Question

Fox Valley Health Care Facilities has three Revenue Producing Departments and four Non-Revenue Producing departments with the data and costs as follows:

Departments	Costs	Cost Driver
Administration	$200,000	Direct costs
Maintenance	300,000	Square Feet
Purchasing	250,000	Number of Purchase Orders
Dietary	200,000	Number of Meals
Sunny Vale Nursing Home	500,000	Revenue Producing – N/A
In-Patient	600,000	Revenue Producing – N/A
Out-Patient	210,000	Revenue Producing – N/A

Cost Driver Data

Departments	Square feet	Purchase Orders	Meals Served
Administration	1,200	1,600	200
Maintenance	3,000	1,400	100
Purchasing	1,000	1,350	150
Dietary	4,000	1,000	200
Sunny Vale Nursing Home	25,000	1,500	600
In-Patient	11,000	1,300	300
Out-Patient	4,000	2,200	100

REQUIRED:

1. Prepare a memo describing and comparing the use of the direct method and the step-down method. Include a recommendation as to which you would use and explain that recommendation.

2. Prepare an Excel spreadsheet supporting your memo.

(a) Prepare a Cost report, using the Direct Method.

(b) Prepare a Cost Report, using Step-down Method.

i.Prepare the step-down.

ii.Determine the total amount of costs of each of the non-revenue producing departments that would be allocated to each of the revenue producing departments. Prepare a separate table providing this information.

Answer 1

The direct method

The direct method is the simplest and most common but least accurate of the methods. All service department costs are allocated directly to production departments. It ignores any service rendered by one service department to another, i.e., no attempt is made to allocate the costs of service departments to other service departments. Thus, no allocation is made of the cost of services rendered to other service departments.

The step-down method

The step-down method is a sequential process. It is slightly more involved than the direct method but is more accurate. The service departments are allocated in order, from the one that provides the most service to other service departments down to the one that provides the least. As each allocation is performed, the costs of the services departments are allocated to both the remaining service departments and the production departments. This method allocates service department costs to other service departments in addition to the producing departments,· i.e. it allows for partial recognition of services rendered by a service departments to another. Direct Method Sunny Vale Nursing home In patient Out patient Total Revenue 500000 600000 210000 1310000 Costs: Administration cost 76335.88 91603.05 32061.07 200000 Maintenance 114503.82 137404.58 48091.60 300000.00 Purchasing 95419.85 114503.82 40076.34 250000.00 Dietry 76335.88 91603.05 32061.07 200000.00 Net Revenue 137404.58 164885.50 57709.92 360000.00 Step Down Maethod Sunny Vale Nursing home In patient Out patient Total Revenue 500000 600000 210000 1310000 Costs: Administartion 143295.90 171955.08 60184.28 375435.2515 Maintenance 121259.92 53354.37 19401.59 194015.88 Purchasing 42554.00 36880.13 62412.53 141846.65 Dietry 143221.33 71610.66 23870.22 238702.22 Net Revenue 49668.85 266199.76 44131.39 360000.00

Working note for the Step down method calculation

Particulars	Details	Administration cost	Maintenance	Purchasing	Dietry	Total
Maintenance	Cost driver- Square foot	1200	3000	1000	4000	9200
	300000	39130.43	97826.09	32608.70	130434.78	300000.00
Purchasing	No of PO	1600	1400	1350	1000	5350.00
	250000	74766.36	65420.56	63084.11	46728.97	250000.00
Dietry	NO of meals	200	100	150	200	650.00
	200000	61538.46	30769.23	46153.85	61538.46	200000.00
		175435.25	194015.88	141846.65	238702.22
	Actual cost	200000
		375435.25	194015.88	141846.65	238702.22
		Cost driver total	40000	5000	1000
		Cost per driver	4.85	28.37	238.70

here we have allocated Maintenace cost, Purchasing cost and Dietry cost to all service departements including Administartion. After allocation we arrived at correct cost relating to each service deprtment. as shown in the table above we arrived at Cost per cost driver for all service department including administrtaion. Under Step down method all costs allcoated to revenue departments on the basis of Cost drivers in order get correct cost.

On the basis of above calculations we can say step down method most appropriate method since all costs are allocated on the basis of their respective cost drivers. where as under direct method there is no appropriate cost allocation methodoligy which leads incorrect cost allocation.