Executive Summary
Westmount Retirement Residence is involved in giving aged people in London a residence where they have comfort, food services, laundry services and round the clock medical services among other things. It largely concentrates on the elderly who are mostly around the age bracket of 75 years. Helen Roswell who is the administrator of Westmount Retirement Residence is of the opinion that the recent decline in profitability is largely attributable to the current costing system. Westmount needs to change its costing approach to reflect changes in the industry and to become competitive.
Among the strengths of the current costing system are its simplicity and its ability to divide costs among the different departments. Its weaknesses include equal distribution of all expenses among all the departments irrespective of the size of these departments. The biggest weakness is that the current costing approach does not attribute costs to the clients but rather divides the total cost among all the clients irrespective of the consumption by each.
Westmount performed poorly in 2005 because of increased competition. Westmount's costing approach is inadequate because it does not capture costs accurately leading to lower profits.
The new costing system will allocate costs based on the suits available at Westmount and the categories of patients based on their medical needs. All costs, but for supportive costs, will be allocated on the basis of suit size as a percentage of the total area in square feet. Supportive costs on the other hand will be allocated as a percentage of the cost of hiring nurse supervisors, nurse attendants and nurse dieticians taking into consideration the amount of these services consumed by each client. This analysis helps in arriving at the new cost per patient under each option. This information will be useful to Roswell in arriving at a properly computed base cost and setting a pricing structure that will enable Westmount to attain the much desired 15% margin and profitability as a whole.
Strengths and Limitations of the current costing model
The current costing model has both strengths and weaknesses. Among its strengths is its simplicity in arriving at the unit cost. It is however not sufficiently comprehensive. This leads to inaccuracies in costing. Secondly, the current costing method attributes costs into the respective departments. This ensures that the costs are well distributed across all the functional areas and is good in tracking the costs incurred by each department. For instance, from the reports created using this costing approach, we can ascertain that supportive services department incurs the most cost which is as a result of wages and benefits. This is followed by the food service department where the cost is divided almost equally between wages and supplies.
The weaknesses of the current costing system include its equal distribution of the general administration expenses, management fees and fixed operating expenses. This can also be referred to as the absorption costing method. The absorption costing method includes both the variable costs as well as the fixed overhead costs in each product. This is used in allocating costs to the departments. However, these departments are not equal both in terms of their area in square feet or the number of employees present in each department. As such, these expenses, instead of being apportioned equally, should be apportioned according to the area or the number of employees or both (Jamal, Mastor, Saat, Ahmed, & Abdulla, 2007).
The second weakness with the current costing model is the fact that it does not capture the actual cost incurred by each of the home's inhabitant. It is obvious that some of Westmount's residents use some services more than others. For instance, the supportive services which represent the highest costs are classified into residents requiring no medical needs, medium medical needs and high medical needs. This approach does not comprehensively capture the essence of costing which is attributing the total costs in the production of a good or a service. A more elaborate costing model should be developed to capture these varying needs among the residents and develop a corresponding pricing model (Murthy & Gurusamy, 2009).
Westmount's poor results in 2005
Westmount performed dismally in 2005 as a result of a number of factors. First of all, competition increased dramatically between the years. Over 17 retirement homes exist in the London area alone. This has increased competition which in turn has eroded the pricing power. Competition shifted towards the price factor making it increasingly difficult for Westmount to price their products at a premium and thus achieve the required level of return to sustain growth and protect their revenues (Schomair, 2008).
Secondly, pricing highly is sensitive as their clientele comprise of individuals over the age of 75 are individuals with average incomes of between 25,000 dollars and 40,000 dollars. This places a cap on the level of prices that Westmount can institute. This is despite of rising cost of living. For instance, the cost of food and supportive services is very high. This requires an increase in prices to maintain the margins. However this is not possible because too high an increase cannot be born by the clients because of their limited incomes (Schomair, 2008).
Westmount's costing system also posses an internal threat. This is because the costing is not based on usage but rather takes a uniform approach. All costs at Westmount are divided among the clientele equally without consideration of each client's individual consumption. Some of the clients even share rooms with their spouses yet this does not result in extra prices for them. Such instances increase the cost of food and other social amenities. The costing approach should be re-evaluated to take these facts into consideration.
New costing system
The three suites are Studio, one bedroom and two bedrooms. The studio room measures 400 square feet, the one bedrooms measure 500 square feet while the two bedroom measure 600 square feet. The total suites are 125. This can be represented in an excel sheet as shown:
Suites
No. of Suites
Size (Sq. Feet)
Percentage (%) Sq. Feet
Studio
75
400
26.67
One B/Room
35
500
33.33
Two B/Room
15
600
40.00
Total
125
100.00
The percentages have been arrived at based on the difference in the sizes of the different rooms. This will form the new basis for costing based on the room sizes as opposed to the traditional method of arbitrary adding 0.25 and 0.5 percent to the base cost. This will be used to allocate costs remaining after supportive services have been allocated. This costs total to $1,917,426 per year ($2,465,999-$548,573). This allocation is illustrated in the excel sheet below:
Actual Remaining Cost Share in ($) per Yr
Suites
Percentage (%)
Cost Amount ($)/Yr
Cost Amount ($)/Yr/Suite
Studio
26.67
511314
6818
One B/Room
33.33
639142
18261
Two B/Room
40.00
766970
51131
Total Cost
100.00
1917426
The three patient levels are represented by those with no medical needs, medium medical needs and high medical needs. These three levels consume supportive services differently and thus should be charged according to their usage of these services as opposed to suite size. Supportive services represent the highest costs in Westmount. The excel sheets below indicate the allocation in percentage of the three supportive costs namely nursing supervisors, nursing attendants and dieticians.
Nursing Supervisors
Patient Care
Res. No.
Hrs/Res/Wk
Hrs/T.Res/Wk
Hrs/T.Res/Yr
(%)
No Medical Needs
55
0.25
13.75
660
6.51
Medium Medical Needs
65
1.5
97.5
4680
46.15
High Medical Needs
40
2.5
100
4800
47.34
Total
211.25
10140
100.00
Nursing Attendants
Patient Care
Res. No.
Hrs/Res/Wk
Hrs/T.Res/Wk
Hrs/T.Res/Yr
(%)
No Medical Needs
55
1.3
71.5
3432
15.66
Medium Medical Needs
65
3
195
9360
42.72
High Medical Needs
40
4.75
190
9120
41.62
Total
456.5
21912
100.00
Dieticians
Patient Care
Res. No.
Hrs/Res/Wk
Hrs/T.Res/Wk
Hrs/T.Res/Yr
(%)
No Medical Needs
55
0.1
5.5
264
8.15
Medium Medical Needs
65
0.4
26
1248
38.52
High Medical Needs
40
0.9
36
1728
53.33
Total
67.5
3240
100.00
The above excel sheets illustrate the percentage share of the nursing supervisors, nursing attendants and dietician's costs between the patient classes of no medical needs, medium medical needs and high medical needs. This will be used in apportioning supportive services costs among the three groups; No medical needs, medium medical needs and high medical needs. A summary of this allocation is shown in the excel sheet below. Note that this information has been derived from the tables above and this table forms the summary.
Cost Share in Percentage (%) per Year
No Medical Needs
Medium Medical Needs
High Medical Needs
Nurse supervisors
6.51
46.15
47.34
Nurse Attendants
15.66
42.72
41.62
Nurse Dieticians
8.15
38.52
53.33
The cost associated with supportive costs in the year 2005 is $548,573. To allocate this between the nurse supervisors, attendants and dieticians, the ratio of their costs per annum should first be determined using data from the current wages payment information and their working hours. This is illustrated in the excel sheet below.
No.
Hrs per Wk
T.Hrs per Wk
Cost per Hr ($)
Wks in Yr
Annual cost ($)
(%)Ann.Cost
Nurse supervisors
5
47
235
18.5
48
208680
38.70
Nurse Attendants
10
50
500
11
48
264000
48.95
Nurse Dieticians
2
37.5
75
18.5
48
66600
12.35
Total
134.5
810
539280
100.00
The percentage annual cost for each of the nurse category from this table can then be used to apportion the supportive cost of $548,573. This is illustrated in the sheet below.
Total cost of Supportive Services
Supervisors
Attendants
Dieticians
100%
38.70
48.95
12.35
548573
212276
268549
67748
This cost figures for each department form the basis through which the table for cost share in percentage is applied to get the exact cost share for the three classes of residents for the year 2005. The table below illustrates the exact costs where each is the percentage share multiplied by the costs incurred for each nurse category as shown in the above table.
No. Meds
Medium Meds
High Meds
Total Cost ($)/Yr
Nurse supervisors
13817
97974
100486
212276
Nurse Attendants
42062
114714
111773
268549
Nurse Dieticians
5520
26096
36132
67748
Total Cost ($)/Yr
61399
238783
248391
548573
Therefore, from this analysis, it can be said that individuals requiring no medication take up $61,399 of the supportive costs, those requiring medium medication consume $238,783 while those requiring high medication consume $248,391 per year. This approach takes into consideration both the three levels of patient care that essentially affect the supportive costs exclusively and the three suite options that affect all other costs including overhead costs. A more elaborate costing approach would have considered resident numbers in apportioning costs such as those of food service and laundry while using the three suit option for recreation, facility and housekeeping and the three levels of patients for supportive costs.
The new cost per patient under each of the options
The new cost under this option will be based on the level of medication required and the suit that a resident occupies. This will result in a combination of costs for the different patients residing in different suits. The Sheet below shows the cost allocation of the supportive costs per resident per year for the three medical classes.
Total Cost ($)/Yr
Residents
Cost Amount ($)/Yr/Resident
No. Meds
61399
55
1116
Medium Meds
238783
65
3674
High Meds
248391
40
6210
Total Cost ($)/Yr
548573
160
11000
The following sheet indicates the cost allocation of all other costs based on the suit size, per suit per year.
Suites
Percentage (%)
Cost Amount ($)/Yr
Cost Amount ($)/Yr/Suite
Studio
26.67
511314
6818
One B/Room
33.33
639142
18261
Two B/Room
40.00
766970
51131
Total Cost
100.00
1917426
The combination of this two costing approaches will give the cost required of every resident per year depending on what suite they reside in and the level of medication required for each resident. The total cost options are thus nine as shown in the excel sheet below.
Other residence costs
Supportive costs
Total cost per client
Studio No. Meds
6818
1116
7934
Studio Medium Meds
6818
3674
10491
Studio High Meds
6818
6210
13027
One B/Room No. Meds
18261
1116
19378
One B/Room Medium Meds
18261
3674
21935
One B/Room High Meds
18261
6210
24471
Two B/Room No. Meds
51131
1116
52248
Two B/Room Medium Meds
51131
3674
54805
Two B/Room High Meds
51131
6210
57341
This information can be summarized in matrix form as shown below. All the figures shown are in dollars. They have been computed per suit and not per individuals living in each suit. In bedroom suites with more than one resident, a premium can be added on the prices below to cater for the extra costs.
No Medication
Medium Medication
High Medication
Studio
7934
10491
13027
One B/Room
19378
21935
24471
Two B/Room
52248
54805
57341
Usefulness of this new information to Roswell
This information is very useful to Roswell as he will now be in a position to easily arrive at a base cost through which he will be able to objectively price the rooms. Roswell only needs to adjust the above information if costs change and to consider the expected inflation in the coming year. Roswell will also be able to differentiate Westmount's products thus increasing the residence's competitiveness.
Prices that Roswell should recommend
Roswell has indicated that he requires a 15% margin over the cost to cover for replacement of assets and growth as well as the shareholders interests. To achieve this, Roswell will just need to add a premium of 15% on the above cost matrix for the various clients. This is illustrated in the excel sheet below:
Total cost per client
15% Margin
Cost Plus 15% Margin
Studio No. Meds
7934
1190
9124
Studio Medium Meds
10491
1574
12065
Studio High Meds
13027
1954
14981
One B/Room No. Meds
19378
2907
22284
One B/Room Medium Meds
21935
3290
25225
One B/Room High Meds
24471
3671
28142
Two B/Room No. Meds
52248
7837
60085
Two B/Room Medium Meds
54805
8221
63026
Two B/Room High Meds
57341
8601
65942
The column cost plus 15% margin represents the new prices. This can be represented in a condensed pricing matrix as shown below.
No Medication
Medium Medication
High Medication
Studio
9124
12065
14981
One B/Room
22284
25225
28142
Two B/Room
60085
63026
65942
