=+7-32 KK Cost allocation, downward demand spiral OBJECTIVE 8 Orchid Homes Ltd operates a chain of 10 nursing homes in the greater Sydney metropolitan area. Its central food-catering facility, Freshfoods, prepares and delivers meals to the nursing homes. It has the capacity to deliver up to 1300000 meals a year. In 2014, based on estimates from the management accountant at each nursing home, Freshfoods budgeted for 975000 meals a year.

294 Chapter 7: Cost management, capacity costing and capacity management M07_HORN3377_02_LT_C07.indd 294 2/09/13 3:41 PM Budgeted fixed costs in 2014 were $1520000. Freshfoods Ltd charged each nursing home $6.36 per meal—$4.80 variable costs plus $1.56 allocated budgeted fixed cost.

Recently, the nursing homes have been complaining about the quality of Freshfoods’s meals and their rising costs. In mid-2014, Orchid Homes Ltd’s managing director announces that all Orchid nursing homes and support facilities will be run as profit centres.

Nursing homes will be free to purchase quality-certified services from outside the system. Josh Ahrens, Freshfoods’s management accountant, is preparing the 2015 budget. He hears that three nursing homes have decided to use outside suppliers for their meals;

this will reduce the 2015 estimated demand to 780000 meals. No change in variable cost per meal or total fixed costs is expected in 2015.

Required 1 How did Josh Ahrens calculate the budgeted fixed cost per meal of $1.56 in 2014?