Allocation Methods in Healthcare

Feb 3rd, 2012
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This paper explains common cost allocation methods including the direct allocation method and the step-down method. It also explains the common cost allocation methods for patient-level costs, including relative value units, ratio of cost to charges, and activity-based costing.

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To stay afloat in todays economy, healthcare organizations need to reorganize and simplify inefficient processes and understand the types and amount of resources they need to deliver care across the establishment. This can only be achieved by applying effective cost allocation methods to indirect costs, including direct allocation and the step-down method. Further, in regard to patient-level costs, these organizations should practice common cost allocation methods by taking into account cost drivers, such as relative value units, the ratio of cost to charges and activity-based costing.Under the direct method of allocating costs, the cash flows from all operating activities need to include the amounts for lines such ascash from customersandcash paid to suppliers, while providing a reconciliation of net income to the cash provided by those operating activities. The direct method requires use of the financial accounting system to record all directly assignable expenses for each cost pool and to select a cost driver for each indirect cost pool (Smith, 2014, sec. 4.3). In this method, costs are allocated among departments only, so there is nothing lost or gained for the entire organization. While the direct method is simple and easy to apply, it does not produce numbers as accurately as the step-down method. On the other hand, the step-down allocation method allows support departments to allocate costs to each other, and ultimately to the operating d

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