Cost allocation downward demand spiral meals to go

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9-45Cost allocation, downward demand spiral. Meals To Go operates achain of 10 hospitals in the Los Angeles area. Its central food-catering facility, Mealman,prepares and delivers meals to the hospitals. It has the capacity to deliver up to 1,460,000 meals ayear. In 2017, based on estimates from each hospital controller, Mealman budgeted for 1,050,000meals a year. Budgeted fixed costs in 2017 were $1,533,000. Each hospital was charged $6.16per meal—$4.70 variable costs plus $1.46 allocated budgeted fixed cost.Recently, the hospitals have been complaining about the quality of Mealman’s meals and theirrising costs. In mid-2017, Meals To Go’s president announces that all Meals To Go hospitals andsupport facilities will be run as profit centers. Hospitals will be free to purchase quality-certifiedservices from outside the system. Dean Wright, Mealman’s controller, is preparing the 2018budget. He hears that three hospitals have decided to use outside suppliers for their meals, whichwill reduce the 2018 estimated demand to 912,500 meals. No change in variable cost per meal ortotal fixed costs is expected in 2018.Required:1.How did Wright calculate the budgeted fixed cost per meal of $1.46 in 2017?2.Using the same approach to calculating budgeted fixed cost per meal and pricing as in 2017,how much would hospitals be charged for each Mealman meal in 2018? What would thereaction of the hospital controllers be to the price?3.Suggest an alternative cost-based price per meal that Wright might propose and that mightbe more acceptable to the hospitals. What can Mealman and Wright do to make this priceprofitable in the long run?SOLUTION(25 min.) Cost allocation, downward demand spiral.SOLUTION EXHIBIT 9-452017 MasterBudget (1)PracticalCapacity(2)2018MasterBudget(3)Budgeted fixed costs $1,533,000$1,533,000$1,533,000Denominator level1,050,0001,460,000912,500Budgeted fixed cost per meal Budgeted fixed costs Denominator level($1,533,0001,050,000; $1,533,0001,460,000; $1,533,000912,500) $ 1.46$ 1.05$ 1.68
Budgeted variable cost per meal4.704.704.70Total budgeted cost per meal$ 6.16$ 5.75$ 6.381.The 2017 budgeted fixed costs are $1,533,000. Mealman budgets for 1,050,000 meals in2017, and this is used as the denominator level to calculate the fixed cost per meal. $1,533,0001,050,000 = $1.46 fixed cost per meal. (see column (1) in Solution Exhibit 9-45).2. In 2018, 3 hospitals have dropped out of the purchasing group and the master budget is912,500 meals. If this is used as the denominator level, fixed cost per meal = $1,533,000 912,500 = $1.68 per meal, and the total budgeted cost per meal would be $6.38 (see column (3)in Solution Exhibit 9-45). If the hospitals have already been complaining about quality and costand are allowed to purchase from outside, they will not accept this higher price. More hospitalsmay begin to purchase meals from outside the system, leading to a downward demand spiral,possibly putting Mealman out of business.3. The basic problem is that Mealman has excess capacity and associated excess fixed costs.If Wright uses the practical capacity of 1,460,000 meals as the denominator level, the fixed costper meal will be $1.05 (see column (2) in Solution Exhibit 9-45), and the total budgeted cost per

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