The Rotorua Hospital Laundry

The Rotorua Hospital Laundry

Report to the hospital management committee on possible improvements to the current budgetary control procedures.

Executive Summary:

The current approach does not reflect the fluctuating costs for the Rotorua Hospital Laundry because of fluctuating demand during the year. It results in the following flaws:

- Resources not allocated efficiently because the current approach does not take into account the doubling in activity during January, February and March

- 16% is added onto the previous year's figures as an incremental figure. However is the 16% reliable?

- Are the previous figures reliable? The current budget is based upon previous figures, if these are incorrect then the current budget will be unreliable.

- Is the $250 unbudgeted bonus justified? Why did the manager get this bonus?

- The current budget was prepared by a recently recruited assistant.

- The basis of which overheads are apportioned for occupancy and administration are unknown. This shows the nature of the budget and the nature of costs are unknown.

Using a flexed budget approach the following figures are obtained as a basis for a budget:

FLEXED ($)

WEIGHT PROCESSED (KG) 240,000

WAGES 10,300

OVERTIME PREMIUM 1,867

DETERGENTS AND OTHER SUPPLIES 2,400

WATER, WATER SOFTENING AND HEATING 2,500

MAINTENANCE 1,333

DEPRECIATION OF PLANT 2,000

MANAGER'S SALARY 1,250

OVERHEAD 9,000

The Rotorua Hospital Laundry should adopt participative budgeting, this would mean budgeted estimates are more accurate and reliable, and also acknowledges and utilises the knowledge of Rotorua Hospital Laundry's front line managers. Zero-based budgeting could also be implemented preventing budgets creeping up each year with inflation and other factors. Or activity-based budgeting could be implemented where the focus is on the budgeted costs of the activities to produce goods and services. This implies that the nature of costs is needed.

Main Findings

Current Approach

The current budgeting system is based on incremental budgeting. Incremental budgeting is a system that prepares budgets using the previous period's budget or actual performance as basis for the next period's budget. Incremental amounts are added to the previous period's budget for the new budget, the allocation of resources is based upon allocations from the previous period. This approach is not recommended as it fails to take into account changing circumstances, it also encourages "spending up to the budget" to ensure a reasonable allocation in the next period.

The current approach to the preparation of quarterly budgets leads to the following errors and flaws:

- The current budget for the hospital's laundry department is broken down into four quarters by dividing the annual budgeted figures by four. This leads to resources not allocated efficiently because it does not take into account the doubling in activity during January, February and March as it assumes equal demand and costs during the four quarters.

- Thu current budget uses incremental budgeting and was established by adding 16% onto the previous year's figures as an incremental figure. However this leads to errors, where did this 16% come from? Is it reliable? Costs increasing by 16% logically do not make sense even if inflation and other factors are considered.

- Are the previous figures reliable? The current budget is based upon previous figures; if the previous figures are incorrect this error is brought forward into the current budget. With incremental budgeting if the 16% is used each year and is incorrect then the error is continued throughout the budget resulting in unreliable figures.

- Another problem with the current approach is the $250 bonus that the manager received. This bonus was unbudgeted. Therefore is it justified? Why did the manager get this bonus?

- The current budget was prepared by a recently recruited assistant in the hospital's administration office. Does this assistant know anything about the laundry systems? And did he leave his office and go to the Hospital to see where costs are spent and needed etc.

- The basis of which overheads are apportioned for occupancy and administration are unknown. This shows the nature of the budget and the nature of costs are unknown.

Flexed Budget for the quarter ended 31st March

ORIGINAL ($) FLEXED

($) ACTUAL

($) VARIANCE ($)

WEIGHT PROCESSED (KG) 180,000 240,000 240,000 -

WAGES 8,800 10,300 12,320 2,020

OVERTIME PREMIUM 1,400 1,867 2,100 233

DETERGENTS AND OTHER SUPPLIES 1,800 2,400 2,700 300

WATER,