Swedish Hospital Uses A Step-Down Method To Allocate 25 Indi

Swedish Hospital Uses A Step Down Method To Allocate 25 Indirect Se

Swedish Hospital employs a step-down method for allocating 25 indirect service department costs, such as information technology, laundry, security, records, and food service, to its six direct patient care units, including surgery, maternity, and psychiatry. Currently, the Food Service (FS) department is positioned as the third service department in the allocation sequence. The hospital is considering altering this sequence by moving FS from its current third position to the 23rd position. The key considerations involve understanding how such a change impacts cost allocation per meal and the strategic implications of reordering.

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Impact of Moving Food Service from the 3rd to the 23rd Position on Cost Allocation

The allocation of FS costs is based on the number of meals served. When FS is positioned earlier in the step-down method, a larger portion of its costs is allocated to other departments before FS itself receives any allocations. Moving FS from the 3rd position to the 23rd position means that the costs associated with FS are allocated later in the process, after many other departments' costs have already been allocated to the units.

This reordering impacts the cost per meal in a specific way. When FS is allocated earlier, its entire cost is apportioned before the remaining departments’ costs are allocated, leading to a more concentrated allocation to each meal. Conversely, when FS is allocated later in the sequence, its costs are spread over the remaining departments’ costs, resulting in a smaller share of the total costs allocated per meal. As a result, moving FS from 3rd to 23rd position typically causes the allocated cost per meal served to decrease because a significant portion of FS costs are allocated later and are shared among more departments with already allocated costs, reducing the proportion attributable directly to FS on a per-meal basis.

The primary cause of this decrease is the 'spread' of FS costs over a larger volume of allocated costs from other departments. When FS is positioned later, it effectively 'receives' a smaller portion of total costs, because many of its costs are allocated out earlier and influence subsequent allocations less significantly. This diminishes the cost per meal served attributed directly to FS.

Considerations for Management Before Reordering Food Service in the Allocation Sequence

Before changing FS's position from the 3rd to the 23rd in the sequence, Swedish management should evaluate several strategic and accounting issues. First, the impact on departmental costs must be considered: shifting FS later in the process reduces its allocated cost per meal but might also obscure the true cost of food services if other departments' costs are allocated before FS and then influence the total costs. Additionally, management should analyze how this reordering affects budget planning, cost control, and decision-making. If FS costs are a significant portion of indirect costs, changing their allocation order could distort the perceived profitability or efficiency of the food service department.

Furthermore, management should assess whether the perceived decrease in allocated costs per meal accurately reflects operational efficiency or merely redistributes costs. The potential for misinterpretation may lead to poor decisions regarding resource allocation, staffing, or policy adjustments. Another consideration involves compliance with accounting standards and internal control policies, which may prescribe specific allocation sequences or require transparency in how costs are assigned. Finally, management should evaluate the consistency of reporting, ensuring that any change in methodology is clearly documented and justified, to maintain the integrity of financial statements and managerial reports.

In summary, moving FS from the 3rd to the 23rd position in the step-down allocation process can lead to lower apparent costs per meal served, driven primarily by how costs are spread across departments. However, this change must be balanced against strategic, operational, and reporting considerations to ensure that cost allocations remain meaningful, fair, and aligned with organizational goals.

Overview and Wood Processing Decisions at Vigdor

Vigdor processes logs into various wood products like veneers, lumber, and wood chips, each of which can be sold immediately as intermediate products or further processed into finished goods. The decision of whether to sell a product as an intermediate or finished good depends on the potential profit margins after accounting for processing costs. The key parameters include the amount of each product per batch, their respective prices, and the processing costs involved in further conversion.

Based on the data, the company must determine which products should be sold as intermediate products and which as finished products, considering the profit margins and processing costs. Further, Vigdor's fixed processing cost per batch is $800, which acts as a threshold for deciding whether processing is economically viable. Additionally, how high this processing cost can rise before processing is no longer profitable is critical for financial planning. Properly allocating the $800 processing cost among the products, either by volume or net realizable value, impacts the profit calculations, influencing operational decisions. Lastly, Vigdor must analyze whether any initial decisions should be revisited based on the profit maximizing objective and how the cost allocation affects profitability analysis.

This case exemplifies key principles of cost allocation, relevant to managerial decision-making regarding product mix and process optimization in a manufacturing environment.