Several years ago, Methodist Hospital initiated its substance abuse program, which focused on counseling current and potential substance abusers. The program was funded by a grant from the state department of health that paid $76 per visit for counseling. Pat Leizinger, CFO of Methodist Hospital, was concerned about the substance abuse program. It had never broken even and, thus, was subsidized by the other patients in the hospital. Mr. Leizinger was preparing the hospital’s budget for 20X8, and he did not like the substance abuse program’s financial situation. The results for 20X7 are shown below:

Revenues ($76 per visit; 17,000 visits) … $1,292,000

Cost of services:

Supplies …………………………………. $ 114,750

Physician salaries …………………………. 204,000

Nurse salaries …………………………….. 153,000

Overhead …………………………………. 676,200

Total direct cost of services ……………. 1,147,950

General and administrative expenses ……. 194,250

Total expenses …………………………. 1,342,200

Net loss …………………………………. $ (50,200)

A recent cost analysis had determined the following facts about the behavior of costs in the substance abuse program:

a. Supplies and physician and nurse salaries were totally variable with respect to number of visits within the range of 15,000–30,000.

b. Variable overhead was equal to 20% of labor costs in 20X7; the remainder of the overhead was fixed.

c. $181,500 of the general and administrative cost was fixed; the remainder varied with number of visits.

d. Costs in 20X8 are expected to behave the same as those in 20X7, except that variable-overhead costs will be 21% of labor costs in 20X8 compared to only 20% of labor costs in 20X7. (Fixed overhead costs will remain the same in 20X8 as in 20X7.)

Leizinger had been pressuring the director of the substance abuse program, Jody Lee, for the last couple of years to try to get her costs under control. Ms. Lee responded that it was a very important program for the community. Besides, the program was so close to breaking even that all it needed was a little more time and the results would be better. She predicted 18,000 visits in 20X8, an increase of nearly 6%, which would certainly make the financial picture brighter.

Leizinger agreed on the importance of the program, but he also said that pressures were building from others in Methodist Hospital to eliminate programs that were a drain on the hospital’s resources. Thus, he believed that if the substance abuse program was not at least at a break-even point in 20X8, the program would be in jeopardy. He doesn’t believe that even the increase of 1,000 visits would be enough to break even.

1. Compute the cost function for the substance abuse program for use in budgeting for 20X8. That is, compute the variable cost per visit and the total annual fixed cost based on the cost analysis that Leizinger conducted.

2. Compute the budgeted profit (loss) for 20X8, assuming that there will be 18,000 visits at $76 each and the costs behave as expected.

3. Suppose that Methodist Hospital accepted the budget for the substance abuse program that you computed in number 2. At the end of 20X8, the actual loss for the program was $15,500 and the actual number of visits was 18,400. Explain the difference between the amount of loss you budgeted in number 2 and the actual loss of $15,500 in as much detail as you can, given the information you have. Based on this, give a one-sentence answer to each of the following questions:

a. What was the financial impact of the extra 400 visits?

b. How well did the substance abuse program control its costs in 20X8?