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# Step-Down Cost Analysis

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Cost Analysis Problem

Problem:

The Downtown Clinic is a 50,000 sq. ft., inner-city primary care facility with a total annual budget of \$1.7 million. However, it is losing its Federal and State grants, and must become self-sufficient to survive. It must now compete for paying customers with other providers, and must enter into contracts with managed care organizations (MCOs) for reimbursement. One such MCO has already made an offer to the Downtown Clinic to care for its enrollees on a cost per visit basis. It is offering \$50.00 per visit, regardless of service. Should the Downtown Clinic accept this offer and enter into a contract with the MCO?

The road to the answer begins with determining the per-visit costs of seeing patients, and the overall income provided by the contract compared with expenses. Below are the data for each of the Clinic's departments, needed to prepare a step-down cost analysis.

Requirements:

Each team's answer to the case study should contain:

1. A spread-sheet step-down cost analysis
2. A narrative explaining the methods used for distribution of costs and calculation of the per visit cost for each service, and the overall per visit cost, and
3. A decision as to whether the clinic should accept the offer or not, and why.

Needed Information:
Pediatrics 8,000 sq. ft;
5,000 patients;
\$185,000 budget;
1.5 docs & 1 nurse; and
3,000 lab orders
OB/GYN

6,000 sq. ft;
8,500 patients;
\$225,000 budget;
2.5 docs & 1.5 nurse; and
2,000 lab orders
Cardiac Center 8,000 sq. ft;
6,000 patients;
\$200,000 budget;
2.0 docs & 2.0 nurse; and
3,000 lab orders
Dental 5,000 sq. ft;
4,500 patients;
\$175,000 budget;
1dentist; and
1,000 lab orders
General Medicine 7,000 sq. ft;
10,000 patients;
\$300,000 budget;
3.5 docs & 2 nurses; and
6,000 lab orders
Lab 9,000 sq. ft.;
\$125,000 budget; and
1 lab tech
Medical Records 5,000 sq. ft.;
\$150,000 budget;
1 medical records employee
\$140,000 budget;
Rent \$80,000
Utilities \$78,000
Cleaning \$42,000.

#### Solution Summary

The solution discusses the step-down cost analysis.

\$2.19

## Split off point, break even analysis

Step down method, Break-even point, Cost Variance, and Split-off point

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4
Blower Company is divided into four departments.
Departments A and B are service departments and Departments 1 and 2 are operating (production) departments
The services of the two service departments are used by the other departments as follows:
Dept. A Dept. B Dept. 1 Dept. 2
Services of:
Department A 50% 20% 30%
Department B 40% 60%
Direct costs incurred
by each department \$60,000 \$50,000 \$70,000 \$80,000

Allocate the service departments to the production departments using the step down method.

8
Joseph Co. has three products A, B, and C, and its fixed costs are \$69,000.
The sales mix for its products are 3 units of A, 4 units of B, and 1 unit of C. Information about the three products follows:
A B C
Projected sales in dollars \$192,000 \$192,000 \$64,000
Selling price per unit \$40 \$30 \$40
Contribution margin ratio 30% 35% 35%

(a) Calculate the company's break-even point in composite units and sales dollars.
(b) Calculate the number of units of each individual product to be sold at the break-even point.

14
Prichard Company has developed the following standard cost data based on 60,000 direct labor hours, which is 75% of capacity.
Fixed overhead is \$360,000 and variable overhead is \$180,000 at this level of activity.

Per Unit
Direct material (3 lbs. @ \$2.00/lb.) \$ 6.00
Direct labor (0.5 hrs. @ \$8.00/hr.) 4.00
Variable overhead (0.5 hrs. @ \$3.00/hr.) 1.50
Fixed overhead (0.5 hrs. @ \$6.00/hrs) 3.00
Total standard cost \$14.50
During the current period, the company operated at 80% of capacity and produced 128,000 units. Actual costs were:
Direct material (380,000 lbs.) \$779,000
Direct labor (63,000 hrs.) 507,150

Calculate the variable overhead spending and efficiency variance and the fixed overhead spending and volume variances. Indicate whether each is favorable or unfavorable.

15
A company puts four products through a common production process.
This process costs \$100,000 each year.
The four products can be sold when they emerge from this process at the "split-off point",
or processed further and then sold. Data about the four products for the coming period are:

Unit Sales Unit Sales
Price per Price per