ABC for Cathalâ€™s Hospital: A Case Study

Activity-Based Costing for Cathalâ€™s Private Hospital: A Case Study

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Learning Outcomes

Learning outcomes:

(i) Select and apply decision-making techniques to facilitate business decisions and promote efficient and effective use of scarce business resources, appreciating the risks and uncertainty inherent in business and controlling those risks.

(ii) Identify and apply appropriate budgeting techniques and methods for planning and control and use standard costing systems to measure and control business performance and to identify remedial action.

(iii) Assess the performance of an organisation from both a financial and non-financial viewpoint.

Question 1:

Cathal’s Private Hospital (CPH) is a well-known and highly reputable provider of a range of orthopaedic surgeries to Irish patients. The hospital has been in operation for ten years and during that time has streamlined all of its services and most of its administrative functions. The hospital accountant is keen to ensure best practice in the finance function, particularly in costing the various surgeries that are conducted and is considering the introduction of activity-based costing (ABC). CPH currently applies a traditional approach to costing surgeries by attributing direct costs as far as possible and allocating hospital overheads based on the patient’s average length of stay (ALOS) in the hospital.

Total hospital overheads for the year are budgeted at €4,801,226 and the total budgeted ALOS for all patients for the year is 23,375 days.

To facilitate the introduction of ABC the hospital accountant has analysed all of the overheads incurred into six categories of expense and has also established the cause or driver of the expense as shown in the table below:

Expense category Cause (driver) of expense
X-ray department costs Number of X-rays provided
Hospital Consultant costs Number of meetings with Hospital Consultant
Operating theatre costs Number of hours spent in operating theatre
Physiotherapy costs Number of physiotherapy sessions
Occupational therapy costs Number of occupational therapy sessions
Sundry hospital costs Average length of stay in the hospital (ALOS)

Budgeted data relating to the expense categories has also been compiled by the hospital accountant and is as follows:

X-ray department costs €1,008,320
Hospital Consultant costs € 960,267
Operating theatre costs €1,104,430
Physiotherapy costs € 624,143
Occupational therapy costs € 528,106
Sundry hospital costs € 575,960

Question 1: Costing Surgeries Using ABC

Total X-rays provided 6,302
Total physiotherapy sessions 15,223
Total occupational therapy sessions 15,003
Total hours in operating theatre 9,154
Total meetings with Hospital Consultants 8,314

Information relating to two surgeries conducted during the year is given below:

Knee surgery Hip surgery

Direct materials cost €425 €960

ALOS 3.5 days 4.2 days

Number of X-rays 2 5

Meetings with Hospital Consultant 2 meetings 4 meetings

Physiotherapy 4 sessions 5 sessions

Occupational therapy 3 sessions 5 sessions

Theatre time 1.25 hours 2 hours

You are required to:

(a) Calculate the total cost of each of the two surgeries noted above using:

The costing approach currently used by Cathal’s Private Hospital. (5 Marks)
Activity based costing. (15 Marks)

(b) Comment in detail on your answers in (a) (i) and (ii) above. (10 marks)

Question 2:

Discuss in detail any two of the following budgeting systems:

Incremental (Traditional) Budgeting
Zero Based Budgeting
Activity Based Budgeting

Rolling Budgets

In particular your answer should focus on the following:

The uses of each system selected and
The advantages and disadvantages of each system selected.
You should also give an example and discuss in detail what type of companies

might use each type of budget selected above, including quantitative

information to support your answer. (30 Marks)

QUESTION 3

Tabs Ltd is a rapidly growing distributor of medical products to retail outlets. It is in the process of formulating plans for the first half of next year. The marketing manager has completed his sales budget for 2022 and is confident that sales estimates will be met or exceeded.

The following sales figures show the growth expected.

Budgeted sales for 2022 (all on credit):

€ €

Jan 1,800,000 Feb 2,000,000

Mar 1,800,000 April 2,200,000

May 2,500,000 June 2,800,000

You are the new financial controller and have been given responsibility for formulating the cash budget, a critical element during a period of rapid expansion.

The following information provided by operating managers will be used in preparing the cash budget:

Question 2: Discussing Rolling Budgets

(i) The company has experienced an excellent record in trade receivable collection and expects this trend to continue. 60% of sales invoices are collected in the month after sale and the remainder in the second month after sale. There are no bad debts.

(ii) The purchase of the medical products is the company’s largest expenditure with the cost equalling 50% of sales. The medical products are purchased in the month before sale. Prior experience shows that 80% of the trade payables are paid in the month after receipt of medical products and the remaining 20% are paid in the second month after receipt.

(iii) Wages are equal to 20% of the current month’s sales. These wages are paid in the month incurred.

(iv) Administrative expenses are budgeted to be € 2,640,000 for the year and the composition is shown below. All of these expenses are incurred evenly throughout the year, except for the rent which is paid in four equal instalments in the last month of each quarter.

€ €

Salaries 480,000 Promotion 660,000

Rent 240,000 Insurance 360,000

Utilities 300,000 Depreciation 600,000

(v) Corporation Tax payments are made in the first month of each quarter and are based upon the profit of the prior quarter. The tax rate is 40%. Tab’s net profit for the fourth quarter of 2021 is projected to be € 612,000.

(vi) Equipment and warehouse facilities are being purchased to support the company’s expanding sales. Purchases of warehouse facilities and equipment are budgeted at € 28,000 for April and € 324,000 for May and are paid for in the month after purchase.

(vii) Tab Ltd has a cash balance of € 100,000 on 31^st March 2022. In the second quarter of 2022 it is estimated that there will be an interest cost of € 8,000 which is payable in June 2022 on a company loan.

You are required to:

a. Prepare a cash budget for the months of April, May and June 2022. Show also the total for the three monthly period (20 Marks).

b. Discuss in detail why cash budgeting is particularly important for a growing company such as Tab’s Ltd. In your solution you should also deal with the following: