Cost allocation, downward demand spiral. Top Catering operates ...

[segrsyd]

Cost allocation, downward demand spiral.
 
  Top Catering operates a chain of 10 hospitals in the Los Angeles area. Its central food-catering facility, Topman, prepares and delivers meals to the hospitals. It has the capacity to deliver up to 1,025,000 meals a year. In 2014, based on estimates from each hospital controller, Topman budgeted for 925,000 meals a year. Budgeted fixed costs in 2014 were 1,517,000. Each hospital was charged 6.24 per meal4.60 variable costs plus 1.64 allocated budgeted fixed cost.
   Recently, the hospitals have been complaining about the quality of Topman's meals and their rising costs. In mid-2014, Top Catering's president announces that all Top Catering hospitals and support facilities will be run as profit centers. Hospitals will be free to purchase quality-certified services from outside the system. Ron Smith, Topman's controller, is preparing the 2015 budget. He hears that three hospitals have decided to use outside suppliers for their meals, which will reduce the 2015 estimated demand to 820,000 meals. No change in variable cost per meal or total fixed costs is expected in 2015.
 
  Required:
  1. How did Smith calculate the budgeted fixed cost per meal of 1.64 in 2014?
  2. Using the same approach to calculating budgeted fixed cost per meal and pricing as in 2014, how much would hospitals be charged for each Topman meal in 2015? What would the reaction of the hospital controllers be to the price?
  3. Suggest an alternative cost-based price per meal that Smith might propose and that might be more acceptable to the hospitals. What can Topman and Smith do to make this price profitable in the long run?

Question 2

Summit Company paid Hacienda Products, a creditor, on account. The transaction would involve a
 a. debit to Cash.
   b. credit to Accounts Payable.
   c. credit to Cash.
   d. debit to Expenses.

[cici]

Answer to Question 1

EXHIBIT 9- 39
2014
Master Budget
(1) Practical
Capacity
(2) 2015 Master Budget
(3)
Budgeted fixed costs 1,517,000 1,517,000 1,517,000
Denominator level 925,000 1,025,000 820,000
Budgeted fixed cost per meal
Budgeted fixed costs Denominator level
(1,517,000 925,000; 1,517,000 1,025,000; 1,517,000 820,000)
 1.64  1.48  1.85
Budgeted variable cost per meal 4.60 4.60 4.60
Total budgeted cost per meal  6.24  6.08  6.45

1. The 2014 budgeted fixed costs are 1,517,000. Topman budgets for 925,000 meals in 2014, and this is used as the denominator level to calculate the fixed cost per meal. 1,517,000 925,000 = 1.64 fixed cost per meal. (see column (1) in Solution Exhibit 9- 39).

2. In 2015, three hospitals have dropped out of the purchasing group, and the master budget is 820,000 meals. If this is used as the denominator level, fixed cost per meal = 1,517,000 820,000 = 1.85 per meal, and the total budgeted cost per meal would be 6.45 (see column (3) in Solution Exhibit 9- 39). If the hospitals have already been complaining about quality and cost and are allowed to purchase from outside, they will not accept this higher price. More hospitals may begin to purchase meals from outside the system, leading to a downward demand spiral, possibly putting Topman out of business.

3. The basic problem is that Topman has excess capacity and the associated excess fixed costs. If Smith uses the practical capacity of 1,025,000 meals as the denominator level, the fixed cost per meal will be 1.48 (see column (2) in Solution Exhibit 9- 39), and the total budgeted cost per meal would be 6.08, probably a more acceptable price to the customers (it may even draw back the three hospitals that have chosen to buy outside). This denominator level will also isolate the cost of unused capacity and not allocate it to the meals produced. To make the 6.08 price per meal profitable in the long run, Smith will have to find ways to either use the extra capacity or reduce Topman's practical capacity and the related fixed costs.

Answer to Question 2

c

[segrsyd]

Correct answers!

[cici]

Great! Please up vote