1. Briefly describe the differences in the four allocation methods discussed in the case. From your standpoint, which of the four methods is conceptually the most reasonable? Why?

Direct allocation: each support department costs are allocated directly to the service departments that use the services. The direct allocation method is relatively simple to apply. None of the costs of providing support services is allocated to other support departments. Only the direct costs of the support departments are allocated to the patient services departments because no indirect costs have been created by intrasupport department allocations. This method is the least costly of the four.

Step down: this method is a compromise between the more simple direct allocation method and the complex reciprocal method. This method recognizes that intrasupport departments effects that the direct method ignores but it doesn’t recognize the full range of interdependencies. It is a sequential, stair step pattern of allocation. Step down allocation talks place in a specific sequence. After each allocation is made in this method, a support department is removed from the process.

Double apportionment: a slightly more complicated version of the step down method. This method first recognizes support provided by service departments to all other service departments as well as to the patient service departments. That first step is called the first allocation/apportionment. Some costs still remain in the support departments after the first step. Then a second apportionment is used to move all remaining support department costs to the patient services departments. Service department support to all other service departments is recognized.

Reciprocal: considered to be more accurate and objective than the direct method. This method recognizes all services that departments provide to and receive from other departments. This method captures all of the intrasupport department relationships, therefore no information is ignored and no biases influence the cost allocation process. This method does rely on the simultaneous solution of a series of equations representing the utilization of intrasupport department services. This method is complex and is known to be difficult to explain to department managers. This method is the most costly of the four.

From my standpoint, the direct allocation method is the most reasonable. It is relatively simple to apply, the least costly and a timely process. 2. What are the allocations to each patient services department, and resulting profitability, under the four allocation methods using the base case cost amounts (Exhibit 4.1) and allocation rates (Exhibit 4.2)? Which do you think is best? Why?

It appears that the numbers are not that different, and because you have graciously provided the completed excel sheet, I can be confident it wasn’t my error!! Thank you! In each allocation method, one dept makes money and the others lose money. I would still stay with the direct allocation method – emphasizing that it is the most simple to determine. The more complex the process, the more likely it is that additional expenses will occur to support the process. 3. Calc 1,2. What happens to the profitability of each clinical service department (AM, OB, PEDS) under each scenario? Why?

Regardless of where the highest direct costs are, adult medicine is the most profitable in the base case, calculation 1 and calculation 2. Adult medicine produces the most revenue and therefore will always have the highest profitability – regardless of where the highest direct costs are allocated. The OB department looks the best in the base case. Pediatrics is negative in each of the calculations.

4. Calc 3. What happens to the profitability of each clinical service department (AM, OB, PEDS) under each scenario? Why?

Again, I am not seeing a significant change in the numbers with calculation 3.
OB takes the biggest hit in calculation3. Both adult medicine and pediatrics do better with these calculations yet one again AM has the better profit.

5. Based on the sensitivity of patient care services’ profitability relative to the method of allocation (Question 2), the relative size of support services cost pools (Question 3), and the allocation rates/percentages (Question 4), what conclusions can you draw regarding the best method to use, if any? Why?

The direct allocation remains the most reasonable in my mind. All calculations are very similar. One service department makes money and the other two services take and hit and lost money. 6. What recommendation(s) do you have for the future fiscal viability of the Practice? Why?

This case has been interesting to me and actually very realistic. I have spent a majority of my nursing career in pediatrics. It is given that pediatrics does not make money for the organization. However, it is a much needed service in our community. Pediatrics is a concern for Apple Valley as well. They have high direct costs associated with the dept. The adult medicine does well and it seems likely that the OB department is justified. I recommend that they do some work to reduce direct costs in the department in effort to continue the much needed service.