Privmed – ACCA Paper 3.3 Dec 2002
Privmed is a privately-owned profit-seeking hospital that specialises in operations to replace hip and knee joints. Privmed traditionally determines its prices by adding a 10% mark-up to the budgeted full cost of an operation. The fixed overheads are absorbed on the basis of operating hours using a predetermined rate.
Privmed operating and financial data for 20X1
Hip Knee Total
Total operating capacity (hours) 10,800
Theatre utilisation ratio 70%
Average duration of operation 3.0 hours 3.6 hours
Number of operations undertaken * 1,270
Total costs $15,036,780
Fixed overheads $12,000,000
* not given
The variable costs per operation are as budgeted.
Privmed budgeted data for 20X1
Hip Knee Total
Fixed overhead $12,000,000
Annual operating hours 8,000
Variable cost per operation $1,450 *
* not given
(a) Calculate the number of hip operations undertaken during the year and the variable cost of
performing a knee operation. (4 marks)
(b) Calculate the prices that Privmed would have charged in 20X1 for:
(i) A hip operation
(ii) A knee operation (4 marks)
(c) An activity based costing study recently discovered that the fixed overheads are determined by
non-operating, time-related activities. The study revealed the following data.
Activity Cost driver Hip Knee overheads
Consultations with potential No of consultations 3,000 2,000 8,980,000
X-rays Number of X-rays 6,200 6,200 1,800,000
Post-operative care Days of care 7,860 23,580 1,220,000
Recalculate the prices that would have been charged in 20X1 for each knee and hip operation by
using an activity based costing approach. (5 marks)
(d) Compare the results of your calculated prices in (b) and (c) and suggest with reasons what pricing
decisions you would recommend to the hospital. (5 marks)
(e) The Regional Public Health Authority is under pressure to reduce the length of its patients' waiting
lists for knee and hip operations. In an effort to improve the situation the area manager has
approached Privmed and asked them to consider whether they would undertake some operations
on a fee-paying basis. The approach is welcome, as the hospital's theatre manager would like to
improve the utilisation of the facilities. Indeed, the hospital recently employed a consultant for a fee of $70,000 to assess the financial viability of undertaking public health authority operations at differing levels. The consultant concluded that contracting to undertake public health authority operations would also add to the administrative workload currently undertaken by the hospital eg billing and quality monitoring activities. It would be necessary to employ an additional clerk for $15,000 pa and additional variable administrative cost per operation would be $150 for a knee operation and $100 for a hip operation. If the hospital were to take on this work, it must also consider an additional requirement to keep 2.5% of its total operating capacity spare to meet the immediate needs of its 'special' clients ie it cannot plan to use this proportion of its total capacity. The public health authority has approached the hospital and has proposed two alternative one-year contracts.
The hospital would be required to perform an equal number of hip and knee operations during the next year that would utilise their remaining available spare capacity. The public health authority has agreed that the contract price should be composed of all the relevant incremental costs of the contract plus an 80% mark up.
The hospital would be required to perform 1,500 knee operations. The public health authority will refund all the additional administrative costs resulting from the contract. The 1,500 additional knee operations would require the hospital to install a temporary operating theatre for a total cost of $500,000 with a two-year life. On completion of the contract, the hospital estimates that it could lease the temporary theatre during its second year with the following revenue estimates. 30% probability of earning $200,000
40% probability of earning $100,000
30% probability of earning $80,000
The public health authority is only prepared to pay $3,500,000 in addition to the refund of administrative costs for this one-year contract.
(i) Calculate the contract price and estimated financial benefit of Contract 1. (7 marks) (ii) Calculate the estimated financial benefit of Contract 2. (3 marks)
Note. The data/calculations in this section are at 20X1 price levels.
(f) If either of the contracts were to be taken on, it would result in no capacity being available to meet an unexpected increase in demand from the hospital's private patients.
Explain the potential revenue consequences of such an event occurring and compile a list of information/data that you require to assess the financial consequences of the private patient demand unexpectedly rising to 80% of the total capacity during the contract year. (7 marks)
(g) Suggest three broad areas of non-financial performance that the public health authority is likely to have to monitor as part of a contract involving knee and hip operations. Your answer should include specific variables that are to be monitored. (5 marks)
(Total = 40 marks)