Week 3 Lecture 1.html

Cost Allocation

An HCO, such as a hospital, has many departments that provide services to patients, such as surgery or emergency care. It also has departments that do not provide services to patients but are nevertheless necessary for providing services, for example, sterilization of instruments for surgery. The surgical department cannot operate without oxygen, sterile instruments, supplies of pharmaceuticals, and a host of other real and intangible services. Among intangibles is a billing department to collect payment for the surgeries. Cost allocation is a process like budgeting, in which the cost of the centers that do not produce revenue are allocated to the departments that use their services. For example, the surgical department may be a heavy user of the services provided by the surgical instrument sterilization department but not the nursing units. It would not be fair for both these departments to pay an equal share of the cost of sterilization of surgical instruments. The cost allocation exercise decides what proportion of the total budget of the surgical instrument sterilization department should be applied to the surgery department and what proportions to other departments that are revenue centers. These costs are indirect, but they go into providing the service offered by the surgery department. This is true of all of the services that enable services that create revenue. The cost allocation process can cause friction within the organization as the revenue earning departments do not want the cost burdens that lower their departmental performance, especially when they feel the cost shares are unfair. As a leader, you must understand the concept of cost allocation and the internal friction it can bring about so that you can deal with these issues in, what TV channels like to call, fair and balanced ways.

In this lecture we looked setting prices and introduce planning a budget. The assignments are critical to cementing your understanding of these processes and concepts. Spend the time you need to get comfortable with them.