The Yew Tree Medical Centre is a retreat which specialises in rehabilitation. In doing this it offers four programmes of care: alcoholic rehabilitation; drug-addict rehabilitation; childrens services; and after-care (counselling and support of patients). The centre employs a number of experienced nurses, physicians and psychologists in treating patients affected by addiction and psychiatric illness. The centres budget for 2011 is as follows.

Professional Salaries 6 Physicians @100,000 19 Psychologists @ 50,000 23 Nurses @ 25,000	600,000 950,000 575,000 2125,000
Medical Supplies	300,000
General Overheads (administrative salaries, rent utilities etc)	1,275,000
Total	3,700,000

Jennifer Cooper, the director of the centre, is keen on determining the cost of each programme offered. She has limited funds and feels that this information will help her to budget better and allocate resources more effectively. For example, Jennifer needs to decide on whether to allocate funds to alcoholic rehabilitation or drug-addict rehabilitation. Her decision rule is that if the cost to treat a drug-addict patient for a year is more than 15% higher than the cost to treat an alcoholic patient for a year, the alcohol programme would receive additional funds.

As a first step, Jennifer, asked the staff to fill out a form indicating the time devoted to each of the four programmes. She then allocated costs of medical supplies on the basis of physician-hours spent in each programme and general overhead on the basis of direct-labour costs (where direct labour is defined to include the time of doctors, psychologists and nurses multiplied by the salary rate of each).

Jennifer compiled the following data describing employee allocations to individual programmes:

	ALCOHOL	DRUG	CHILDREN	AFTER-CARE	TOTAL EMPLOYEES
PHJYSICIANS		2	4		6
PSYCHOLOGISTS	6	4		9	19
NURSES	4	6	4	9	23

Eighty patients are in residence in the alcohol programme, each staying about six months. Thus, the clinic provides 40 patient-years of service to the alcohol programme. Similarly, 100 patients are involved in the drug programme for about six months each. Thus the clinic provides 50 patient-years of service to the drug programme.

Jennifer is, however, not entirely happy with her existing costing system. In her view, what we need is a system that can yield insight into the efficiencies with which various activities are performed. This can help us decide whether to eliminate redundant activities or improve their efficiencies. She has asked her accountant, Dorothy Bates, to investigate the possibility of implementing a more sophisticated Activity-Based costing system. Dorothy is puzzled over the use of a more sophisticated system and is especially concerned about how to manage Jennifers expectations. After much research, Dorothy obtains the following information:

medical supplies depends on the number of patients in each department and the length of their stays (that is, patient-years).

General overhead costs consist of:

Rent and clinic maintenance 200,000

Administrative costs to manage patient charts, food, laundry 800,000

Laboratory services 275,000

Total 1,275,000

	ALCOHOL	DRUG	CHILDREN	AFTER-CARE	TOTAL
Square feet of space occupied by each programme	9,000	9,000	10,000	12,000	40,000
Patient-years of service	40	50	50	60	200
Number of patients	80	100	200	120	500
Number of laboratory tests	400	1,400	3,000	700	5,500

Required:

1) Calculation of indirect-cost rates for medical supplies and general overhead under Jennifers existing costing system.

2) Calculation of the cost of each programme and the cost per patient-year of the alcoholic and drug programmes, using Jennifers existing costing system. Using the existing costing system, should Jennifer allocate additional funds to the drug programme or the alcoholic programme?

3) Using an Activity-Based costing (ABC) approach, select cost-allocation bases that you believe are the most appropriate for allocating indirect costs to programmes, clearly explaining the reasons behind your choices. Use this information to calculate the cost of each programme and the cost per patientyear of the alcohol and drug programmes. Using the ABC system, should Jennifer allocate additional funds to the drug programme or to the alcohol programme?