Shifa Medical Centre (SMC)

“We’ve got a budget crisis! Instead of a surplus of almost $100,000, we’re looking at a potential
deficit of over $145,000. Not only won’t we be able to buy the new equipment that everyone’s
been screaming for, but I don’t see how we can pay physicians the bonuses they’re counting on.”
– Dr. Khan, Senior Physician and Founder, Medial Associates
Chahat Khan, M.D., the senior physician member of Shifa Medical Centre, a
small physician medical centre located in Aligarh, Uttar Pradesh, was expressing her
concern about the results of the year’s operations. One reason for the problem was
that third-party administrators had lowered the rate for one of the centre’s visit types,
but there appeared to be some other, perhaps more important, explanations as well.
Dr. Khan decided to analyze the reasons for the poor performance and present
her findings at the centre’s annual strategic planning retreat, which was about 5 days
away.

Background
Shifa Medical Centre (SMC) has been established about 20 years ago by Dr.
Khan and a colleague she has met during her residency. Over the years, it has grown,
and has expanded the team of physicians and extenders to meet the increased
demand for services. Since past several years now, SMC has been an exclusive Third-
Party Administrators (TPA) linked medical centre that gets reimbursement from
insurance companies through TPAs for all the services to its patients.

Financial Matters
SMC’s physicians were paid according to a combination of a base salary and a
bonus. Because different visit types required different levels of physician intensity, Dr.
Khan and her colleagues has a lengthy discussion at last year’s retreat about different
approaches to measuring productivity. They had finally settled on revenue as the best
method. Everyone has agreed that, since the payment for each visit type was rough
reflection of its intensity, revenue generation was not only a simple way to measure
each physician’s productivity, but a good one as well.
SMC’s physicians and extenders also had agreed upon the following principles
to guide their budgeting activities and compensation arrangements:

1. While most third-party payers classified visits by precise codes, four visit types
(initial visit, routine physical, intensive follow up, and routine follow up) were
sufficient for budgeting purposes.
2. Physicians would be available to see outpatients for 32 hours a week (eight 4-hour
sessions). They also had agreed that, with time off for continuing medical
education and vacations, they would be available for a total of 1,500 hours a year
(about 47 weeks).
3. The extenders would be expected to see patients for 1,400 hours a year – less than
the physicians since they had some other responsibilities.
4. Although physicians were paid by a combination of base salary and bonus, the
extenders would be on a straight salary with no bonus. Physicians could share
their bonuses with one or more extenders who they thought were especially
helpful.
5. Each physician’s base salary would be set at 42 percent of his or her expected
revenue generation. Ten percent of that amount would be kept in reserve until the
end of the year, and paid out as a year-end bonus if the centre reached at least 95
percent of its total revenue target.

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 6. The remaining revenue would be used to cover SMC’s operating expenses and to
provide the surplus needed to fund renovations, expansions etc.
Current Year’s Budget
In preparing the current year’s budget, Dr. Khan has met with each physician
individually to arrive at his or her visit forecast, broken down by the four visit types.
She and SMC’s administrator, Gurpreet Handa, had then summed the individual
physician forecasts to obtain a total for the entire centre.
Dr. Khan has asked Mr. Handa to treat physicians, extenders and medical
supplies as “variable expenses” for budgeting and performance evaluation purposes,
in that they were expected to increase or decrease in rough proportion to the number
of visits. While this was not completely precise, Dr. Khan found the approach a useful
way to “attach” costs to each visit type.
Medical supplies included a wide variety of disposable items needed in
conjunction with a visit. To keep the budget simple, Dr. Khan has asked Mr. Handa to
measure medical supplies in terms of “units” and to use an average costs per unit.
The budget’s fixed expenses included rent, cleaning, administrative staff, office
supplies and similar items.

Using estimates prepared by Dr. Khan for the above items, Mr. Handa had
calculated the total variable expenses per visit for each visit type. He next had
multiplied the revenue and total variable expenses per visit by the anticipated number
of visits to get total revenue and total variable expenses by visit type. He deducted the
later from the former to give the contribution to fixed expenses. Finally, he deducted
the anticipated fixed expenses from total contribution to give a total budgeted surplus
for the year. Details of his work are shown in Exhibit 1.

The Budget Crisis

Dr. Khan’s “budget crisis” is indicated in Exhibit 2. However, about $125,000
of this was in the bonus pool. Since the centre has achieved its revenue target, the
physicians were expecting to be paid the full $125,000. However, doing so would
create a deficit for the year of over $145,000. As Dr. Khan said:

“This is an even bigger problem than it first appears to be. Although revenue generation
exceeded the target, the physicians worked an average of only about 1,100 hours each for
the year. The rate of $1.35 per minute that we used in the budget assumed they would work
1,500 hours each during the year, for a total of 9,000 hours. With only 6,600 hours of work,
the effective rate per minute has increased to $1.84.”

To better understand the reasons for the shift in financial performance, Dr.
Khan has asked Mr. Handa to use the data in Exhibits 1 and 2 as the bases for a
report on results for the year. His report was to contain a complete breakdown of the
reasons why SMC’s actual surplus has diverged from the budgeted one. Dr. Khan
would use the report for her presentation at the retreat.

Required:
Q. 1 Prepare a flexible budget for year as per the format of ‘Original Budget’ of Exhibit
1: Original Budget given in the case.

Q. 2 Compute the following variances and create a summary table of Variances as per
the format Exhibit 3 given below in your answer book. (Ignore Fixed Overhead
variances).

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 Exhibit 1: Original Budget
Initial Routine Intensive Routine
Total
Consult Physical Visit Visit
#visits 3,000 4,000 6,000 6,000 19,000
Budgeted Price Per
150 110 80 60
Visit
Budgeted Total
450,000 440,000 480,000 360,000 1,730,000
Revenue

Budgeted Variable
106.5 77.75 44 31
expense per visit
Total Variable
319500 311000 264000 186000 1,080,500
Expenses
Contribution 130500 129000 216000 174000 649,500
Less: Total Fixed Cost 550,000
Surplus 99,500
Variable Expense Details
Physician Care
Average #minutes per
60 45 20 10
visit
Average wage per
1.35 1.35 1.35 1.35
minute
Total Expense per
81 60.75 27 13.5
visit

Extended Care
Average #minutes per
15 10 10 15
visit
Average wage per
0.9 0.9 0.9 0.9
minute
Total Expense per
13.5 9 9 13.5
visit

Medical Supplies
Average #units per
3 2 2 1
visit
Average expense per
4 4 4 4
unit
Total Expense per
12 8 8 4
visit

Total Average
Variable Expense 106.5 77.75 44 31
per visit

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 Exhibit 2: Actual Results for the Current Year
Initial Routine Intensive Routine
Total
Consult Physical Visit Visit
#visits 2,500 5,500 5,600 7,000 20,600
Actual Price Per Visit 150 110 75 65
Total Revenue 375,000 605,000 420,000 455,000 1,855,000
Total Variable
303,250 622,600 288,960 235,900 1,450,710
Expenses
Contribution 71,750 -17,600 131,040 219,100 404,290
Less: Total Fixed Cost 550,000
Surplus (145,710)
Variable Expense Details
Physician Care
Average #minutes per
45 30 15 5
visit
Average wage per
1.84 1.84 1.84 1.84
minute
Total Expense per
82.8 55.2 27.6 9.2
visit

Extended Care
Average #minutes per
25 40 15 20
visit
Average wage per
1 1 1 1
minute
Total Expense per
25 40 15 20
visit

Medical Supplies
Average #units per
3 4 2 1
visit
Average expense per
4.5 4.5 4.5 4.5
unit
Total Expense per
13.5 18 9 4.5
visit

Total Average
Variable Expense 121.3 113.2 51.6 33.7
per visit

Exhibit 3: Summary Table Format for answer

Initial Intensive
Variances Routine Physical Routine Visit
Consult Visit
Visit Volume
Revenue Price
Physical Care
Productivity/Efficiency
Wage Rate
Extender Care
Productivity/Efficiency
Wage Rate
Medical Supplies
Usage
Price
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