Westmount Retirement Residence - Case Study Example

THE WESTMOUNT RETIREMENT RESIDENCE CASE TABLE OF CONTENTS EXECUTIVE SUMMARY 3 2. MAIN REPORT 4 2 Evaluation of the strengths and limitations of the current costing model at Westmount Retirement Residence 4 2.2 Westmount’s poor results in 2005 5 2.3. New Costing System for Westmount 7 2.4 The new costing information 10 3. REFERENCES 12 1. EXECUTIVE SUMMARY The existing costing and pricing system of Westmount Retirement Residence has many limitations. It treats all costs (including variable costs) as period costs and allocates them evenly on the expected number of residents. The costing system makes differentiation only on the basis of the size of accommodation. It does not make any differentiation based on the required level of medical needs of the residents. The only strength of the pricing system lies in its simplicity. Westmount Retirement Residence’s required net profit margin is 15%. In the year 2005, its net profit margin was only 2.267%. This happened because it seems that the actual number of residents were much less than the expected number of residents. Westmount’s current prices are considerably less than the prices charged by its competitors. The new costing system is based on the three suite options and on the three levels of medical needs of the residents. The costs of supportive services have been allocated based on the level of medical needs of the residents. Half the costs of facilities have been allocated based on square feet area of the three different suite options. The pricing recommendations, based on the new costing system have been made to Helen Rosewell in the final section of the main report. The recommended pricing is based on the new costing system. It is also recommended that spouses living in one bedroom should be charged twice the monthly rates. 2. MAIN REPORT 2.1 Evaluation of the strengths and limitations of the current costing model at Westmount Retirement Residence The biggest limitation of the current costing model at Westmount is that it does not give a clear picture of how much each of the services that are being offered at Westmount cost. The pricing system charges the same price per month from the residents irrespective of the services used by them. This pricing is only based on the type of residence being used by the residents. The costing model does not reflect the level of medical care and service required by the individual clients. The price differentiation is based solely on the size of the accommodations. The model is also is based on the implicit assumption that a resident having a 25% larger accommodation is also using 25% more services of Westmount. The costing system does not show any difference between patients requiring different levels of medical needs. There are usually three categories of residents at Westmount: those requiring no medical need, those requiring medium medical need and those requiring high medical needs. The biggest drawback of this costing system is that it is treating all the costs as fixed or period costs. The costing system is unable to differentiate between fixed costs and variable costs. All the costs are treated as periodic costs and they are charged to the expected number of residents. If the actual number of resident that turn out is less than the expected number of residents, then this costing policy will have a negative impact on the profitability of Westmount. The costing policy of Westmount also does not take into account scenario analysis (Michael R. et al, 2008). The costing policy makes the allocations of the different costs on one forecast (in this case it was made on the basis of one expectation i.e. of 160 customers.) A better costing strategy will be to take into account the different possible scenarios (optimistic, most likely and pessimistic ). For instance it can forecast that based on optimistic scenario 180 residents are expected to come. Based on most likely 160 residents are expected to come. And based on pessimistic scenario, 140 residents are expected to come. Costing based on such a scenario will be much more effective The only strength of this costing policy is that it is a very simple model. It is not complicated. If the actual number of residents match the expected number of residents then this costing policy will succeed in generating the required rate of return for the shareholders of Westmount ( 15% net profit margin). 2.2 Westmount’s poor results in 2005 The revenue from residents in 2005 was $2,455,569. If all the rooms had been occupied for the whole year, then the revenues for Westmount in the year 2005 would have been: Cost per studio room apartment 15412.49 Add inflation 0.05 Cost after adjusting for inflation 16183.11 Profit margin 0.15 Fee per studio apartment 19038.96 Cost per one bedroom unit 20228.89 Profit margin 0.15 Fee per bed-room unit 23798.7 Cost per two bedroom unit 24274.67 Profit margin 0.15 Fee to be charged from the residents 28558.44 Number of units of studio apartments 75 Number of units of one bedroom units 35 Number of units of two bedroom units 15 Weighted average fee to be charged per resident 21514.02 Expected number of residents in 2005 160 Expected revenues in 2005 3442244 Actual revenues realised in 2005 from residents 2455569 Actual number of residents that turned up in 2005 114.1381 Actual number of residents that turned out in 2005 has been calculated as: Actual revenues realized from residents in 2005 / Weighted average fee charged from each resident. This is equal to: 2455569/ 21514.02 = 114.1381 The weighted average fee to be charged per resident has been calculated as: ( Fee to be charged for one studio apartment* Number of studio apartments + Fee to be charged for one bedroom units* Number of one bed room units+ Fee to be charged for two bedroom units * number of two bedroom units )/ Total number of units ( 125). Therefore one of the main reasons behind the poor economic performance of Westmount during the year 2005 was that the actual number of residents that turned up was 114. This was much less than the projected or expected number of residents which was 160. This could have been avoided if Westmount had done its costing based on scenario analysis ( pessimistic, optimistic and most likely) (Leslie Chadwick, 2000 ) . In the pessimistic scenario, the fee per resident should have been different from the fee charged per resident in the optimistic or most likely scenario. As we can see , in 2005, number of residents who turned up were much less than the expected number of residents. This was a kind of pessimistic scenario for Westmount. In such a scenario Westmount should have charged a higher fee from the residents than the one it actually charged from them ( which were based on the excepted scenario of 160 residents) The net profit of Westmount during the year 2005 was $57,446. Net profit margin of Westmount during the year 2005 Net profits 57446 Revenues (including non-resident revenues 2523445 Net profit margin of Westmount in the year 2005 0.022765 The net profit margin of Westmount during the year 2005 was only 2.267%. The required net profit margin of the shareholders of Westmount is 15%. Supposing that the expected number of residents, 160, had turned up during the year 2005, below is what would have been achieved: Net profit margin if 160 residents had turned up at Westmount during 2005 Revenues realised 3442244 Other revenues 67876 Total costs 2465999 Total revenues 3510120 Net profits 1044121 Net profit margin 0.303326 Thus if 160 residents had turned up in 2005, the actual net profit margin would have been 30%. The poor results of Westmount can therefore be explained by its flawed costing system. This costing system treats even its variable costs as fixed costs. It then spreads those costs over the expected number of residents to assess the fee to be charged from the residents. When the actual numbers of residents that turn up are less than the expected number of residents, then the above basis of allocation proves to be flawed thereby resulting in loss making. This flawed costing is also responsible for the very low costs that Westmount is charging with respect to its competitors. For a 250 square feet studio apartment, the monthly rent at Chelsea park retirement is $2100. This does not include the cost of intense medical needs of patients. Patients with intense medical needs could purchase nursing and medical equipment at an additional cost. For one bedroom unit (500 square feet), the monthly charge of Chelsea Park is $ 2960. For two bedroom units, the monthly charge of Chelsea Park is $3228. Another of its competitors, Central Park Lodge, charges a monthly rate of $2395 for 300 square feet studio apartments. For 400 square feet one bed room units, it charges $4070 per month. For extra medical care, Central Park Lodge charges $3200 extra. Longworth Retirement Residence charge $2700 per month for a 330 square feet studio apartment. It charges $3335 monthly for a one bedroom unit of size 525 square feet. For seniors who prefer more independent living, a la carte purchase option is available for amenities. Comparing the rates charged by the competitors with those charged by Westmount in the year 2005: For a 400 square feet studio apartment Westmount charged monthly fee of $1586.58 only. For 500 square feet one bedroom unit Westmount charged a monthly fee of only $1983.225. For 600 square feet two bedroom units, Westmount charged a monthly fee of only $2379.87. This clearly shows that due to Westmount‘s flawed costing model, the company was running at a loss. In the retirement industry, pricing has emerged as a means of distinguishing between residence options. In spite of this, the rates charged by Westmount are much less than its competitors. There is scope for improving financial performance by charging higher prices based on services offered to the residents of Westmount. 2.3. New Costing System for Westmount The three suite options at Westmount are: i) Studio suites ii) One bedroom suites iii) Two bedroom suites. The three levels of required patient care are: i) No medical needs. ii) Medium medical needs. iii) High medical needs.   Cost of facilities 206183 50% of these to be allocated to all the residents. Let the expected number of residents be 160 50% of cost of facilities 103091.5 This will be allocated on per head basis 644.3219 Remaining 50% of the cost of facilities will be charged on a per square feet basis Total number of studio units 75 Total number of one bedroom units 35 Total number of two bedroom units 15 Size of studio unit in square feet 400 Size of one bedroom unit 500 Size of two bedroom unit 600 Total number of square feet available for accommodation at Westmount 56500 Facilities to be charged at per square feet rate 1.824628 Hours of nursing supervision per week per resident on no medical needs 13.75 Hours of nursing supervision per week per resident on medium medical needs 97.5 Hours of nursing supervision per week per resident on high medical care 100 Wages of nursing supervisors per hour 18.5 Total support staff 17 Annual supplies used by the support staff 10181 Supplies per unit of support staff 598.8824 Supplies per nurse per week 12.47672 Total wages of the nursing supervisors annually 18.50*47*48*5= 208,680 Add cost of annual supplies attributed to the nursing staff 598.8824*5= 2994.412 Total annual wages of the personal care nursing attendants 10*11*50*48=264000 Total annual wages of the dieticians 65712 Total wages of the support staff 538392 Total overhead costs 951167 Total square feet used by the six departments 115900 Per square feet of overhead costs 8.20679 Square feet used by the support staff 10200 Amount of overheads to be allocated to the support services 83709.26 Overhead per unit of support staff 4924.074 Total overhead to be attributed to nursing supervisors 24620.37 Total annual cost of the nursing staff 233899.3 Share of those on no medical care of the total nursing costs 15224.21 Annual nursing cost per resident on no medical care 276.8039 Share of those on medium medical care of the total nursing costs 107953.5 Annual nursing cost per resident on medium medical care 1660.823 Share of those on high medical care 110721.5 Annual cost per unit of high nursing care 2768.039 Total hours of dietician required for persons on no medical care 5.5 Total hours of dietician required for persons on medium medical care 26 Total hours of dietician required for persons on high medical care per week 36 Total annual costs attributed to dietician 76757.91 Total annual overhead attributed to those on no medical care 6254.348 Allocation to those on medium medical care 29566.01 Allocation to those on high medical care 40937.55 Per unit cost 113.7154 Per unit cost for medium medical care 454.8617 per resident cost on those with high medical care 1023.439 Hours of personal attendant care on those with no medical care per week 71.5 Hours of personal attendant care on those with medium medical care per week 195 Hours of attendants on those with high medical care per week 190 Total annual costs attributed to attendants 319229.6 Allocation to those on no medical care 49999.81 Allocation to those on medium medical care 136363.1 Allocation to those on high medical care 132866.6 Per resident costs of those having no medical needs 909.0875 Per resident costs of those on medium medical care 2097.894 Per resident costs of those on high medical care 3321.666 According to the new costing policy the costs for those on no medical care will be: Studio apartment 12845.87 One bedroom unit 15732.43 Ttwo bedroom unit 18619 According to the new costing policy the costs for those on medium medical care will be: studio units 15029.99 one bedroom units 16668.51 two bedroom unit 20438.19 According to the new costing policy, the costs for those on high medical care should be: Studio unit 18659.4 One bedroom unit 21545.97 Two bedroom unit 24432.53 Based on the above new costing system, the costs of support services have been allocated putting into consideration the level of medical needs of the residents ranging from no medical care/ needs, medium and high medical needs. Half the costs of facilities have been allocated based on square feet area of the residential units. The other half facility costs have been allocated equally to the expected number of residents. The remaining costs (e.g. food, laundry etc.) have been allocated equally over the expected number of residents. 2.4 The new costing information The new costing information will be very useful for Helen Rosewell when it comes to pricing. Helen Rosewell should add a 15% price margin and inflation rate of 5% in order to get the prices for the different suites and medical care options. Based on the new costs, the new prices will be: a) For no medical needs: Studio units: (12845.87*1.05)/ .85 = 15868.42765 One bedroom units: (15732.4*1.05)/ .85= 19434.14 Two bedroom units: (18619*1.05)/ .85= 22999.94 b) For those on medium medical needs: Studio units: (15029.99*1.05)/ .85= 18566.45824 One bedroom units: (16668.51*1.05)/ .85= 20590.51. Two bedroom units: (20438.19*1.05)/ .85=25247.17588 c) For those on high medical needs: Studio units: (18659.4*1.05)/ .85= 23049.84706 One bedroom units: (21545.97*1.05)/ .85= 26615.61 Two bedroom units: (24432.53*1.05)/ .85= 30181.36059 The new costing and pricing information shows that the costs are directly proportional to the level of medical care required by the residents. Residents who require high medical care are costlier to serve and therefore should be priced accordingly. It is also recommended that spouses living in one bed-room should be charged twice the monthly price. This is because they probably consume twice the amount of every service like food , laundry etc. I would also like to recommend that Westmount needs to make many more changes to its costing system. It should clearly distinguish between fixed costs and variable costs. The fixed costs are period costs and they are independent of the number of residents who come during the period ( say a year) (E.J.Mclaney, Peter Atrill, 2010). But the variable costs vary directly with the number of residents who attend Westmount in a period. More the number of residents more will be the variable costs. A clear identification of variable costs will help the management of Westmount and Helen Rosewell in cost controlling. One example of variable costs in that of supplies in food. A tighter control on variable costs will enhance the profitability of Westmount and will improve its financial performance. 3. REFERENCES 1. E.J.Mclaney, Peter Atrill, 2010, Accounting: An Introduction: 5th Edition, Prentice Hall. 2. Leslie Chadwick, 2000, Management Accounting, Routledge. 3. Michael R. et al, 2008, Cost Accounting, Thompson. Read More