Essay: Chapter 8 of the text introduces several methods of allocating costs as well as strategies for pricing services. Answer the following questions by employing the concepts in this chapter. Summarize your views.
What cost allocation method would you favor? Why?
Of the pricing strategies provided in the module, which would be most appropriate for: A clinic, A local hospital, Emergency health services.
Problem: Using the local clinic scenario given in Module 3, and referring to the operating budget on page 282 of the text, create a simple operating budget for the local clinic developed in the scenario in Module 2. Further, identify what you would change if you were to convert this budget to a flexible budget as described in Exhibit 8.4 on page 288 of the text. Present your simple operating budget as well as your flexible budget in a spreadsheet. Also, document your assumptions and rationale for the budget.
1000-1250 document; answers must thoroughly address the questions in a clear, concise manner
Include a title page and reference page in APA style. Separate each section in your paper with a clear heading that allows your professor to know which bullet you are addressing in that section of your paper. Support your ideas with at least three (3) citations in your essay. Make sure to reference the citations using the APA writing style for the essay. The cover page and reference page do not count towards the minimum word amount.
nclude the appropriate APA style in-text citations and references for all resources utilized to answer the question
Cost Allocation Methods
Cost allocation is used to allocate the expenses of a department to other departments. Costs in healthcare organizations include overhead costs that administrators, management personnel, financial staff, housekeeping, and maintenance personnel incur. The costs are allocated to departments that help the organization generate income. Direct and indirect costs comprise the full cost of running a department, and they are based on services offered in that department (Anderson et al., 2020). Various cost allocation methods are utilized, including the direct, reciprocal, and step-down methods. The direct cost allocation method does not include services offered by a support department to another. The reciprocal and step-down methods recognize the interdependencies between the support departments and address intrasupport department allocations. (Allocating costs in Healthcare Essay-Example)
Preferred Cost Allocation Method
The reciprocal method is the most preferred of the three because it is more accurate and objective. It acknowledges the support department interdependencies regarding human resources, housekeeping, and administration. These interdependencies create additional costs that are not recognized in the direct cost allocation method but are still incurred by the healthcare facility. This method acknowledges the services each department provides and gets from the other departments. It captures every intrasupport department relationship, preventing any information from being ignored or bias from being introduced during the cost allocation method. It adopts simultaneous equations to allocate a service department’s costs to other departments and between the service departments. The high accuracy of this method is because it allocates all service center costs of both operational departments and service centers. An organization can quickly compare the costs of the various departments. However, the method is complex, making it challenging to understand for department heads and costly to adopt. (Allocating costs in Healthcare Essay-Example)
Two pricing strategies, full cost pricing and marginal cost pricing, are commonly used in healthcare organizations. Full cost pricing acknowledges that healthcare organizations need to set prices that cover all incurred costs linked to the running of the business to remain viable and sustainable. Marginal cost pricing includes only the cost of additional utility services for a unit or service, and fixed costs do not increase. Appropriate pricing strategies for a:
Full-cost pricing is the most appropriate for a clinic because most clinics are not reimbursed, and healthcare users have to pay the full cost of the services they receive. Clinics receive less support from the government or philanthropic organizations and people, necessitating the need to price services to recover all the costs incurred. Therefore, for every service, the price should include direct variable costs of offering the service, direct fixed costs, appropriate share of the overhead expenses, and profit components because most clinics operate to realize profits. It can be difficult to estimate the cost of every service, but the total revenue must cover all costs the organization incurred.(Allocating costs in Healthcare Essay-Example)
A Local Hospital
For a local hospital, marginal cost pricing is the most appropriate. The primary purpose of local hospitals is not to make a profit but rather to offer much-needed healthcare services to the local community. However, to remain viable, the hospital has to be able to pay for all the costs incurred. Therefore, the pricing of an item or service should be up to the point where the marginal cost equals the marginal revenue. Beyond this point, the costs might exceed revenues. The cost of providing the extra unit or service does not necessitate an increase in direct and overhead costs (Anessi-Pessina et al., 2020). The marginal costs incurred are associated with the variable costs associated with offering the service. It is more applicable in a local hospital because hospitals do not need to pay for additional labor or find additional staff for an additional day of stay. Also, the fact that most local hospitals are based on Medicare and Medicaid makes the marginal cost pricing the most appropriate. (Allocating costs in Healthcare Essay-Example)
Emergency Health Services
The cost of emergency services includes direct costs for trauma treatment, follow-up, admission, and critical care procedures. Emergency health services’ main purpose is not a profit target but to help patients recover from physical trauma. Marginal cost pricing would be appropriate in the emergency department because only additional utility services necessitate paying for any additional stay day, which is less than the full cost, which comprises all costs and a profit component. Most emergency services are paid through Medicare and Medicaid reimbursement, making marginal cost pricing the most appropriate.
Converting to a Flexible Budget
An operating budget covers an organization’s revenues and expenses over a specific period. The budget is prepared before the operating duration and aligns with the organization’s goals (Al-Habib, 2020). A fixed budget provides a clear and defined approach provided by the management at the beginning of a financial period. The fixed budget relies on estimations of key elements of operations such as the number of visits, cost per hour, cost of equipment, and labor costs. The fixed budget provides a tally of the expected revenues and costs and helps estimate the profit or loss statements (Gapenski, & Reiter, 2008). A systemized fixed budget helps provide cash flow projections for the organization. The flexible budget, on the other hand, provides an estimate of the revenues and expenses of the organization based on the current volume levels and is subject to change (Gapenski, & Reiter, 2008). The flexible budget can be adjusted and restructured based on activity levels and capacity usage. Key determinants include labor inputs and the cost of equipment.
To change the budget to a flexible budget, it is imperative to identify the variable costs, determine how the variables, such as labor and supplies, change and calculate the total overhead costs. Hence in the budget, key changes would be on the variable costs such as labor and supplies and would depend on the input needed. When the organization has a high number of visits, the variable costs will rise compared to a lower number of visits, equating to a low labor cost. The principle to account for in the flexible budget would be the degree of change of variable costs each month.(Allocating costs in Healthcare Essay-Example)
Assumptions and Rationale for the Budget.
The budget relies on estimates and future projects of critical elements such as the number of visits. The elements are subject to market changes, among other factors determining the clinic’s performance. Furthermore, variable costs such as labor and supplies are subject to changes in policy and market forces. These costs can change per the changes beyond the control of the organization. The budget’s rationale is the ability to capture and estimate both short-term and long-term budgets. As such, the budget allocates funds to elements such as overhead costs, which helps establish stability and planning (Gapenski, & Reiter, 2008). By following a laid-out plan, the organization sustains itself and maintains accountability per policies. Besides, the budget allows the clinic to foreshadow changes in performance that may affect critical aspects of the company’s financials.(Allocating costs in Healthcare Essay-Example)
Al-Habib, N. M. I. (2020). Leadership and organizational performance: Is it essential in healthcare systems improvement? A review of literature. Saudi Journal of Anaesthesia, 14(1), 69.
Anessi-Pessina, E., Barbera, C., Langella, C., Manes-Rossi, F., Sancino, A., Sicilia, M., & Steccolini, I. (2020). Reconsidering public budgeting after the COVID-19 outbreak: key lessons and future challenges. Journal of Public Budgeting, Accounting & Financial Management.
Anderson, D. M., Cronk, R., Best, L., Radin, M., Schram, H., Tracy, J. W., & Bartram, J. (2020). Budgeting for environmental health services in healthcare facilities: a ten-step model for planning and costing. International journal of environmental research and public health, 17(6), 2075.
Gapenski, L. C., & Reiter, K. L. (2008). Healthcare finance: An introduction to accounting and financial management. Chicago, IL;: Health Administration Press.