Distinction Between Direct and Indirect Costs
The critical distinction for the manager is that the cost is directly attributable. Whatever the manager is responsible for that is, the unit, the department, or the patient is known as a cost object. Direct costs can be specifically associated with a particular unit or department or patient. Indirect costs, on the other hand, cannot be specifically associated with a particular costs object. It is helpful to recognize that direct costs are incurred for the sole benefit of a particular operating unit- a department. As a rule of thumb, if the answer to the following question is “yes”, then the cost is a direct cost: “if the operating unit (such as a department) did not exist, would this cost not be in existence?”. Indirect costs, in contrast, are incurred for the overall operation and not for any one unit. As a rule of thumb, if the answer to the following question is “yes” then the cost is an indirect cost: “Must this cost be allocated in order to be assigned to the unit (such as a department)?”
The responsibility center makes a manager responsible for both the revenue/volume (inflow) side and the expense (outflow) side of a department, division, unit, or program. In other words, the manager is responsible for generating revenue/volume and for controlling costs.
Although the lines of managerial responsibility will vary in healthcare organizations, the relationship between and among responsibility centers, support centers, and overall supervision will remain.
Distinction Between Product and Period Costs
Product cost is a term that was used originally associated with manufacturing rather than with services. The concept of product cost assumes that a product has been manufactured and placed into inventory while waiting to be sold. Then, whenever that product is sold, the product is matched with revenue and recognized as a cost. Period costs, in the original manufacturing interpretation, are not connected with the manufacturing process. They are matched with revenue on the basis of the period during which the cost is incurred. The business of healthcare service organizations is service delivery, not the manufacturing of products. In healthcare organizations, product cost can be viewed as traceable to the cost object of the department, division, or unit. A period cost is not traceable in this manner.
Another way to view this distinction is to think of product costs as those costs necessary to actually deliver the service, whereas period costs are costs necessary to support the existence of the organization itself. Finally, medical supply and pharmacy departments do have inventories on hand. In their case, a product is purchased rather than manufactured and placed into inventory while waiting to be dispensed. Then, whenever the product is matched with revenue and recognizes as a cost of providing the service to the patient. Therefore, the product cost concept is important to managers of departments that hold a significant amount of inventory.