Winston Medical Clinic proposed the acquisition of some expensive X-ray equipment to be used for unusual cases. The equipment would be shared by the Orthopedic Department and the Rehabilitation Department. The depreciation and related fixed costs of operating the equipment were predicted at $14,000 per month. The variable costs were predicted at $30 per patient procedure.

Clinic management asked each department to predict its usage of the equipment over its expected useful life of 5 years. The Orthopedic Department predicted an average usage of 75 X-rays per month, while the Rehabilitation Department predicted 50 X-rays. Management 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, the Orthopedic Department had 50 X-rays and the Rehabilitation

Department had 50 X-rays. Compute the total costs allocated to each department.

2. Suppose the manager of the equipment had various operating inefficiencies so that the total October costs were $18,500. 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 totaled 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 in October. Compute the total costs allocated to the Orthopedic Department and to the Rehabilitation Department. Compare the results with those in number 1. What is the major weakness in this traditional method? What are some of its possible behavioral effects?

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