Many provinces have a hospital regulatory board that must approve the acquisition of specified medical equipment before hospitals can qualify for cost-based reimbursement related to that equipment. That is, hospitals cannot bill government agencies for the use of the equipment unless the boards originally authorized the acquisitions.

Two hospitals in one province proposed the acquisition and sharing of some expensive X-ray equipment to be used for unusual cases. The depreciation and related fixed costs of operating the equipment were predicted at $12,000 per month. The variable costs were predicted at $30 per patient procedure.

The board asked each hospital to predict its usage of the equipment over its expected useful life of five years. University Hospital predicted an average usage of 75 X-rays per month; Children’s Hospital of 50 Xrays. The board regarded this information as critical to the size and degree of sophistication that would be justified. That is, if the number of X-rays exceeded a certain quantity per month, a different configuration of space, equipment, and personnel would be required that would mean
higher fixed costs per month.

1. Suppose fixed costs are allocated on the basis of the hospitals’ predicted average use per month. Variable costs are allocated on the basis of $30 per X-ray, the budgeted variable-cost rate for the current fiscal year. In October, University Hospital had 50 X-rays and Children’s Hospital had 50 X-rays. Compute the total costs allocated to University Hospital and to Children’s Hospital.

2. Suppose the manager of the equipment had various operating inefficiencies so that the total October costs were $16,500. Would you change your answers in number 1? Why?

3. A traditional method of cost allocation does not use the method in number 1. Instead, an allocation rate depends on the actual costs and actual volume encountered. The actual costs are totalled for the month and divided by the actual number of X-rays during the month. Suppose the actual costs agreed exactly with the budget for a total of 100 actual X-rays. Compute the total costs allocated to University Hospital and to Children’s Hospital. Compare the results with those in number 1. What is the major weakness in this traditional method? What are some of its possible behavioural effects?

4. Describe any undesirable behavioural effects of the method described in number 1. How would you counteract any tendencies toward deliberate false predictions of long-run usage?