Cost allocation, downward demand spiral. Top Catering operates a chain of 10 hospitals in the Los Angeles area. Its central food-catering facility, Topman, prepares and delivers meals to the hospitals. It has the capacity to deliver up to 1,025,000 meals a year. In 2014, based on estimates from each hospital controller, Topman budgeted for 925,000 meals a year. Budgeted fixed costs in 2014 were $1,517,000. Each hospital was charged $6.24 per meal—$4.60 variable costs plus $1.64 allocated budgeted fixed cost. Recently, the hospitals have been complaining about the quality of Topman’s meals and their rising costs. In mid-2014, Top Catering’s president announces that all Top Catering hospitals and support facilities will be run as profit centers. Hospitals will be free to purchase quality-certified services from outside the system. Ron Smith, Topman’s controller, is preparing the 2015 budget. He hears that three hospitals have decided to use outside suppliers for their meals, which will reduce the 2015 estimated demand to 820,000 meals. No change in variable cost per meal or total fixed costs is expected in 2015. 1. How did Smith calculate the budgeted fixed cost per meal of $1.64 in 2014? 2. Using the same approach to calculating budgeted fixed cost per meal and pricing as in 2014, how much would hospitals be charged for each Topman meal in 2015? What would the reaction of the hospital controllers be to the price? 3. Suggest an alternative cost-based price per meal that Smith might propose and that might be more acceptable to the hospitals. What can Topman and Smith do to make this price profitable in the long run?
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