Problem 1.

 David Jones, the new administrator for a surgical clinic, was trying to
determine how to allocate his indirect expenses. His staff was complaining that the
current method of taking a percentage of revenues was unfair. He decided to try to
allocate utilities based on square footage of each department, administration based on
direct costs, and laboratory based on tests. Use the information in the chart below to
answer the question.

Step 1. I gather my information:

In order to answer this question, the Total for Direct Expenses must be corrected first. The

correct Total for Direct Expenses should be 3,375,000, not 3,625,000. That is a huge

difference of 250,000 which if I were to solve this problem, has to be corrected.

Sq. Footage Direct Expenses Lab Tests

Utilities 200,000

Administration 2,000 500,000

Laboratory 2,000 625,000

Day-op Suite 3,000 1,400,000 4,000

Cystoscopy 1,500 350,000 500

Endoscopy 1,500 300,000 500

TOTAL 10,000 3,375,000 5,000

Step 2. Compute my information:

Square Footage Direct Expenses Lab Tests

Utilities
Administration 2,000
Laboratory 2,000 625,000
Day-Op Suite 3,000 1,400,000 4,000
Cystoscopy 1,500 350,000 500
Endoscopy 1,500 300,000 500
TOTAL 10,000 2,675,000 5,000
Step 3. Compute my information: This will show allocation
percentage %.
In order to gain the Sq. Ft. % per department, what I did was I divided the Sq. Footage per
department by the TOTAL Sq. Footage.
Department Square Footage Calculation Sq. Ft % Per
Department
Utilities
Administration 2,000 2,000/10,000 = 20%
Laboratory 2,000 2,000/10,000 = 20%
Day-Op Suite 3,000 3,000/10,000 = 30%
Cystoscopy 1,500 1,500/10,000 = 15%
Endoscopy 1,500 1,500/10,000 = 15%
TOTAL (Entire 10,000
Building)

Next, I want to figure out the Direct Cost %, so in order for me to do that, I will need to
take the total direct cost of each department and divide by the total direct cost and below
you will see my calculations as to how I came up with the solutions:
Department Direct Costs Calculation Direct Cost %
Utilities
Laboratory 625,000 625,000/2,675,000 = 23% or 23.36449%
Day-Op Suite 1,400,000 1,400,000/2,675,000 = 52% or 52.33645%
Cystoscopy 350,000 350,000/2,675,000 = 13% or 13.08411%
Endoscopy 300,000 300,000/2,675,000 = 11% or 11.21495%
TOTAL (Direct Cost) 2,675,000

Now, I want to figure out the department direct cost %(H). What I did in order to
get the % is I took each direct cost and divided them by the total direct cost of
2,675,000 that I just figured out in the step above when I was figuring out the
direct cost %.
Department Department Direct Total Direct Cost Calculation Dept. Direct
Cost Cost % (H)
Day-Op Suite 1,400,000 2,675,000 1,400,000/2,675,000 = 52% or 52.33645%
Cystoscopy 350,000 2,675,000 350,000/2,675,000 = 13% or 13.08411%
Endoscopy 300,000 2,675,000 300,000/2,675,000 = 11% or 11.21495%

Column I. This step is where I want to find the Lab Tests % and how I do that is I took
each of the line-item lab tests and divide by the total lab tests.
Lab Tests Calculation Lab Tests %
Day-Op Suite 4,000 4,000/5,000 = 80% or .80%
Cystoscopy 500 500/5,000 = 10% or .10%
Endoscopy 500 500/5,000 = 10% or .10%
TOTAL 5,000
Step 4. Allocate Costs. There are five steps within Step 4.
First, Column J will be taken from Step 1.
Direct Costs
Utilities 200,000
Administration 500,000
Laboratory 625,000
Day-Op Suite 1,400,000
Cystoscopy 350,000
Endoscopy 300,000
TOTAL 3,375,000

Second, Column K will be calculated by taking the total utility cost of $200,000 and
multiply it by the information in Step 3, Column G.
Department Utility Costs Dept. Sq. Ft. % Calculation Utilities per Dept.
Utilities 200,000
Administration 500,000 20% 200,000 * 20% = 40,000
Laboratory 625,000 20% 200,000 * 20% = 40,000
Day-Op Suite 1,400,000 30% 200,000 * 30% = 60,000
Cystoscopy 350,000 15% 200,000 * 15% = 30,000
Endoscopy 300,000 15% 200,000 * 15% = 30,000
TOTAL

Third, Column L is where I calculated the total Administration of $540,000 multiplied by

the percentages in Column H.
Direct Utilities Calculation Total Direct Calculatio Dept.
Costs Administratio Costs % n Admin.
n Costs
Utilities
Administratio 500,000 40,000 500,000 + (540,000)
n 40,000 =
Laboratory 625,000 23.36449% 540,000 * 126,168
23.36449% =
Day-Op Suite 1,400,000 52.33645% 540,000 * 282,617
52.33645% =
Cystoscopy 350,000 13.08411% 540,000 * 70,654
13.08411% =
Endoscopy 300,000 11.21495% 540,000 * 60,561
11.21495% =
TOTAL
Fourth, Column M is where I will calculate the total Laboratory which is Column J +
Column K + Column L.
J K L M N
Direct Costs Utilities Administration Laboratory TOTAL
Utilities $200,000 ($200,000)
Administration $500,000 40,000 ($540,000)
Laboratory $625,000 40,000 126,168 ($791,168)
Day-Op Suite $1,400,000 60,000 282,617 632,934 $2,375,551
Cystoscopy $350,000 30,000 70,654 79,117 $529,771
Endoscopy $300,000 30,000 60,561 79,117 $469,678
TOTAL $3,375,000 $0 $0 $0

Based on the scenario above, the Endoscopy Dept.’s total expenses are $469,678.

Problem 2. Your hospital has been approached by a major HMO to perform all their MS-DRG
470 cases (major joint procedures). They have offered a flat price of $10,000 per case. You have
reviewed your charges for MS-DRG 470 during the last year and found the following profile:

Cost/Charge Variable Cost %

Average Charge $15,000

Average LOS 5 Days

Routine Charge $3,600 0.80 60%

Operating Room 2,657 0.80 80%

Anesthesiology 293 0.80 80%

Lab 1,035 0.70 30%

Radiology 345 0.75 50%

Medical Supplies 4,524 0.50 90%

Pharmacy 1,230 0.50 90%

Other Ancillary 1,316 0.80 60%

TOTAL ANCILLARY $11,400 0.75 50%

What I want to find out here for Problem 2 is what the MS-DRG 470 is. This is how I will
calculate:
Routine Charges = $3,600
Hospital’s Charge to Ratio = 0.80 or 80%
Total Ancillary = $11,400
Average Charge $15,000
Average LOS 5 DAYS
Routine Charge $3,600 Cost/Charge 0.80 Variable Cost %60
Operating Room 2,657 0.80 80
Anesthesiology 293 0.80 80
Lab 1,035 0.70 30
Radiology 345 0.75 50
Medical Supplies 4,524 0.50 90
Pharmacy 1,230 0.50 90
Other Ancillary 1,316 0.80 60
TOTAL Ancillary $11,400 0.75 50

In the above data set, assume that the hospital's cost to charge ratio is 0.80 for routine services
and 0.75 for all other ancillary services. Using this information, what would the average cost of
MS-DRG 470 be?
What I will do next is to calculate the total ancillary services by adding all the items, except for
the routine charge.
2,657 + 293 + 1,035 + 345 + 4,524 + 1,230 + 1,316 = 11,400
ALL OTHER ANCILLARY SERVICES RATIO:
80% or Routine Charges 0.8 (3,600) = 2,880
75% of Other Ancillary Services 0.75 (11,400) = 8,550
TOTAL of Both 2,880 + 8,550 = 11,430
AVERAGE COST OF MS-DRG 470 = $11,430
ROUTINE CHARGE = $3,600

Operating Room 2,657

Anesthesiology 293
Lab 1,035
Radiology 345
Medical Supplies 4,524
Pharmacy 1,230
Other Ancillary 1,316
TOTAL Ancillary $11,400
Problem 3. A free-standing ambulatory care center averages $70 in charges per patient.
Variable costs are approximately $12 per patient, and fixed costs are about $1.5 million per
year. Using these data, how many patients must be seen each day, assuming a 365-day
operation, to reach the break-even point?
First I break down the numbers in the problem:
Charges per patient per day = $70
Approx. Variable Costs per patient per day = $12
Fixed Costs per year = $1.5M
In order for me to find the fixed costs per day I use this formula:
$1.5M/365 days = $4,109.59 fixed costs per day

Now, I look at how x = the patients needed to be seen each day to break even.
The formula will look like this:
Charges per patient per day (x) = fixed costs per year + approximate variable costs per patient
per day
70x = 1.5M + 12x
Charges per patient per day (x) – approximate variable costs per patient per day = 1.5M or 58x
= 1.5M
58 = $70 - $12
70x – 12x = 1.5M or 58x = 1.5M
1/58 * 58x = 1.5M * 1/58
x = 1.5M/58 or x = 25,862.07 per year
25,862.07/365 days = 70.85 or break even is rounded up to equal 71 patients each day that
need to be seen to break even