From your text and at least one scholarly source, describe how service center costs are allocated using the various allocation methods. Illustrate its use by using a
health care example.

Chapter 11
Product Costing: Attaching Costs
to Patient Services
Learning Objectives
• Understand why and how costs are attached to patient services.
• Describe how direct materials, direct labor, and clinic/hospital overhead are costed to
patient services.
• Explain why predetermined overhead rates are usually used for costing.
• Identify the main differences among alternative measures for the denominator in the
overhead rate.
• Explain why services should be costed for pricing purposes by using an overhead rate
computed at normal volume levels.
• Describe how to allocate service center costs so that they can be included in overhead
rates of operating departments.
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Section 11.1 Costing of Patient Services CHAPTER 11
Chapter Outline
11.1 Costing of Patient Services
11.2 Costing of Direct Costs
Costing of Direct Materials
Costing of Direct Labor
11.3 Costing of Hospital/Clinic Overhead
Predetermined Overhead Rate
Multiple Overhead Rates
Alternative Concepts of Volume
11.4 Cost of Providing Services
Direct Method
Step (Sequential) Method
Treatment of Revenues
Allocation of Costs by Behavior
11.5 Ethical Issues For Cost Allocation
Costs are used to accomplish an assortment of needs: to evaluate the profitability of
goods and services, to aid in pricing and bidding decisions for negotiating contracts
with insurers, to plan and budget operations, to evaluate performance, to control costs,
and to establish inventory values for the balance sheet and cost of goods and services sold
for the income statement.
This chapter discusses accounting for costs and presents ways to identify costs with products
or services. Accounting for direct materials and direct labor comes first. Then, accounting
for clinic/hospital overhead covers simple to more complex situations. Finally, we
discuss how service center costs, such as transportation or laboratory costs, are included
in patient service costs.
11.1 Costing of Patient Services
Serving patient needs involves the use of resources. As mentioned in Chapter 9, the
costs of these resources are typically classified as materials, labor, and overhead. The
costs are accumulated by jobs (patient care or procedure) or by departments. Then they
are assigned to each unit of output (product, such as medical equipment, or service, such
as nursing care or laboratory test) based on each unit’s use of the resources. These relationships
for assigning costs to products or services are depicted in Figure 11.1.
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Section 11.2 Costing of Direct Costs CHAPTER 11
Figure 11.1: A view of cost linkage
The principles underlying product costing are applicable to manufacturing companies
and service organizations. For example, a hospital may be interested in determining the
cost of a specific medical treatment or the cost of outpatient care. A medical supply store
may wish to know the costs associated with carrying and selling a particular line of wheelchairs.
A building contractor, on the other hand, will accumulate costs by project. If a contractor
is constructing a hospital for a community, for instance, the contractor will identify
and trace the costs to the hospital project. A university may be interested in the estimation,
measurement, and control of a program to train nurses and physicians. A museum may
want to determine the cost of a particular exhibit for a season.
Regardless of the type of organization, costs are identified as direct costs when they can be
readily connected to a cost objective. Indirect costs, which cannot as easily be connected
to an objective, must be allocated using some reasonable basis for allocation. For example,
all patient care requires heat and light, but that would not be billed per patient; instead it
would be an indirect cost.