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A hospital has five service departments and five clinical departments and five outputs DRG1, DRG2, DRG3, DRG4 and DRG5. The costs of the service department must first be passed onto the clinical departments. Then the costs of the clinical department must be allocated to DRG categories to determine the per-unit cost of each DRG. Budgeted patient numbers for 2010 for each DRG category is:

DRG1 2,200

DRG2 1,200

DRG3 300

DRG4 350

DRG5 550

Budgeted costs for the service departments are:

Administration $300,000

Cleaning $410,000

Security $120,000

Medical records $400,000

Laundry $750,000

The direct costs of the clinical departments are:

Radiology $1,400,000

Laboratory $1,000,000

Physiotherapy $140,000

Nursing $2,400,000

Oncology $2,000,000

• Administration costs are to be allocated on the basis of staff numbers.

• Cleaning costs are to be allocated on the basis of area occupied.

• Security is to be allocated equally among the clinical departments.

• Medical records are to be allocated according to patient episodes of care.

• Laundry is to be allocated on the basis of kilos of laundry handled.


a. Given the above information, calculate the unit costs of each DRG.

b. The government pays the following reimbursements for these DRG categories:

DRG1 $1,000

DRG2 $1,200

DRG3 $7,000

DRG4 $6,000

DRG5 $3,500

Given that this hospital is funded on a case-mix basis, explain how the government would calculate these reimbursement rates.

c. Given the hospital’s cost structure and these reimbursement rates, what actions should this hospital take with regard to the provision of these DRG services?

d. Suppose that instead of case-mix funding the hospital was simply reimbursed for its actual costs in providing the above DRG services. For example, if the hospital incurred costs of $1,500 to provide DRG1 it was reimbursed $1,500 for each DRG1 patient. How would this payment system affect the way in which the hospital provided these services – i.e. would the hospital’s reaction be different to the way it would have acted in your answer to part 3?

the London Private Hospital has 3 patient services departments – Adult Medicine, Obstetrics and Paediatrics. It also has 3 patient support departments – administration, Facilities and Finance. The revenues of the three patient services departments are:

Adult medicine $12 million

Obstetrics $6 million

Paediatrics $2 million

The direct costs of all 6 departments are:

Adult medicine $6 million

Obstetrics $3.6 million

Paediatrics $1.2 million

Administration $1 million

Facilities $4.4 million

Finance $1.8 million

Direct costs of the support departments are allocated to patient services departments using the direct method on the basis of the % of services provided to the support departments to the patient service departments.

Allocate the support overheads to the 3 patient service departments on the basis of the % of services provided.

b. Calculate the profit and loss position for each of the patient service departments and the hospital as a whole.

c. Should the hospital consider closing down any or all of the patient service departments to increase its profitability or reduce its losses? Explain why or why not.

Hint: All costs of the supporting units are to be allocated to cost objects.

Hint: Allocations rate depends solely on each cost object's cost driver and how much in total is allocated to cost objects

Hint: Allocation rates have a numerator and denominator component. The key is to adjust these based on information provided in the question.

Describe the advantages and disadvantages of paying physicians on a fee-for-service basis as compared to salaried or capitated payment. (Word limit: 500 words)

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