In 2015, only 740,000 Topman meals were produced and sold to the hospitals. Smith suspects that hospital controllers had systematically inflated their 2015 meal estimates.

In Problem 9-39, 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 meal—$ 4.60 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. Recall that Topman uses the master-budget capacity utilization to allocate fixed costs and to price meals. What was the effect of production-volume variance on Topman’s operating income in 2015?

2. Why might hospital controllers deliberately overestimate their future meal counts?

3. What other evidence should Top Catering’s president seek to investigate Smith’s concerns?

4. Suggest two specific steps that Smith might take to reduce hospital controllers’ incentives to inflate their estimated meal counts.