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Case

Lincoln Dietary Department

The dietary department at Lincoln General Hospital produced breakfast, lunch, and dinner for its patients. Most meals were standard, but some patients needed special meals for which the department had to purchase special ingredients. Standard ingredients were used in large volumes, whereas special ingredients were used in very low volumes.
The department was located in the basement of the hospital, where it conducted all its activities. It “sold” its meals to the hospital clinical care departments at a transfer price equal to the full production cost plus a markup of 20 percent.
The department’s budgeted costs broke down as follows:

Exhibit 5A.1 shows the budgeted direct material and labor costs for the two types of meals. Exhibit 5A.2 shows a breakdown of the department’s $1,533,000 of overhead costs, which at that time were allocated to each meal on the basis of the meal’s direct material cost. Exhibit 5A.3 shows the budgeted meal data. As it indicates, the department expected to produce 300,000 regular meals but only 50,000 special meals. As it also indicates, having both regular and special meals placed some demand on the purchasing staff because the required purchase orders varied considerably in terms of the number of meals they would encompass.
The meals were produced in batches. Because of their ingredients, the special meals needed to be produced in small batches, in contrast to the regular meals, which could be produced in large batches. This affected quality control, because inspections were done by batch. Similarly, each batch needed to be set up: the material handlers needed to take the ingredients out of refrigeration and prepare them for cooking. The meals also were packed in batches for delivery to the floor.
At a recent management meeting, several nurses had noted that the cost of meals had been increasing steadily over the past few years. They emphasized that they were not concerned about the dietary department’s 20 percent markup, which they knew was needed to cover the support center costs (mainly plant depreciation, administration and general, housekeeping, and laundry) that were allocated to the department. They also realized and accepted the fact that the special meals would cost more. In fact, most thought that the special meals were reasonably priced, perhaps half of what they might cost in another hospital. The nurses’ main complaint was with the cost of the regular meals.
The manager of the dietary department agreed to look into the matter and present a report at the next monthly management meeting.