CASE 1

COST ALLOCATION CONCEPTS

(Houston Dialysis Center)
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The taking over of the building space of the Dialysis Center by the
Outpatient Clinic, for its expansion, as well as a the construction of a new
building for the Dialysis Center is fair for all the relevant aspects of the
operation of the hospital as a whole.

The expansion of the Outpatient Clinic will yield to additional revenues

for the same allocated cost resulting to an increase in profit.

The construction of a new building for the Dialysis Center, for the same
area as its old space, albeit giving it its own cost allocation, will yield cost
computations that are exclusively incurred by the Dialysis Center. In effect, it
no longer bears the cost allocation from the facilities and depreciation
expenses in the building which is simultaneously utilized by another
department. Thus, the cost incurred by the Dialysis Center would now be
determined as directly attributable to its own operations.

In answering the dilemma of Linda, it should be well-noted that the

hospital is a not-for-profit institution, hence, the bonus incentives are purely
matters of privilege and Linda has no demandable right over the same.
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Actual costing determines the actual cash flow without regard to the
accrual of the expenses incurred. As all methods of cost allocations, it has its
own pros and cons. The determining factor adopting such method is the
weight of its advantages against its disadvantages.

Using actual costing will definitely yield actual profit or loss

computations. It will determine the actual cash flow and will be useful in
determining cash on hand.

However, using the method of actual costing limits the determination of

projected estimates. It would be nigh difficult to use as basis for management
planning because it may vary depending on the actual cash outflow or the
actual costs incurred. It does not help in projecting future estimates because
the actual costs incurred may change over time.

In the present case, the cost allocation used determines the actual costs
attributable to the Dialysis Center thereby producing an amount which is
without a doubt an expense incurred by the said department contrary to the
past allocation where it is not determinate whether such allocated cost is
actually incurred by the respective departments. The new allocation scheme is
more favorable because the cost allocated is directly attributable now to the
department which incurred such costs.
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In adopting the new allocation method, the total costs incurred after
twenty (20) years would now be used as basis for annual estimates of costs
incurred. Since the long-term debt is already paid, the amount of facilities
costs would now consist primarily of building depreciation which may be
allocated throughout the remaining life of the building.
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The new Dialysis Center would definitely attract more patients. It has
been stated that the location of the new Dialysis Center is much more
convenient for dialysis patients and can be more efficiently utilized than the
old space allowing for a substantial increase in patient volume and, thus,
would yield a substantial increase in revenues and ultimately will result to an
increase in profits.
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The treatment of the revenues and costs as regards the drugs annually
used for dialysis treatments is unfair for the Dialysis Center. The hospital
(pharmacy) should not record it in its profit and loss statement because the
activity did not involve the pharmacy. It is unfair because by using (selling)
such drugs, some operational costs were incurred by the Dialysis Center and
were not shouldered by the pharmacy. In effect, the pharmacy recorded a
profit from an activity where the Dialysis Center incurred its own costs. The
profit reflected in the profit and loss statement deprived the Dialysis Center of
revenues from its operational costs incurred.

As a remedy, the pharmacy should not include in, its profit and loss
statement, the revenue-producing activity attributable to the operations of the
Dialysis Center because it does not reflect the operational costs incurred by
the Dialysis Center in connection with the revenue-producing activity.
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In handling the pharmacy revenues and the final allocation amounts,

the hospital should trace the activity involved regarding the revenue
generated by the pharmacy. The department which incurred the costs in
connection with the revenue should be the one to record the transaction in its
own profit and loss statement.