HA 620 Unit 5 cost allocation report example

Sixteen Point Eight Million Dollars of Overhead, Four Pools, Four Drivers, Five Departments: A Cost Allocation Report That Shows Its Mechanics

Student Name

Health Care Administration, Herzing University

HA 620: Healthcare Economics, Finance, and Resource Management

Instructor Name

February 12, 2026

Sixteen Point Eight Million Dollars of Overhead, Four Pools, Four Drivers, Five Departments: A Cost Allocation Report That Shows Its Mechanics

Purpose and Method

The composite 180-bed hospital needs a full cost for each revenue-producing department in order to price services, evaluate the new infusion suite from Unit 3, and prepare its Medicare cost report. This report allocates $16.8 million of support department costs to five revenue-producing departments: inpatient medical, surgery, emergency, imaging, and infusion. It uses the direct method, which allocates each support pool straight to the revenue departments and ignores services that support departments provide to one another. The step-down method, which allocates support pools in sequence, is more precise when support departments serve each other heavily; the direct method is used here because it is transparent and because a test step-down allocation changed no department's total by more than 3% (Pink & Song, 2020).

The Pools and Their Drivers

Support costs are grouped into four pools that behave alike, and each pool is assigned one driver. The driver is the decision on which the whole allocation rests, so each choice is justified.

Facilities, $4,800,000: driver is square footage occupied. Facilities costs (maintenance, utilities, security, housekeeping of common areas) rise with space, and space is measured reliably.

Information systems, $3,600,000: driver is named users of the electronic health record. Most information systems cost comes from licenses, support, and training, all of which scale with users.

Billing, $2,400,000: driver is claims processed. Each claim requires coding, submission, follow-up, and posting, so work scales with claims rather than dollars.

Administration, $6,000,000: driver is full-time equivalent employees. Administrative functions such as human resources, finance, and executive leadership scale with the size of the workforce more than with any other measure.

Driver Quantities

Quantities by department, from the fiscal year's records.

Rates and Allocations

Rates: facilities $4,800,000 ÷ 125,000 = $38.40 per square foot; information systems $3,600,000 ÷ 840 = $4,285.71 per user; billing $2,400,000 ÷ 96,000 = $25.00 per claim; administration $6,000,000 ÷ 740 = $8,108.11 per FTE. Allocations are rounded to the dollar, with any rounding difference placed in the largest department so each pool allocates exactly its total.

How Much the Driver Choice Matters

To show the sensitivity, billing was re-allocated using net revenue share instead of claims, a driver some hospitals use because it is easy to obtain. With net revenue shares of 50% inpatient, 25% surgery, 12% emergency, 10% imaging, and 3% infusion, billing allocations would become $1,200,000, $600,000, $288,000, $240,000, and $72,000. Imaging's billing allocation would fall from $1,050,000 to $240,000, and inpatient's would rise from $225,000 to $1,200,000. Imaging processes many small claims and inpatient few large ones, so the claims driver reflects the work the billing office actually does, while the revenue driver would make imaging look cheaper and inpatient care more expensive than they are. The report keeps the claims driver for that reason. The choice of driver, not the arithmetic, decides who carries the cost.

What the Allocation Means for the Infusion Suite

The break-even analysis in Unit 3 used only the suite's direct costs and found break-even at 1,493 visits. With its allocated overhead of $399,852 added, full fixed costs become $899,852 and break-even rises to $899,852 ÷ $335 = 2,686.1, or 2,687 visits a year. The projected first-year volume of 3,000 visits still exceeds that figure, but by a much smaller margin. Both numbers are correct for different questions: the direct-cost figure answers whether the suite covers the costs it adds; the full-cost figure answers whether it carries its share of the hospital's fixed overhead. A decision to open the suite can rest on the first; its pricing and long-run evaluation should rest on the second.

How Department Managers Will See It

Allocated overhead is often resented by department managers, who see charges they cannot control appear on their reports. Three practices will be used to make the allocation useful rather than contentious. First, each manager will receive the driver quantities for their department alongside the allocation, so they can see, for example, that emergency's large billing allocation comes from 36,000 claims, not from a judgment about the department. Second, allocated costs will be shown below the line of direct costs the manager controls, so that performance reviews distinguish the two. Third, the drivers will be reviewed each year with a small group of managers, and any proposed change will be tested for its effect on every department before it is adopted, as the billing example above was.

There is also a behavioral effect to watch. When a driver is something a department can influence, allocation creates an incentive. Charging information systems by named users may encourage departments to remove inactive accounts, which is useful; charging administration by FTEs could, in principle, discourage hiring where it is needed. The drivers chosen here were judged to create more useful incentives than harmful ones, and that judgment will be revisited if managers report otherwise.

Limits

Traditional allocation assigns overhead by averages and can misstate the cost of specific services. Time-driven activity-based costing, which traces the time and resources each patient pathway consumes, has been adopted in health care to address this, though reviews note that implementation is demanding (Keel et al., 2017), and that accurate cost measurement at the level of the patient pathway is the starting point for managing value (Kaplan & Porter, 2011). This report is a department-level allocation and should not be used to price individual services without further analysis. The next step would be a pilot of time-driven costing for one high-volume pathway, such as outpatient infusion, where the time data are already recorded. The hospital and figures are composite.

References

Kaplan, R. S., & Porter, M. E. (2011). How to solve the cost crisis in health care. Harvard Business Review, 89(9), 46-52.

Keel, G., Savage, C., Rafiq, M., & Mazzocato, P. (2017). Time-driven activity-based costing in health care: A systematic review of the literature. Health Policy, 121(7), 755-763. https://doi.org/10.1016/j.healthpol.2017.04.013

Pink, G. H., & Song, P. H. (2020). Gapenski's fundamentals of healthcare finance (3rd ed.). Health Administration Press.