Question

ATC 12-1 Business Applications Case   Allocating fixed costs at HealthSouth Corporation

HealthSouth Corporation claims to be “the nation’s largest owner and operator of inpatient rehabilitation hospitals in terms of revenues, number of hospitals, and patients treated and discharged.” As of December 31, 2014, the company derived 94.5 percent of its revenues from inpatient services. During 2014, it treated and discharged 134,515 patients, and the average length of a patient’s stay was 13.2 days. If one patient occupying one bed for one day represents a “patient-day,” then HealthSouth produced 1,775,598 patient-days of output during 2014 (134,515 × 13.2 = 1,775,598). During this period, HealthSouth incurred depreciation costs of $107,700,000. For the purpose of this problem, assume that all of this depreciation related to the property, plant, and equipment of inpatient hospitals.

Required

1. Indicate whether the depreciation cost is a:
   1. (1) Product (i.e., patient) cost or a general, selling, and administrative cost.
   2. (2) Fixed or variable cost relative to the volume of production.
   3. (3) Direct or indirect cost if the cost object is the cost of patient services provided in 2014.

2. Assume that HealthSouth incurred depreciation of $8,975,000 during each month of the 2014 fiscal year, but that it produced 160,000 patient-days of service during February and 135,000 patient-days of service during March. Based on monthly costs and service levels, what was the average amount of depreciation cost per patient-day of service provided during each of these two months, assuming each patient-day of service was charged the same amount of depreciation?

3. If HealthSouth expected to produce 1,850,000 patient-days of service during 2014 and estimated its annual depreciation costs to be $110,000,000, what would have been its predetermined overhead charge per patient-day of service for depreciation? Explain the advantage of using this amount to determine the cost of providing one patient-day of service in February and March versus the amounts you computed in Requirement b.

4. If HealthSouth’s management had estimated the profit per patient-day of service based on its budgeted production of 1,850,000 patient-days, would you expect its actual profit per patient-day of service to be higher or lower than expected? Explain.

Answer 1

Step 1 of 7

a)

1)

Depreciation cost is a general, selling and administrative cost because is not directly related to the treatment of patients.

Step 2 of 7

2)

The total depreciation cost of property, plant and equipment is fixed regardless of the number of patient-days produced. Hence, it is a Fixed cost.

Step 3 of 7

3)

The depreciation cost is an indirect cost since it cannot be related to the cost of patient services easily.

Step 4 of 7

b)

Compute the allocation rate as follows. Since 2 months (January and February) are considered, data for both months are included in the computation.

Allocation rate = Total cost to be allocated / Cost driver

= 2 X $8,975,000 / (1,60,000 + 1,35,000)

= $ 60.84

Average depreciation cost per patient-day of service was $60.84

Step 5 of 7

c)

Compute the allocation rate as follows.

Allocation rate = Total cost to be allocated / Cost driver

= 110,000,000 / 1,850,000

= $59.459

The predetermine overhead charge per patient-day of service for depreciation is $ 59.459

Step 6 of 7

This method uses depreciation for the whole year, and patient-days for a whole year. Annual figures are advantageous for smoothing the costs over varying levels of patient-days

Step 7 of 7

d)

If management had estimated the profit per patient-day of services based on it budgeted production of 1,850,000 units instead of an 1,775,598 patient-days of actual output during 2011, then the estimate (expected) profit per patient-day of service would be lower than the actual because the denominator would be bigger when dividing by 1,850,000 instead of 1,775,598. In other words, the actual profit per patient-day would be higher than expected.