Essentials Of Cost Accounting

Business

Quiz 5 :

Costing for Nonroutine Decisions

Quiz 5 :

Costing for Nonroutine Decisions

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Should sunk costs be carefully included or carefully excluded from a nonroutine decision analysis? Why?
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Sunk cost refers to those costs that have already been incurred and thus cannot be recovered.
Nonroutine decisions are the decisions which are taken when an uncommon situation occurs. These are those situations which the manager has never dealt before and not even similar ones. So, Nonroutine decision making is quite risky and includes lot of anxiety and stress.
Sunk cost should be carefully excluded from the Nonroutine decision analysis.
This is because the key in non routine analysis is to look to the future rather than past but sunk cost is the costs that has already incurred in the past. This is the reason why sunk costs should be not be considered in non routine decision analysis.

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The Healthy Hospital has been pushed by its physicians to add an open heart surgery unit. This has always been resisted on the grounds that therew?as not adequate demand to make the unit financially reasonable. Under the DRG system, Healthy could expect to receive average reimbursement of $56,000 per open heart surgery for each of an anticipated 100 open heart surgeries per year. Incremental costs would be expected to be $60,000 per case, so a loss would be incurred. However, the prestige associated with offering open heart surgery would attract new affiliations. It is expected that 10 additional general practice physicians would join the staff and each of these 10 physicians would generate 20 patients per year, spread across a wide variety of DRGs. Struggling has excess capacity and would welcome additional patients. It is expected that the average DRG reimbursement for these new patients would be $28,000. The average cost is expected to be $27,800. The average marginal cost is expected to be $26,400. Should Healthy add open heart surgery as a loss leader?
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Average cost is referred as per unit cost of goods produced. It is calculated by dividing the total cost by the number of goods produced. The total cost includes fixed and variable cost.
However, marginal cost  calculates the amount of change in the total  cost , when an additional unit is produced.
Average cost is computed by using the formula:
img While the formula to calculate marginal cost is:
img Thus,  marginal cost determine the cost of producing one additional unit of output.
With the acceptance of proposal the additional 10 surgeons will generate 20 patients. Hence surgeries by each surgeon lead to total 200 surgeries.
The Reimbursement on each surgery is $28000.The average cost of each surgery (100 surgeries anticipated) is $27,800 while the Marginal cost of each surgery (100 surgeries additional) is $26,400.
In order to determine that whether the firm should start business or not then profit/loss should be calculated on each surgery.
img Calculate total revenue using the formula.
img Hence the total revenue for the organization will be $5,600,000.
Calculate total cost using the formula.
img Thus, the total cost amounts to $5,420,000.
The total revenue exceeds the cost. Hence, calculate the profit using the formula.
img As it is clearly seen that hospital H would receive a profit of $180,000 so it should accept the proposal.

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Distinguish between cost-benefit analysis and cost-effectiveness analysis.
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Cost-benefit analysis and Cost-effectiveness analysis are the sub-types of decision analysis. Decision analysis refers to the technique which helps to make decisions under conditions of uncertainty. These techniques attempt to weigh the pros and cons of a decision.
Differences between cost-benefit analysis and cost-effectiveness analysis are listed as follows:
1. Cost-benefit analysis is a systematic approach of measuring the economic worth of a project or investment whereas the cost-effectiveness analysis is that approach that calculates the monetary value of all project costs.
2. Cost-benefit analysis measures costs and benefits expressed in terms of monetary units whereas the cost-effectiveness analysis measures the project results in units rather than monetary figure.
3. Cost-benefit analysis is the only approach which determines that whether the benefits of an action exceed its costs whereas the cost-effectiveness analysis cannot determine it.

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What is the role of relevant costs in comparing alternatives while making a non-routine decision? How are costs common to all alternatives treated?
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What are some examples of nonroutine decisions?
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Finkler Residential Treatment Facility anticipates that it will have 25,000 patient days next year. This is substantially below its capacity of 35,000 patient-days per year. The facility has variable costs of $75 per patient-day. Its fixed costs are $1,500,000 per year. a) Calculate the average cost per patient day for Finkler Residential Treatment Facility at a volume of 25,000 patientdays and at 30,000 patient-days. b) Assume that an HMO offers to generate 5,000 patient-days per year. It currently sends no patients to Finkler Residential Treatment Facility. It is willing to pay a maximum flat amount of $90 per patient-day. Assuming that its case mix is similar to the current 25,000 patient-days, should Finkler accept its business?
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What is the goal of using relevant cost information? How are costs common to all alternatives treated?
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Your large urban hospital is considering the possibility of transferring the capacity for 30,000 ambulatory care visits from the hospital's outpatient department (OPD) to free-standing clinics. Average costs of care in free-standing clinics are lower than in OPDs. But more important, evidence suggests that in urban areas, in patient utilization and to tal visits decrease when ambulatory care is moved to a free-standing setting. Conservative estimates are that inpatient utilization will drop by 10 percent and that ambulatory utilization will drop by 5 percent. Estimate the benefits (savings) and costs of this initiative. The following provide all of the information you need to know to do the analysis. You should assess savings and costs in both the short run and long run. In the short run, only variable costs of hospital and OPD care can be saved; fixed costs can be eliminated only in the long run. Required information: (1) Number of visits transferred: 30,000 (2) Number of people transferred: 6,000 (3) Current average inpatient days per person: 1.1 (4) Current average ambulatory visits per person: 5.0 (5) Average cost per day--inpatient: $500 (6) Percentage variable cost-inpatient: 30% (7) Average revenue per day-in patient: $450 (8) Average cost per visit-OPD: $70 (9) Percentage variable cost-OPD: 40% (10) Average revenue per visit-OPD: $55 (11) Average cost per visit-new site: $50 (12) Average revenue per visit-new site: $55
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