SERVICES RESOURCE POOL

SIZE OF POOL

COST DRIVER

Registered nurses

$239,120

Full-time equivalents (FTEs)

Licensed practical nurses

404,064

FTEs

Nursing administration and support staff

115,168

Number of treatments

Dialysis machine operators

124,928

Number of clinic treatments

$883,280

NURSING SERVICES COST DRIVER

TOTAL

HD

PD

RNs, FTE

7

5

2

LPNs, FTE

19

15

4

Total number of dialysis treatments

34,967

14,343

20,624

Number of clinic dialysis treatments

14,343

14,343

Bernadone felt that the 85:15 spilt was still reasonable for the durable equipment use, and, in any case, the relatively small size of this resource expense category probably did not warrant additional study and data collection.

REQUIRED

1) Prepare the revised set of cost estimates and treatment profit and loss statements for HD and PD using the information gathered during Phase I. What led to any major difference between the RDD method for allocating cost and the Phase I ABC method?

2) Use the information on the distribution of nursing and machine operator resources to calculate revised product-line income statements and profit and loss statements for individual treatments.

3) Analyze the newly produced information and assess its implications for managers at SFHDC. What decisions might managers of the clinic make with this new information that might differ from those made using information from the RCC method only?

4) What improvements, if any, would you make in developing an ABC model for SFHDC?

Prepare you case response using the five steps of strategic decision making. Only steps one through four are relevant since time-series data is not available

CLINIC INCOME STATEMENT	TOTAL	HD	PD
Revenues
Number of patients	164	102	62
Number of treatments	34,067	14,343	20,624
Total revenue	$3,006,775	$1,860,287	$1,146,488
Supply costs
Standard supplies (drugs, syringes)	664,900	512,619	152,281
Episodic supplies (for special conditions)	310,695	98,680	212,015
Total supply costs	975,595	611,299	364,296
Service costs
General overhead (occupancy, administration)	785,825
Durable equipment (maintenance, depreciation)	137,046
Nursing services (RNs, LPNs, nursing administrators
equipment technicians)	883,280
Total service costs	1,806,151	1,117,463	688,688
Total operating expenses	2,781,746	1,728,762	1,052,984
Net income	$225,029	$131,525	$93,504
Treatment Level Profit
Average charge per treatment	$129.70	$55.59
Average cost per treatment	120.53	51.06
Profit per treatment	$9.17	$4.53

Solution

1… Phase   I GENERAL OVERHEAD RESOURCE COST POOL SIZE OF POOL COST DRIVER HD PD Facility costs (rent, depreciation) 233226 Square feet of space 233226/30000*18900= 146932 233226/30000*11100= 86294 Administration and support staff 354682 Number of patients 354682/164*102= 220595 354682/164*62= 134087 Communication systems and medical records 157219 Number of treatments 157219/34967*14343= 64489 157219/34967*20624= 92730 Utilities 40698 Estimated kilowatt usage 40698/662700*563295= 34593 40698/662700*99405= 6105 Total 785825 466610 319215 2.   Phase II NURSING SERVICES RESOURCE POOL SIZE OF POOL COST DRIVER HD PD Registered nurses 239120 Full-time equivalents (FTEs) 239120/7*5= 170800 239120/7*2= 68320 Licensed practical nurses 404064 FTEs 404064/19*15= 318998 404064/19*4= 85066 Nursing administration and support staff 115168 Number of treatments 115168/34967*14343= 47240 115168/34967*20624= 67928 Dialysis machine operators 124928 Number of clinic treatments 124929/14343*14343= 124928 0 883280 661966 221314 CLINIC INCOME STATEMENT TOTAL HD PD Revenues Number of patients 164 102 62 Number of treatments 34,067 14,343 20,624 Total revenue 3006775 1860287 1146488 Supply costs : Standard supplies (drugs, syringes) 664900 512619 152281 Episodic supplies (for special conditions) 310,695 98,680 212015 Total supply costs 975,595 611,299 364,296 Service costs : General overhead (occupancy, administration) 785825 466610 319,215 Durable equipment (maintenance, depreciation)85:15 137,046 116489 20557 Nursing services (RNs, LPNs, nursing administrators.equipment technicians 883280 661966 221314 Total service costs 1806151 1245065 561,086 Total operating expenses(Supply+service costs) 2781746 1856364 925,382 Net income 225029 3923 221106 Treatment Level Profit Average charge per treatment(Total Revenue/No.of Treatments) 129.70 55.59 Average cost per treatment(Total Cost/No.of treatments) 129.43 44.87 Profit per treatment(Av. Chg.-Av. Cost) 0.27 10.72 Analysis of individual service costs: General overhead (occupancy, administration) 785825 466610 319,215 % to Total 59.38% 40.62% Nursing services (RNs, LPNs, nursing administrators.equipment technicians(85:15) 883280 661966 221314 % to Total 74.94% 25.06% Durable equipment (maintenance, depreciation) 137,046 116489 20557 % to Total 85% 15% In all the cases, proportionate charge of service costs is not the same as 61:39 as under RCC method . Durable equipment (maintenance & depn.) is understandably more for HD treatments as it is entirely hospital-based. Also nursing services are more in HD treatments, for the same reason. And there is a slight decrease in general OH Because of the revision in service cost allocation , both total cost & per treatment charge has gone up for HD & decreased for PD treatments. So, profit per treatment has decreased for HD & increased for PD The Goal of ABC analysis is to determine the accurate cost so as to measure profits accurately So,there should be accuracy in identifying all activities, without any exception, & allocating costs to each activity Also the cost & time element should justify the exercise. Pros & cons   with the existing system should be analysed and finally ABC should be justified as a cost effective exercise.