Question 1 CASE STUDY (60 MARKS) HARBOUR HEIGHTS HOSPITAL Harbour Heights Hospital (HHH) is a medium-sized private hospital located in Macandrew Bay in Dunedin. As its name suggests, it has a spectacular view of the Dunedin harbour, which appeals to many recuperating patients. HHH has been offering its services for 20 years and specialises in operations on moveable joints. That is, it offers hip replacement operations for a basic fee of $8,000 per operation, knee replacement operations for $10,000 per operation and shoulder replacement operations for $6,000 per operation. As well as providing these surgical operations, HHH provides pre-operation (i.e. before) and post-operation (i.e. after) in-patient care for those patients undergoing the surgical operations. There is considerable demand for such operations in Dunedin as it has an ageing population and the waiting lists at the Public Hospital for the same operations are quite lengthy. In the past year HHH has carried out 600 hip replacements, 800 knee replacements and 400 shoulder replacements. HHH runs two operating theatres (rooms) and aims to achieve a return (before tax) on sales of 14%. In the past ten years HHH had been exposed to increasing competitive pressure. Potential patients are eyeing Asia (particularly Thailand), with a view to having their operations done more cheaply. Another more immediate threat is that of Tiaki Hospital which commenced business about ten years ago in Mosgiel. It offers similar services to HHH. Mosgiel has flat terrain and has therefore attracted retirees and retirement homes to the area. This is the exact demographic of the population who more commonly require hip, knee or shoulder operations. Tiaki Hospital charges $8,600 for a hip replacement operation, $8,200 for a knee replacement operation and $6,000 for a shoulder replacement operation. Chris Jointly, the Chief Executive Officer (CEO) at HHH is concerned about the price Tiaki Hospital charges for a knee replacement. The number of knee replacements carried out at HHH has been gradually decreasing (whilst demand for the other operations has remained steady) and the hospital now has spare capacity. Chris believes the cheaper price at Tiaki Hospital may have something to do with the decreasing volumes. He can't understand how Tiaki could be offering such a low price and still be making a profit. Chris has a long meeting with HHH's management accountant Nick Pain in order to understand the costing and pricing procedures at HHH. He finds out that surgeons are paid a fixed fee for each surgical operation they perform in the operating theatres and an additional amount for any follow-up consultations. Post-operation follow-up consultations are only undertaken if there are any complications in relation to the surgical operation. There is no additional fee charged to patients for any follow-up consultations. All other staff are paid annual salaries. Nick Pain provides the CEO with other relevant data for the latest year, which is displayed in Exhibit 1. HHH uses a single overhead rate, based on revenue, to charge the cost of support activities to the operations. Chris Jointly vaguely remembers from his university accountancy studies that a single flat rate can often be improved by calculating department allocation rates or activity allocation rates. He asks Nick Pain to provide further information about support activity overhead costs which are displayed in Exhibit 2. 2 N 3 Exhibit 1 Procedure information for past year for HHH Hip Replacement Knee Replacement Shoulder Replacement Average time per 2.0 1.2 1.5 operation (hours) Number of 1 4 operations per theatre session In-patient days 3 2 1 per operation Surgeon's fee per 1,200 1,800 1,500 operation ($) Percentage of 8 5 10 operations with complications (%) Surgeon's fee for a 300 300 300 follow-up consultation ($) Cost of medical 400 200 300 supplies per operation ($) Exhibit 2 Information about support activities at HHH for past year Activity Cost driver Overheads ($) Theatre preparation for Number of theatre 864,000 each session sessions Operating theatre usage Operating time (hours) 1,449,000 Nursing and other aligned In-patient days 5,428,000 services Administration Sales revenue 1,216,000 Other overheads Number of operations 923,000 Required: (a) Calculate the overhead rate currently used to allocate support costs to the different operations. (3 marks) (b) Calculate the profit (before tax) per operation for each of the three operations, using the current basis for charging the costs of support activities to operations. (10 marks) (c) Based on your results in (b) above, what is HHH's current return (before tax) on sales for each operation and in total? (2 marks) (d) If Nick Pain was to use activity based costing, how would he decide on the best cost driver for each activity? (8 marks) (e) Calculate the profit (before tax) per operation for each of the three operations, using Activity Based Costing for charging the costs of support activities to operations. (18 marks) (f) Based on your results in (e) above, what is HHH's current return (before tax) on sales for each operation and in total? (2 marks) (8) How can the Activity Based Costing results assist Chris Jointly in pricing the operations? (6 marks) (h) Why is Chris Jointly concerned about having excess capacity? (3 marks) (i) What do you suggest Chris Jointly do? (8 marks)