Question

Dave Merrill vacationed at Lake Tahoe last winter.​ Unfortunately, he broke his ankle while skiing and spent two days at the Sierra University Hospital. Merrill​'s insurance company received a $4,400

bill for his​ two-day stay.

One item that caught Merrill​'s attention was an $11.75 charge for a roll of cotton. Merrill

is a salesman for Johnson​ & Johnson and knows that the cost to the hospital of the roll of cotton is between $2.15 to $2.95. He asked for a breakdown of the $11.75 charge. The accounting office of the hospital sent him the following​information:

a.	Invoiced cost of cotton roll	$2.35
b.	Cost of processing paperwork for purchase	0.58
c.	Supplies-room management fee	0.75
d.	Operating-room and patient-room handling costs	1.59
e.	Administrative hospital costs	1.14
f.	University teaching-related costs	0.60
g.	Malpractice insurance costs	1.25
h.	Cost of treating uninsured patients	2.89
i.	Profit component	0.60
	Total	$11.75

Merrill believes the overhead charge is outrageous. He​ comments, "There was nothing I could do about it. When they come in and dab your​ stitches, it's not as if you can​ say, 'Keep your cotton roll. I brought my​ own.'"

1.	Compute the overhead rate Sierra University Hospital charged on the cotton roll. Begin by determining the​ formula, then calculate the overhead rate.
2.	What criteria might Sierra use to justify allocation of the overhead items ​b-i in the preceding​ list? Examine each item separately and match it to the appropriate criteria.
3.	What should Merrill do about the $11.75 charge for the cotton​ roll?

Answer 1

1.

Direct costs	= $2.35
Indirect costs ($11.75– $2.35)	= $9.40
Overhead rate = ($9.40/$2.35)	= 400%

2. Sierra might use following criteria to justify the allocation of the overhead items b-i in the preceding list.

Items	Overhead Cost Item	Allocation Criteria
b	Processing of paperwork for purchase	Cause and effect
c	Supply-room management fee	Benefits received
d	Operating-room and patient-room handling costs	Cause and effect
e	Administrative hospital costs	Benefits received
f	University teaching-related costs	Ability to bear
g	Malpractice insurance costs	Ability to bear or benefits received
h	Cost of treating uninsured patients	Ability to bear
i	Profit component	None. This is not a cost.

3.Assuming that Meltzer’s insurance company is responsible for paying the $4,400 bill, Meltzer might express extremely strong reaction at the amount of the bill. Meltzer’s insurance company that likely has the more benefits to challenge the bill, even though Meltzer objects strongly to one or more overhead items because Individual patients have very little power in the medical territory. Further, insurance companies have rights to decide that some of the costs are not reimbursable—for example, the costs of treating uninsured patients.