Case Study: Cost Allocation & Downward demand spiral

Delhi Health Maintenance operates a chain of 10 Hospitals in the Delhi. For many
years, it has operated a central food-catering facility in Noida, Which delivers meals to the
hospitals. The Noida facility has the capacity to serve 36, 50,000 meals a year

(10,000 meals a day). In 2020 it budgeted for 29, 20,000 meals (8,000 meals a day), based on
demand estimates from each hospital controller. The budgeted variable cost per meal in 2020
is Rs. 38, which includes delivery to the hospital. Budgeted fixed costs for 2020 are Rs. 4, 38,
00,000.

In July 2020, The new DHM president announces that each hospital is to be a profit
centre. In addition, the head of each hospital can purchase services from outside DHM,
provided those services meet the DHM quality requirements. The President gives catering as
an example. Rahul, the head of the Noida catering facility, is less than pleased. This facility
will also become a profit centre (it has been cost centre for many years) under the
reorganization.

Rahul charged each hospital Rs. 53 per meal in 2020- comprising Rs. 38 variable cost
plus Rs. 15 allocation of budgeted fixed cost. Several hospitals complained about the Rs. 53
cost, as well as the quality of the food. Moreover, the cost rose from Rs. 49 in 2019 to Rs. 53
cost in 2020. Rahul defended the increase, claiming he needed to spread the same fixed cost
over a smaller number of patients –days in 2020. DHM experienced negative press on a local
TV Station in 2019 and early 2020, and the local doctors are referring fewer patients to the
DHM hospitals..

In October 2020, Rahul started to prepare the 2021 budget, including the new cost to
be charged per meal. He estimated that the total annual demand for meals at all DHM hospitals
would be 25,50,000. Then he learned that 3 of the 10 hospitals will use an outside canteen
service, which reduce the 2021 budgeted demand at the Noida facility to 20, 00,000 meals. No
change in total fixed costs of variable cost per meal is expected in 2020.

1. How did Rahul compute the budgeted fixed cost per meal in 2020? -3 Marks
2. What alternative cost- per meal figures might Rahul compute for meals delivered DHM
hospitals in 2021? Which cost figure should Rahul use? Why?- 3 Marks
3. What factors should Rahul consider in pricing meals the Noida facility prepares for the
DHM hospitals?- 4 Marks
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