Why a Patient Day Costs $803, Not $490: Allocating Administration, Housekeeping and Dietary Costs by the Step-Down Method at a 60-Bed Hospital
[Student Name]
University of Phoenix
HCS/380: Health Care Accounting
Week 3 Assignment
[Instructor Name]
[Date]
The hospital and all figures are a composite written for a model paper.
A composite 60-bed rural hospital is negotiating a contract with a regional health plan that wants to pay a per diem, a fixed amount for each inpatient day. The medical-surgical unit's direct costs, mainly nursing salaries and supplies, were $4.8 million for 9,800 patient days last year, or about $490 a day. The plan offered $620 a day, well above that figure. The chief financial officer warned that accepting $620 on the strength of a $490 cost would mean losing money on every patient the plan sent. This paper shows why, by allocating the hospital's support department costs to its patient care departments.
Direct and Indirect Costs
A cost is direct to a department if it can be traced to that department, such as the salaries of nurses who work only on the medical-surgical unit. Indirect costs support many departments and cannot be traced to one, such as the costs of administration, housekeeping and dietary services. Full cost is direct cost plus a share of indirect costs, and it is the relevant figure for pricing decisions that must cover all costs over time (Pink & Song, 2020).
The hospital has three support departments, administration and general at $3.2 million, housekeeping at $0.9 million and dietary at $0.6 million, and three revenue-producing departments, medical-surgical at $4.8 million, emergency at $2.6 million and laboratory at $1.4 million. Total costs are $13.5 million.
Choosing the Allocation Bases
Each support department's costs are allocated on a base that reflects how other departments use its services. Administration and general costs, such as the executive team, finance and human resources, are allocated on full-time equivalent employees, since much of that work relates to staff. Housekeeping is allocated on square feet cleaned. Dietary is allocated on meals served, which go almost entirely to inpatients: 90% to medical-surgical and 10% to the emergency department, for patients held for observation.
The Step-Down Sequence
The step-down method allocates support departments in order, starting with the one that serves the most other departments, and each department, once allocated, receives no further costs (Cleverley & Cleverley, 2018). Administration serves every department, including housekeeping and dietary, so it goes first; housekeeping cleans the dietary department's space, so it goes second; dietary goes last.
Step 1: Administration and general
The departments receiving administration costs have 130 full-time equivalents: housekeeping 14, dietary 10, medical-surgical 60, emergency 30 and laboratory 16. The $3.2 million is allocated as about $345,000 to housekeeping, $246,000 to dietary, $1,477,000 to medical-surgical, $738,000 to emergency and $394,000 to laboratory.
Step 2: Housekeeping
Housekeeping's costs are now its own $900,000 plus $345,000 from administration, about $1,245,000. The remaining departments occupy 40,000 square feet: dietary 3,000, medical-surgical 24,000, emergency 9,000 and laboratory 4,000. Housekeeping allocates about $93,000 to dietary, $747,000 to medical-surgical, $280,000 to emergency and $124,000 to laboratory.
Step 3: Dietary
Dietary now holds its own $600,000 plus $246,000 from administration and $93,000 from housekeeping, about $940,000. It allocates 90%, about $846,000, to medical-surgical and 10%, about $94,000, to emergency.
Full Costs
After allocation, the medical-surgical unit's full cost is $4.8 million in direct costs plus about $1,477,000 from administration, $747,000 from housekeeping and $846,000 from dietary, about $7.87 million. The emergency department's full cost is about $3.71 million, and the laboratory's is about $1.92 million. Together they total $13.5 million, the hospital's total costs, which confirms that every dollar has been allocated once.
Dividing the medical-surgical full cost by 9,800 patient days gives about $803 per day. The plan's offer of $620 a day would cover direct costs but fall about $183 a day short of full cost.
Comparing the Direct Method
The direct method allocates each support department only to revenue departments, ignoring services support departments provide to each other. Using the same bases, it assigns the medical-surgical unit about $7.74 million, or about $789 per day, about 2% less than the step-down result. The difference is small here because the support departments serve each other relatively little, but in larger hospitals with many support departments the step-down method gives a more accurate picture. The step-down method is also the approach required in the Medicare cost report, which hospitals must file each year.
Limits of Allocated Costs
Allocated full costs are averages built on assumptions. A patient day on the medical-surgical unit costs $803 on average, but a day for a patient recovering from surgery uses far more nursing time than a day for a patient awaiting placement. The bases are also approximations: administration costs do not rise exactly with staff. Kaplan et al. (2014) showed how time-driven activity-based costing, which measures the time each staff member and resource spends on each step of a patient's care, can reveal differences in cost that allocation methods hide, and it helped the organizations they studied find ways to reduce cost without harming care.
Allocated costs also mislead short-term decisions. If the hospital has empty beds, much of the $803 would be incurred whether or not the health plan's patients came, since administration and housekeeping costs do not fall when a bed is empty. The relevant cost for a decision to fill empty beds is the incremental cost, closer to the direct variable cost.
Recommendation
The hospital should counter the plan's offer with a per diem closer to full cost, around $800, and use the analysis in negotiation. If the plan will not move, the hospital could accept a lower rate only for a limited volume of patients in beds that would otherwise be empty, where the incremental cost is lower, and should review the contract annually.
Conclusion
A patient day on the medical-surgical unit appeared to cost $490 when only direct costs were counted. Allocating administration, housekeeping and dietary costs by the step-down method raised the full cost to about $803, showing that a $620 per diem would not cover the hospital's costs over time. Cost allocation gives managers a full picture for pricing and contracting, but its averages must be used with judgment, especially for short-term decisions.
References
Cleverley, W. O., & Cleverley, J. O. (2018). Essentials of health care finance (8th ed.). Jones & Bartlett Learning.
Kaplan, R. S., Witkowski, M., Abbott, M., Guzman, A. B., Higgins, L. D., Meara, J. G., Padden, E., Shah, A. S., Waters, P., Weidemeier, M., Wertheimer, S., & Feeley, T. W. (2014). Using time-driven activity-based costing to identify value improvement opportunities in healthcare. Journal of Healthcare Management, 59(6), 399-412. https://doi.org/10.1097/00115514-201411000-00005
Pink, G. H., & Song, P. H. (2020). Gapenski's healthcare finance: An introduction to accounting and financial management (7th ed.). Health Administration Press.
How this HCS 380 Week 3 example is structured
The HCS/380 shelf page offers a custom sample for the Week 3 deliverable, and cost accounting is a standard middle-weeks topic in health care accounting. The paper works one allocation from start to finish, because the step-down method is learned by doing it rather than reading a definition. Each allocation base is justified, each step is calculated and the final sections test the method against an alternative and name its limits. Students search this week as HCS 380 Week 3, HCS380 Wk 3 or HCS/380 Wk 3; all three are the same assignment.
HCS/380 Week 3 questions, answered
What might HCS/380 Week 3 ask for?
Many HCS/380 sections cover cost accounting in the middle weeks, including cost classification and allocating overhead or support department costs. Assignments often ask students to explain or perform a cost allocation for a health care organization. Your own instructions set the exact task.
What is the step-down method?
A way of allocating support department costs in sequence. The support department serving the most other departments is allocated first, to all remaining departments, including other support departments. Each allocated department is then closed, and the process continues until all support costs rest in revenue-producing departments.
Why allocate overhead at all?
Because patient care departments cannot operate without administration, housekeeping, dietary and other support services. Allocating those costs gives the full cost of each service, which is needed for pricing, contract negotiation, cost reports and decisions about which services to offer.
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