FRIENDS AND FAMILY MEDICINE: FRIENDS AND FAMILY MEDICINE (the Group) is a medical practice with four locations in the SPAIN/MADRID Area. The clinical staff consists of 20 physicians and all of them practice in one or more areas of family medicine, and 71 employes and nurses. The Group is organized into three patient services departments: Adult Medicine, Obstetrics, and Pediatrics. Supporting these patient service departments are three support departments: Administration, Facilities, and Information Technology. Exhibit 1 contains the Groups summary revenue and cost projections. The traditional medical business of the Group has been firmly decreasing since Huracan Mara and regarding the COVID-19 pandemic the Groups new strategic planning asks for a better administration of health services, giving emphasis to the cost management system and with the objective to know the true financial position of the Group. The Group is planning to invest in an expensive telemedicine system in the coming years given the fact that the Group is a telemedicine certified center. The Group is also looking to expand its medical practices and/or replace the existing ones to compete with other medical groups in the local healthcare market, given the fact that the groups profitability is not that good, as it was in previous years before Huracan Mara and the COVID-19 pandemic. In addition, the Group is considering reducing the number of nonessential employees based on the actual market needs depending on the results of a cost study ready to be done. There are federal funds coming for financial aid during the COVID-19 pandemic but as Carlos Rodrguez Ocasio, the Groups Financial Chief has stated This financial aid funds are not forever.

As part of a much-needed administration overhaul specifically in the cost management system, the Group contracted with a major accounting firm to estimate the amount of services provided by the support departments to each other and to each patient service department. The intent of the study was to provide data that would help the Group develop a better cost allocation system to replace the outdated, subjective, and arbitrary system currently in use. The results of this study are shown in Exhibits 2a & 2b. This data in Exhibits 2a & 2b is based on an extensive study using sound managerial accounting techniques. Thus, both senior management and department heads at the Group are comfortable with the resulting allocation percentages. Another step in the cost allocation process improvement initiative is to choose the allocation method. There are three allocation methods under consideration: direct, step-down, and reciprocal. A decision has been made to start the allocation process with the direct and step-down method and to leave the reciprocal standby. To aid in the decision, Carlos Rodriguez Ocasio has asked PATRICIA PEREZ, an administrative resident from the Graduate School of Public Health UPR at the Group, to conduct a study and to make a recommendation regarding the best allocation method. There are several possible approaches to the task, but PATRICIA PEREZ has decided to examine by doing. That is, she plans to use the data in Exhibit 1a & 2a to determine the overhead cost allocation under the first two methods direct and step-down. Once this is done, she will be able to compare and analyze the results. Of course, the final decision cannot be made without considering the costs involved in implementing each allocation method. When PATRICIA PEREZ asked Carlos Rodrguez Ocasio about the cost inherent in each allocation method, Carlos Rodriguez Ocasio said, I dont know! Assume that direct method is the least costly, the reciprocal method is the costliest, and the step-down falls somewhere in between. He also expects PATRICIA PEREZ to make some judgements on the relative profitability (P & L) of the patient services departments under the recommended allocation system. The Group has established a 10% profit goal in relation to revenues.

Exhibit 1
FRIENDS AND FAMILY MEDICINE Departmental Revenue and Cost Projections
Revenues
Adult Medicine	$ 12,000,000
Obstetrics	$ 6,000,000
Pediatrics	$ 2,000,000
Total Revenue	$ 20,000,000
Direct Costs
Adult Medicine (AM)	$ 6,000,000
Obstetrics (Obs)	$ 3,600,000
Pediatrics (Ped)	$ 1,200,000
Subtotal	$ 10,800,000
Direct Costs
Administration (Admin)	$ 1,000,000
Facilities (Facilities)	$ 4,400,000
IT Department	$ 1,800,000
Subtotal	$ 7,200,000
Total Costs	$ 18,000,000
Pretax Profit	$ 2,000,000

Exhibit 2a
FRIENDS AND FAMILY MEDICINE Annually based Study Data Results
	Support Departments			Operating Department
	Admin	Facilities	IT Dept	AM	OBS	PED
Costs	$ 1,000,000	$ 4,400,000	$ 1,800,000	$ 6,000,000	$ 3,600,000	$ 1,200,000
Computer- Hours Used	2000	1200	3500	1200	900	1800
Number of Employees	5	8	12	12	18	36
Square Feed Used	350	250	450	800	550	120
Number of Visits				2400	11200	18500
Exhibit 2b
Relationship of Direct, Indirect, Fixed and Variable Costs
	Direct	Indirect	Total
Fixed	$ 7,500,000	$ 6,000,000	$ 13,500,000
Variable	$ 3,300,000	$ 2,000,000	$ 5,300,000
Total	$ 10,800,000	$ 8,000,000	$ 18,800,000

Exhibit 3
FRIENDS AND FAMILY MEDICINE Scenarios to Changes in Overhead Cost Data
New Direct Expenses for Scenario 1
Administration	$ 4,400,000
Facilities	$ 1,000,000
IT Department	$ 1,800,000
Total Overhead Expenses	$ 7,200,000
New Direct Expenses for Scenario 2
Administration	$ 1,000,000
Facilities	$ 1,800,000
IT Department	$ 4,400,000
Total Overhead Expenses	$ 7,200,000

Assume that you are in PATRICIA PEREZs shoes. Complete her assignment and prepare a report to the Groups executive committee with the following elements:

1. A complete and detailed cost allocation process using the direct and step-down methods with detailed comparisons and analysis based on the cost allocation theory.
2. A complete and detailed profitability study of the cost allocation results with P & Ls using the direct and step-down methods based on the cost allocation theory.
3. A complete and detailed two (2) scenarios analysis of the cost allocation results from the direct and step-down methods to the relative sizes of the direct costs at each support department as presented in Exhibit 3. Note that to do a scenario analysis the cost allocation process has to be done again with the new direct expenses of the support departments specified in Exhibit 3, to see if these new changes significantly affect the previous results. Then a profitability analysis with P & Ls is done again using the new cost allocation results.
4. A complete and detailed third scenario using the CVP model studied theory to produce a total annual cost function of the Groups operation, and then use this total annual cost function to project the total Groups expenses for next year. Then combine these projected expenses with the annual projected revenue to produce a profitability result with a P & L. Please assume the actual total revenue and visits are the same for next years projection.
5. A complete comparison and profitability analysis between (2), (3) and (4), using the studied cost management theory, to recommend the best course of action for the Group.