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Category: Tax
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Experience:  CPA with tax experience.
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What method of cost allocation was used, how were cost centres

Resolved Question:

What method of cost allocation was used, how were cost centres determined, how would fixed and variable costin?

One year ago, Academic Hospital and
nearby Western Hospital merged. As part
of the merger, Academic Hospital eliminated
its small maternity service, and Western
Hospital eliminated most of its internal
laboratory. The two hospitals are both
owned by one parent organization, yet they
remain distinct profit centers, with an “each
tub on its own bottom” philosophy.
A problem recently arose when Western
Hospital demanded a price reduction
for the laboratory work associated with an
amniocentesis. This procedure is performed
at Western on a regular basis, but after the
merger, the laboratory work for it has been
performed at Academic.
However, Western had recently found
that an independent laboratory would do
the work for $375, as compared with the
$400 Academic was charging. Although the
total dollars involved were not substantial
(Western only had about 300 amniocenteses
per year), all agreed that an important
policy issue was involved and that resolution
should be sought.
A joint oversight committee of the two
hospitals found that the direct incremental
costs of performing the amniocenteses were
$300 in labor and supplies. In addition,
Academic was charging $90 for overhead
that would be incurred whether or not the
amniocentesis laboratory tests were done at
Academic, and $60 for profit. It was also
found that Western was currently making a
$105 profit on the entire procedure but
could raise that profit by $75 if it could get
the laboratory work done for $75 less.
How much would the transfer price be
• full charges,
• variable costs,
• market price, and
• negotiated price?
How much profit does each hospital make
under each alternative? How much do the
combined hospitals make under each of the
above alternatives? What would happen if
Western purchased from an outside laboratory
for $375?
Submitted: 5 years ago.
Category: Tax
Expert:  JKCPA replied 5 years ago.
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