Managerial Accounting Basics Cost Allocation Direct Method The

Managerial Accounting Basics Cost Allocation - Direct Method The Impact of Cost Structure on Risk - Reimbursement is tied exclusively to volume (FFS), then the provider’s financial risk is minimized if all costs are variable. If reimbursement is exclusively capitated, then the provider’s financial risk is minimized if all costs are fixed. Utilization management: FFS – increasing # of visits, increases profit; Capitation – increasing # of visits does NOT increase profits Number of members: Capitation – increasing members, increases profits Cost Allocation – classified by its relationship to the unit of activity. is to assign indirect costs to the departments that create the need for such costs, typically the patient service departments Types: Direct – costs unique and exclusive to a subunit Indirect or overhead – costs associated with shared resources used by the entire organization Cost Pool – is the overhead amount to be allocated (Ex – overhead costs of the HR dept. Cost Driver – the basis on which the cost pool will be allocated. (This will be given. Ex: Sq Footage) - Critical to the cost allocation process - goal is high correlation with actual overhead consumed - should promote organization cost reduction Managerial accounting: - Uses organizational and subunit data - Designed for use by managers - Primarily forward looking - Does not adhere to external standards Cost Classifications: *Fixed – independent of volume-Rent, Salaries Variable – depends on volume-Supplies, Pharmacies *no costs are fixed throughout an infinite range of volumes. Thus, the concept of cost classifications according to volume must be applied within some “relevant range” of patient volume. Cost Definitions: Full or Total Cost - the sum of all costs associated with the cost objective. It equals direct cost + indirect cost Direct Costs – costs for your department, specifically. (MRI machine for radiology) Indirect Costs (Overhead) – costs spread across the entire organization. (Housekeeping or Admin) Average Cost = TC/# units AVG Variable Costs=VC/# units Marginal Costs are the "additional" costs incurred as the result of providing one more unit of service (incremental costs). *Marginal costs are equal to Variable costs unless there are changes in Step-Fixed costs. Traditional Allocation Process 1. Identify the cost pool – dollar cost of the overhead activity to be allocated. 2. Determine the cost driver – basis on which the overhead costs will be allocated 3. Calculate the allocation rate – numerical value used to make the allocation **Allocation rate = [Dollars in cost pool / Total volume of cost driver]** 4. Determine the allocation amount (Multiply above by Results: Profit center—a business unit that generates revenues as well as costs; therefore dd. PROFITABILITY can be measured Cost Center—a business unit that does not generate revenues and hence only its dd. COSTS can be measured Allocation Method 1. Direct method - costs of each support department are allocated directly to, and only to, the patient services departments. 2. Step-down method - some (but not all) of the intra-support department relationships are recognized. 3. Activity-Based Costing (ABC) – unlike traditional cost allocation (top-down system), ABC begins with individual activities that comprise the services provided - Requires more info and is more complex than traditional costing Forecasted (Projected) Profit and Loss (P&L) Statementuses cost structure information along with the revenue forecast and projected volume to forecast profitability Total Contribution Margin- Revenue-VC Contribution Margin per unit –Rev/# units-VC/#units Breakeven Analysis – can be used to determine breakeven volume - volume needed for an organization to be financially self-sufficient (TR=TC=0 or TR-TC=0) - Accounting breakeven (zero profit) - Economic breakeven (with profit) Total Revenue = Fixed Rev. + (price x quantity) = FR + VR Total Cost = Fixed cost + (AVG VC x quantity) P&L Format Breakeven Analysis: Total Rev – Total VC – FC = 0 (breakeven) Contribution Margin Format: CM x Q = Fixed Costs (no economic profit) : CM x Q = Fixed Costs + Profits (economic profit) Marginal (Incremental Analysis) (CM=240, VC=112. 48, Unit=4) Marginal cost of each visit is the variable cost rate (VCR=Variable cost/unit=$28. 12) Marginal Revenue (CM/unit) of the new contract is $60, so the CM/unit is $60 $28. 12 = $31. 82 for each unit 1. Assume a hospital’s Housekeeping Department has direct costs of $100, 000 2. The cost driver is the amount of space occupied. User departments in total occupy 200, 000 square feet of space. 3. Allocation rate is $100, 000 / 200, 000 = $0. 50 per sq. ft. of space occupied. 4. If the Critical Care Department occupies 10, 000 sq. ft. of space its allocation would be $5000? (. 5*10, 000) Cost Allocation – ABC Method + = Minor Exam(Mi. E)(1500) plus Major Exam(Ma. E)(500)=Total (2000). Total divided by Annual Cost(25, 000)=Allocation Rate(12. 50). Physical Exam minutes for Mi. E (60) times total Mi. E Exams(1500) plus Physical Exam Ma. E minutes(120) times total Mi. E Exams(500)=Total(150, 000). Total divided by Physical Exam Annual Costs(300, 000) FFS: Number of visits times revenue per visit Variance Analysis Capitation: PMPM times Member Months Budget Variance Analysis – technique applied to budget data to: - Identify problem areas - Enhance control - Helps managers: prepare budgets for upcoming year, control results in the current year, and evaluate the performance of operating units Reasons why actual results might differ from the static (master) budget: - Sales and other cost-driver activities were not the same as originally forecasted. - Revenue or variable costs per unit of activity and fixed costs period were not as expected. Which Variances Merit Examination? Variances greater than the specified dollar amount Variances greater than specified percentages Variances that persist for some time period Combinations of the above The ones your manager cares about Traditional Variance Analysis - Variance can be “Favorable” (F), or “Unfavorable” (U) Three types of data used: - The static or budgeted amount is the original budget, unadjusted for realized volume - The realized, or actual data reflect after-the-fact results. - The flexible budget is one that has been adjusted to reflect realized volume only ; using all other budget (initial) assumptions. Cost is what changes from actual. Flex=Actual Volume, Budget Costs

Statement of Cash Flow STATEMENT OF CASH FLOWS – combines both I/S and B/S data. Reports transactions over a PERIOD OF TIME; Operating Activities Refers to the primary revenue generating activities of a business Start with net income Depreciation/amortization expense for the year is a results in a positive adjustment (increase) on cash flow statement Any changes to working capital (current assets, current liabilities) goes in this section Positive change (increase) in an asset (except CASH) account result in a negative adjustment (decrease) on cash flow statement Positive change (increase) in a liability account result in a positive adjustment (increase) on cash flow statement + loss on sale of equipment or other assets (OR -gain) / + decrease in Inventory (OR -increase in Inventory) / increase (OR + decrease) in A/Receivable / + increase (OR - decrease) in A/Payable / + increase (OR – decrease)in Accrued Expense / + decrease (- increase) in Prepaid Expenses/Insurance Investing Activities Consider this section to reflect purchases and sales of NON -CURRENT assets or sales of investments or securities Refers to changes in regard to investment gains/losses and new investments or sales of fixed assets Proceeds from sale of assets or investments results in positive adjustment on CF statement Purchase of investments, such as stocks and bonds, results in negative adjustment to CF + Increase (- Decrease) in Notes payable (liability) Financing Activities Considers activities associated with all liabilities and stockholders’ equity, except for current liabilities Transactions with owners or lenders to provide long-term funds to the company or return those funds to the owners or lenders Proceeds from issuance of stock or debt result in positive adjustment on CF statement Issuance of dividends results in negative adjustment on CF statement + Issuance of bonds - Purchase of Treasury Stock Redemption of Bonds - Payment of Dividends