What impact does this discount have on the decision?

Alternative 1 involves the purchase of th Show more Panhandle Medical Practice (Activity-Based Costing) Alternative 1 involves the purchase of three ultrasound machines one for each of the practices three locations Alternative 2 patientscheduling would be the same but only one ultrasound machine would be purchased. It would be mounted in a van that the technician would drive to each of the three practice locations. Most of the operating costs of the two alternatives are identical but Alternative 2 has the added cost of operatingthe van and setting up the machineafter each move. The two alternatives differsubstantially in initialcosts because Alternative 1 requires three ultrasound machines at a cost of $75000each whereas Alternative 2 requires only one. HoweverAlternative 2 requiresa van which with necessary modifications would cost $40000.Thus the start- upcosts for Alternative 1 total 3 $75000= $225000 while those for Alternative 2 amount to only $75000+ $40000 = $115000. Note though that becausethe two alternatives have different operating costs a propercost analysis of the two alternatives must include both initial (capital) and operatingcosts. The hospitals financial staff considered several methodsfor estimating the operating costs of each alternative. After much discussion they decidedthat the activity-based costing (ABC) method would be best. Furthermore an ad hoc task force was assigned the task of performing the cost analysis. To begin the ABC analysis the task force had to develop the activities involved in the two alternatives. This was accomplished by conducting walk- throughs of the entire processfrom the standpoints of the patientthe ultrasound technician and the billingand collections department. The results are containedin Table 1. A reviewof the activities confirms that allexcept onemachine setupare applicable to both alternatives. The next step in the ABC process is to detailthe costs associated with each activity. This step uses financial operational and volume data along with theappropriate cost driverfor each activity to estimate resource consumption. Note that traditional costing which often focuses on department-level costs typically first deals with direct costs and then allocates indirect(overhead) costs proportionally according to a predetermined allocation rate. In ABC the activities required to producesome service including both direct and indirect are estimated simultaneously. For example Table 1 contains activities that entail directcosts (such as technician time) and activities that entailindirect costs (such as billingand collection). Although the ABC methodis more complex and hence costlier than the traditional method it is the only way to accurately (more or less) estimate the costs of individual services. Activity cost detail on a per-procedure basis is shown in Table 2. In essence each activity is assigned a cost driver that is most highly correlated with the actual utilization of resources. Then the numberof driver units along with the cost per unit is estimated for each activity. The product of the number of units multiplied by the cost per unit gives the cost of each activity. Finallythe activity costs are summedto obtain the total cost per procedure. Many of the activitycosts cannot be estimated withouta volume estimate. The bestestimate is that 50 procedures would be done each week regardless of which alternative is chosen. Assumingthe technician works 48 weeks per year theannual volume estimateis 2400 procedures. Of course a much greater total volume can be accommodated under Alternative 1 with three machines than with Alternative 2 with only one machine. Howeverto keep the initial analysis manageable the decision was made to assume the same annualvolume regardless of the alternative chosen. In addition to the costs mentionedthus far some other costs are thoughtto be relevant to the decision.First in additionto the obvious costs of operating the van (primarily gas expenses) it is estimatedthat annual maintenance costs will run about $1000. Furthermore annual maintenance costs on each of the three machinesunder Alternative 1 are estimatedat $500 while the annual maintenance costs for the single machineunder Alternative 2 are estimatedat a higher $1000 becauseof added wear and tear. Also the manufacturer of the ultrasound machines has indicatedthat a 5 percent discount may be availableif three machinesas opposed to only one are purchased. Finally to have a rough estimateof total annualcosts over the life of the equipment it is necessary to make assumptions about the usefullife of the ultrasound machines and the van. Althoughsomewhat controversial the decision was made to assumea five-year life for both the ultrasound machines and the van. Furthermore the assumptionwas made that the value of these assets would be negligible at the end of five years. TABLE 1 Panhandle RegionalMedical Center Activities Associated with Alternatives 1 and 2 1. Appointment scheduling 2. Patient check-in 3. Ultrasound testing 4. Patient checkout 5. Film processing 6. Film reading 7. Billing and collection 8. General administration 9. Transportation and setup (Alternative 2 only) TABLE 2 Panhandle RegionalMedical Center Activity Cost Detail Activity Cost Driver Volume Cost per Unit Appointment scheduling Receptionist time 3 minutes $ .20 Patient check-in Receptionist time 5 minutes .20 Ultrasound testing Technician time 45 minutes .40 Physician time 1.5 minutes 3.00 Supplies per procedure 1 packet 9.00 Patient checkout Receptionist time 5 minutes .20 Film processing Technician time 10 minutes .40 Film reading Contract terms per procedure 40.00 Billing and collection Overhead costs per procedure 6.80 General administration Overhead costs per procedure 1.25 Transportation/setup* Technician time 6 minutes 1.00 *Alternative 2 only Notes: 1. Physiciantime for testing(15 minutes) is needed for one of every ten patients. 2. Supplies consistof linen probe cover gel film and print paper. 3. There are no radiologists in the practice.Films will be read by the hospitals radiologists at a contractfee of $40 per procedure. 4. Billingand collection costs are based on an average cost per medical services bill. 5. Generaladministration costs are based on an estimateof facilities and otheradministrative costs. 6. Transportation/setup is based on ten procedures per day at each location and includes vehicle operatingcosts excluding maintenance. QUESTIONS 1. Estimate the base case cost of each alternative regarding the provision of ultrasound services. (For now ignore the discount if three units are purchased.) 2. Which alternative has the lower total cost? 3. What value for travel and setup costs would make the costs of the two alternatives the same? 4. Now consider the 5 percent discount. What impact does this discount have on the decision? What discount amount would make the two alternatives equal in costs? Show less

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