The Universal Health System (UHS) provides the entire healthcare service to residents in Illopia. The UHS is funded centrally through revenues from taxpayers. However, the government is not involved in the day-to-day running of the UHS, which is largely managed regionally by a number of self-governing trusts, such as the Sickham UHS Trust.
The Sickham UHS Trust runs one hospital in Sickham and, like other trusts in Illopia, receives 70% of its income largely from the UHS’ ‘payments by results’ scheme, which was established two years ago. Under this scheme, the trust receives a pre-set tariff (fee income) for each service it provides. If the Trust manages to provide any of its services at a lower cost than the pre-set tariff, it is allowed to use the surplus as it wishes. Similarly, it has to bear the cost of any deficits itself. Currently, the Trust knows that a number of its services simply cannot be provided at the tariff paid and accepts that these always lead to a deficit. Similarly, other services always seem to create a surplus. This is partly because different trusts define their services and account for overheads differently. Also, it is partly due to regional differences in costs, which are not taken into account by the scheme, which operates on the basis that ‘one tariff fits all’.
The remaining 30% of the Trust’s income comes from transplant and heart operations. Since these are not covered by the scheme, the payment the Trust receives is based on the actual costs it incurs in providing the operations. However, the Trust is not allowed to exceed the total budget provided for these operations in any one year.
Over recent years, the Trust’s board of directors has become increasingly dissatisfied with the financial performance of the Trust and has blamed it on poor costing systems, leading to an inability to control costs. As a result, the finance director and his second in command – the financial controller – have now been replaced. The board of directors has taken this decision after complaining that ‘the Trust simply cannot sustain the big deficit between income and spending’. The new financial controller comes from a manufacturing background and is a great advocate of target costing, believing that the introduction of a target costing system at the Sickham UHS Trust is the answer to all of its problems. The new financial director is unconvinced, believing target costing to be only really suitable in manufacturing companies.
Required:
(a) Explain the main steps involved in developing a target price and target cost for a product in a typical manufacturing company. (6 marks)
(b) Explain four key characteristics that distinguish services from manufacturing. (4 marks)
(c) Describe how the Sickham UHS Trust is likely, in the current circumstances, to try to derive: (i) a target cost for the services that it provides under the ‘payment by results’ scheme; and (2 marks) (ii) a target cost for transplants and heart operations. (2 marks)
(d) Discuss THREE of the particular difficulties that the Sickham UHS Trust may find in using target costing in its service provision. (6 marks)