Cost Allocation Problem

Cost Allocation Problem

Bridget Schall

ACC/HC 561

February 27, 2011

Cost Allocation Problem

Two hospitals, Academic Hospital and Western Hospital, merged. As a result of the merger, Academic Hospital discontinued its maternity service and Western Hospital stopped its internal laboratory service. The two hospitals are part of one parent organization, but remain two distinct profit centers. Recently Western Hospital demanded that Academic Hospital reduce its price of laboratory work associated with an amniocentesis. Western Hospital performs the procedure and sends the specimen to Academic Hospital for analysis. Western recently discovered that an independent lab could analyze the specimen for $375. Academic was charging $400. Western did about 300 procedures annually, but an important policy issue was raised by considering outsourcing the service to an independent lab. The joint oversight committee discovered the following: the cost in labor and supplies for performing the amniocentesis was $300; Academic charged $90 for overhead and $60 for profit; Western currently made $105 profit on the entire procedure and would earn $75 more profit if the specimens went to the outside lab. The joint oversight group determined the transfer price under full charges, variable costs, market price, and the negotiated price. Next the group determined individual hospital profit under each alternative and then the combined profit (Finkler, Ward, & Baker, 2007).

Transfer Prices by Alternative

Full Charges

Labor and Supplies | $300 |

Overhead | $90 |

Profit | $60 |

Transfer Price | $450 |

Variable Costs

Labor and Supplies | $300 |

Profit (60/390*300) | $45 |

Transfer Price | $345 |

Market Price

Independent Lab Charge | $375 |

Transfer Price | $375 |

Negotiated Price

Academic Hospital Charge | $400 |

Transfer Price | $400 |

Individual and Combined Profit by Alternative

Full Charges

| Academic | Western |

Sale/Transfer Price...