Chapter 7 for Wk 3 Checkpoint

Topics: Management, Cost, Cost accounting Pages: 19 (2483 words) Published: October 11, 2013
CHAPTER

Cost Classifications

DISTINCTION BETWEEN DIRECT AND
INDIRECT COSTS
Direct costs can be specifically associated with a particular unit or department or patient. The critical distinction for
the manager is that the cost is directly attributable. Whatever the manager is responsible for—that is, the unit, the department, or the patient—is known as a cost object.
The somewhat vague definition of a cost object is any
unit for which a separate cost measurement is desired. It
might help the manager to think of a cost object as a cost objective instead.1 The important thing is that direct costs can be traced. Indirect costs, on the other hand, cannot
be specifically associated with a particular cost object.
The controller’s office is an example of indirect cost.
The controller’s office is essential to the overall organization itself, but its cost is not specifically or directly associated with providing healthcare services. The critical distinction for the manager is that indirect costs usually

cannot be traced, but instead must be allocated or apportioned in some manner.2 Figure 6-1 illustrates the direct–indirect cost distinction.
To summarize, it is helpful to recognize that direct
costs are incurred for the sole benefit of a particular operating unit—a department, for example. As a rule of thumb, if the answer to the following question is “yes,” then the cost is a direct cost: “If the operating unit (such as a department) did not exist, would this cost not be in

existence?”
Indirect costs, in contrast, are incurred for the overall
operation and not for any one unit. Because they are
shared, indirect costs are sometimes called joint costs or

49

6
Progress Notes
After completing this chapter,
you should be able to

1. Distinguish between direct and
indirect costs.
2. Understand why the difference
is important to management.
3. Understand the composition
and purpose of responsibility
centers.
4. Distinguish between product
and period costs.

50

CHAPTER 6 Cost Classifications

Direct
Costs

common costs. As a rule of thumb, if the answer to the following question is “yes,” then the cost is an indirect cost: “Must this cost be
allocated in order to be assigned to the unit
(such as a department)?”

Indirect
Costs

Are
Traced
to

Are
Allocated
to

EXAMPLES OF DIRECT COST AND
INDIRECT COST

It is important for managers to recognize direct and indirect costs and how they are treated on reports. Two sets of examples illustrate the reporting of direct and indirect Cost Object
costs. The first example concerns a radiology department; the second concerns a dialysis center. Figure 6–1 Assigning Costs to the Cost Object.
Table 6-1 represents a report of two line
items—direct costs and indirect costs—for a
radiology department. The report concerns
procedure numbers 557, 558, 559, 560, and
561 and a total. In this report, the manager
can observe the proportionate differences between direct and indirect costs and can also see the differences among the five types of procedures.
Greater detail is provided to the manager in Table 6-2, which presents the method of allocating indirect costs and the result of such allocation. Managers should notice that the “totals” line carries forward and becomes the “indirect cost” line in Table 6-1. The purpose of the report in Table 6-2 is to reveal details that support the main report in Table 6-1. Thus,

Table 6–1 Example of Radiology Departments Direct and Indirect Cost Totals Dept: Radiology—Diagnostic
Cost Summary—Year to Date November ______

Indirect Cost
Centers
Direct costs
Indirect costs*
Totals

CC #557
Diagnostic
Radiology

CC #558
Ultrasound

CC #559
Nuclear
Medicine

$1,000,000
300,000
$1,300,000

$600,000
195,375
$795,375

$1,200,000
221,500
$1,421,500

CC #560
CT
Scan

CC #561
Radiation
Therapy

Total

$1,800,000
338,500
$2,138,500

$1,400,000
211,625
$1,611,625...
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