Assignment Question

Pathos Radiology Center (PRC) performs X-rays, ultrasounds, computer tomography (CT) scans, and magnetic resonance imaging (MRI). PRC has developed a reputation as a top radiology center in the state. It has achieved this status because it constantly re-examines its processes and procedures. It has been using a single, facility wide overhead allocation rate. The Vice President of Finance believes that PRC can make better process improvements if it uses more disaggregated cost information. She says, “We have state-of-the-art medical imaging technology. Can’t we have state-of-the-art accounting technology?” Calculate the budgeted cost per service for X-rays, ultrasounds, CT scans, and MRI using direct technician labor costs as the allocation basis. Calculate the budgeted cost per service of X-rays, ultrasounds, CT scans, and MRI if PRC allocated overhead costs using activity-based costing. Evaluate the differences between the 2 costing models, and assess the value of activity-based costing for management profitability analysis and decision making. Explain how the disaggregation of information could be helpful to PRC’s intention to continuously improve its services.

Answer

Introduction

Pathos Radiology Center (PRC) is a prominent medical facility known for its expertise in radiology services, including X-rays, ultrasounds, computer tomography (CT) scans, and magnetic resonance imaging (MRI). Over the years, PRC has earned a reputation as a top radiology center in the state due to its commitment to continuous improvement (Kaplan & Anderson, 2007). This essay explores the need for PRC to transition from a single, facility-wide overhead allocation rate to activity-based costing (ABC) to better manage its costs and enhance profitability. We will calculate the budgeted cost per service for X-rays, ultrasounds, CT scans, and MRIs under both costing models, evaluate the differences, and highlight the value of ABC for profitability analysis and decision-making (Cooper & Kaplan, 1991). Furthermore, we will discuss how the disaggregation of information through ABC can support PRC’s quest for continuous improvement in service delivery.

Calculation of Budgeted Cost per Service

To understand the financial implications of transitioning to ABC, we first need to calculate the budgeted cost per service for X-rays, ultrasounds, CT scans, and MRIs using direct technician labor costs as the allocation basis. Subsequently, we will calculate the budgeted cost per service under the ABC model.

Budgeted Cost per Service using Direct Technician Labor Costs

In this traditional costing method, overhead costs are allocated based on direct technician labor costs. This method typically results in a single overhead allocation rate applied uniformly across all services.

Let’s assume the following direct technician labor costs and overhead expenses for PRC:

• Direct Technician Labor Costs: $500,000
• Overhead Expenses: $200,000

Using these figures, the budgeted cost per service under the traditional method is calculated as follows:

Budgeted Cost per Service = (Direct Technician Labor Costs + Overhead Expenses) / Number of Services

Budgeted Cost per Service = ($500,000 + $200,000) / 4 services Budgeted Cost per Service = $175,000 per service (Kaplan & Anderson, 2007).

Budgeted Cost per Service using Activity-Based Costing (ABC)

ABC allocates overhead costs based on the activities that drive those costs. In the case of PRC, activities could include machine setup, equipment maintenance, and administrative support. To calculate the budgeted cost per service under ABC, we would need to identify the cost drivers for each activity and allocate costs accordingly. However, for the sake of illustration, let’s assume the following hypothetical ABC allocations:

• X-rays: $60,000
• Ultrasounds: $45,000
• CT scans: $40,000
• MRIs: $55,000

The budgeted cost per service under ABC is calculated as follows:

Budgeted Cost per Service (X-rays) = X-ray ABC Allocation Budgeted Cost per Service (Ultrasounds) = Ultrasound ABC Allocation Budgeted Cost per Service (CT scans) = CT Scan ABC Allocation Budgeted Cost per Service (MRIs) = MRI ABC Allocation

Therefore, the budgeted costs per service under ABC are as follows:

• • X-rays: $60,000
  • Ultrasounds: $45,000
  • CT scans: $40,000
  • MRIs: $55,000 (Kaplan & Anderson, 2007).

Evaluation of Costing Models

Now that we have calculated the budgeted cost per service under both costing models, it is crucial to evaluate the differences between the two approaches and assess the value of ABC for management profitability analysis and decision-making (Cooper & Kaplan, 1991).

Differences between Traditional and ABC Costing Models

The key difference between the traditional costing and ABC models lies in the allocation of overhead costs. In the traditional model, overhead costs are distributed uniformly based on direct labor costs, leading to a flat rate across all services. In contrast, ABC allocates costs based on specific activities, resulting in a more accurate reflection of the actual resource consumption associated with each service.

In our calculations, we observed significant variations in budgeted costs per service under the two models. For instance, the traditional model assigns a budgeted cost of $175,000 per service across the board, whereas ABC provides a more nuanced breakdown of costs per service. For example, it identifies that X-rays require $60,000, ultrasounds need $45,000, CT scans entail $40,000, and MRIs incur $55,000.

These differences reflect the inherent limitations of the traditional costing model, which may lead to overcosting or undercosting of services. Overcosting can deter price competitiveness, while undercosting can result in profit erosion (Kaplan & Anderson, 2007).

Value of Activity-Based Costing for Management Profitability Analysis and Decision-Making

ABC offers several advantages over traditional costing models, making it a valuable tool for management profitability analysis and decision-making (Cooper & Kaplan, 1991):

Cost Accuracy: ABC provides a more accurate representation of costs associated with each service by linking overhead expenses to specific cost drivers. This accuracy enables management to make informed decisions regarding pricing, resource allocation, and cost reduction strategies.

Resource Optimization: With a detailed understanding of cost drivers, PRC can allocate resources more efficiently. For example, if MRI services are found to be more resource-intensive, the center can focus on optimizing processes and resources specifically for MRIs.

Profitability Insights: ABC allows PRC to assess the profitability of individual services. By comparing the budgeted costs to revenue generated for each service, management can identify high-margin and low-margin services, helping them prioritize areas for improvement.

Pricing Strategy: Accurate cost information from ABC enables PRC to set competitive prices that reflect the true cost of delivering services. This can help attract more patients and improve market positioning.

Continuous Improvement: ABC supports PRC’s commitment to continuous improvement. By identifying cost drivers and resource inefficiencies, the center can continuously refine its processes and enhance service quality (Cooper & Kaplan, 1991).

Disaggregation of Information for Continuous Improvement

The disaggregation of information through ABC aligns seamlessly with PRC’s intention to continuously improve its services. Here are several ways in which this disaggregation can be helpful:

Identifying Cost Drivers: ABC breaks down overhead costs into specific activities or cost drivers. This granular view helps PRC pinpoint the exact factors contributing to high costs in certain services. For example, if MRI services are costlier due to longer machine setup times, PRC can focus on streamlining this aspect of the process (Kaplan & Anderson, 2007).

Resource Allocation: PRC can allocate resources more effectively by matching them to the specific requirements of each service. This ensures that the center invests in areas that drive value and eliminates wasteful spending (Cooper & Kaplan, 1991).

Performance Measurement: ABC facilitates the tracking of performance metrics for each service. PRC can monitor key indicators such as service turnaround time, resource utilization, and profitability, allowing for timely interventions when necessary (Kaplan & Anderson, 2007).

Continuous Cost Reduction: Armed with detailed cost information, PRC can initiate cost reduction initiatives where needed. This includes renegotiating supplier contracts, optimizing equipment usage, and enhancing staff productivity (Cooper & Kaplan, 1991).

Service Improvement: The ability to analyze costs on a per-service basis enables PRC to focus on service quality enhancements. By allocating resources effectively and identifying bottlenecks, PRC can provide faster, more efficient, and cost-effective services to its patients (Kaplan & Anderson, 2007).

 Conclusion

The adoption of activity-based costing (ABC) offers Pathos Radiology Center (PRC) a valuable opportunity to improve cost management, profitability analysis, and decision-making. By accurately assigning overhead costs based on specific cost drivers, ABC provides a more nuanced understanding of the costs associated with each service, ultimately leading to better resource allocation and improved service quality (Cooper & Kaplan, 1991). Moreover, ABC aligns seamlessly with PRC’s commitment to continuous improvement by disaggregating information and enabling data-driven enhancements in service delivery (Kaplan & Anderson, 2007). In the ever-evolving healthcare landscape, embracing advanced accounting technology like ABC positions PRC as a leader in both medical imaging and financial efficiency.

References

Cooper, R., & Kaplan, R. S. (1991). Profit priorities from activity-based costing. Harvard Business Review, 69(3), 130-135.

Kaplan, R. S., & Anderson, S. R. (2007). Time-driven activity-based costing. Harvard Business Review, 85(11), 131-138.

Frequently Ask Questions ( FQA)

Q1: What are the key services offered by Pathos Radiology Center (PRC)?

A1: Pathos Radiology Center offers a range of radiology services, including X-rays, ultrasounds, computer tomography (CT) scans, and magnetic resonance imaging (MRI).

Q2: How did PRC achieve its reputation as a top radiology center in the state?

A2: PRC earned its reputation by continuously re-examining its processes and procedures to deliver high-quality radiology services.

Q3: Why did the Vice President of Finance at PRC propose transitioning from a single overhead allocation rate to activity-based costing (ABC)?

A3: The Vice President of Finance believes that ABC can provide more disaggregated cost information, allowing for better process improvements and aligning the center’s accounting technology with its state-of-the-art medical imaging technology.

Q4: How is the budgeted cost per service calculated using direct technician labor costs as the allocation basis?

A4: The budgeted cost per service is calculated by adding direct technician labor costs and overhead expenses, then dividing by the number of services. In the paper, it was calculated as ($500,000 + $200,000) / 4 services, resulting in $175,000 per service.

Q5: What is the advantage of using activity-based costing (ABC) for profitability analysis and decision-making at PRC?

A5: ABC provides more accurate cost information by linking overhead expenses to specific cost drivers, enabling better resource allocation, pricing strategies, and continuous improvement efforts.

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