CVP Case - Accounting Assignment

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A. Ronald Kucic

University of Denver

James E. Sorensen

University of Denver

Lisa M. Victoravich

University of Denver

INTRODUCTION

In June of the current year Dr. Thomas Russell, Executive

Director, and Susan Smyth, Accountant, at the Bridgestone

Behavioral Health Center were discussing the necessity

of gaining a better understanding of how to monitor the

Center’s operating and financial performance. Located

in Cleveland, Ohio, Bridgestone provides prevention,

intervention, and treatment services for individuals with

substance abuse problems. Bridgestone’s management is

concerned about its financial performance after realizing

a loss in the prior year although a small profit was

projected. Despite management’s concern and attention

of Bridgestone’s profitability troubles, the Center’s annual

budget once again contains a projection for a meager profit of

$7,000 (see Exhibit 1).

Thomas: According to the financial reports that you have

prepared, we have been fighting to reach breakeven over

the past three years. We have been able to just get past

breakeven recently, but I am worried—it seems like only

a slight variation in our operations could throw us into an

operating loss. I’ve been actively involved in managing the

Center, and I don’t understand how we avoid showing a loss!

Susan: Unfortunately, I have no oversight with respect to

monitoring performance since my job is to input the financial

and units of service numbers into the accounting system

as they occur. I am currently working more than 40 hours a

week so I am not sure what else I could do. Maybe we can

hire someone like a consultant to help us?

Thomas: In reality, securing some outside assistance seems

to be a good option to avoid future losses. Since my training

is in psychology, I don’t have the accounting background to

take the task on myself. We need someone who specializes

in financial management for nonprofit human service

organizations.

BRIDGESTONE BACKGROUND

HISTORY AND MISSION Bridgestone is a comprehensive outpatient substance

abuse treatment center located in the Midwest United

States. Since 1985, Bridgestone has offered a continuum of

outpatient services, including counseling, crisis intervention,

detoxification, and methadone maintenance. The Bridgestone

mission is to be a leader in healing and changing lives

by providing high quality behavioral health care and

rehabilitation to all individuals in need. With this mission, the

Center promises to advance behavioral healthcare through

the creation of innovative services and enriching the lives of

patients one by one.

EXECUTIVE DIRECTOR AND SUPPORTING STAFF Dr. Thomas Russell, Executive Director, has over 30 years

of behavioral health addiction experience and holds a

Masters of Social Work from Ohio University and a Ph.D.

in Clinical Psychology with a specialization on Addiction

Counseling from Northwestern University. He is a fellow

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ISSN 1940-204X

Bridgestone Behavioral Health Center: Cost-Volume-Profit (CVP) Analysis for Planning and Control

of the American College of Addiction Examiners and is a

former faculty member of the Ohio University Department

of Psychology. Dr. Russell is the author of numerous papers

in the field of addictions and presents frequently at major

conferences.

In addition to a highly qualified Executive Director,

Bridgestone has an outstanding support staff. They

consistently maintain a low client-to-staff ratio with highly

trained professionals who are well prepared to support

patients in a large array of circumstances. The staff members

at Bridgestone are like a family and are defined by their

integrity and expertise. They are the key reason for the

Center’s success in terms of the thousands of lives that they

have changed.

PATIENT TESTIMONIALS Patient and family member testimonials include:

“ I wanted to say thank you for helping my daughter!

I know of lots of therapists…in fact I am one.

After 20 years of practice I was very frustrated

sending my daughter to treatment until Bridgestone.

Yes there are therapists…but your folks are

THERAPISTS, with a capital T.”

“ Today is my one year anniversary of sobriety, which

would not have been possible without the help

of the counselors at Bridgestone. I can’t say thank

you enough!”

“ I’m thankful to Bridgestone for the treatment I

received. The road to recovery was not an easy road

back. I still do the same elementary things today

that I had to do to achieve recovery. I realized that

honesty and open-mindedness was a must. I had to

surrender all—I wanted real success.”

BEHAVIORAL HEALTH AND ADDICTION SERVICES Bridgestone offers 10 services designed to treat a large array

of substance dependencies from the point of detoxification

to supporting long-term sobriety and preventing relapses.

Patient Assessment – Patient assessment is performed by

an addiction counselor who uses a number of methods to

determine if an alcohol or drug use problem truly exists. If

such a diagnosis is established, it is necessary to determine

the extent or severity of disease, if there is a need for

medical detoxification, and the services or level of care

required to safely and successfully achieve sobriety.

Lab Urinalysis – Laboratory urinalysis services are performed

for screening and intervention purposes. This is aimed

at helping the patient withstand urges to use drugs. Such

monitoring also can provide early evidence of drug use so

that the individual’s treatment plan can be properly adjusted.

Case Management – Case management serves to monitor

patient progress and compliance with recommended

addiction treatment plans. Reports to outside parties such as

courts, children’s protective services, licensing boards, and

employers are provided as needed.

Group Counseling – Groups are considered the most effective

method of breaking patterns of isolation, which is typical

of clients during their active addiction stage. During group

counseling, clients have the opportunity to examine their

thoughts through sharing, listening, and receiving feedback

from their peers. In a group setting, clients also learn to

develop social skills.

Individual Counseling – Individuals with addictions often

consider their problems unique and, therefore, are best

understood in a one-on-one session with their counselor.

Individual counseling sessions focus on the patient’s

progress in the educational process, group participation, drug

monitoring, compliance, 12–step work, and identification of

areas for improvement to achieve long-term sobriety.

Crisis Intervention – Due to the volatile nature of the disease

of addiction, Bridgestone provides crisis intervention or

emergency counseling for stressful situations that may lead

to relapse or to help patients work through cravings or urges

that could lead to a relapse.

Intensive Outpatient – Outpatient care focuses on education

and counseling in both individual and group settings to

achieve abstinence and to develop a self-responsible plan of

addiction recovery for each patient. The program lasts six to

eight weeks depending on individual progress and involves

three three-hour sessions per week.

Medical Somatic – The service evaluates and monitors

the needs of adults, children, and adolescents exhibiting

symptoms associated with a Diagnostic and Statistical Manual

of Mental Disorders, Fourth Edition, (DSM-IV) diagnosis.

(DSM-V is expected in 2013.) This consists of evaluating a

patient’s need for psychotropic medications associated with

psychotic disorders, severe mood disorders, impulse control

disorders, bi-polar disorders, and other psychiatric conditions

impairing daily functioning.

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Methadone Maintenance – Patients with an opiate addiction

are provided with individualized healthcare and medically

prescribed methadone to relieve withdrawal symptoms,

reduce the opiate craving, and bring about a biochemical

balance in the body.

Ambulatory Detoxification – Ambulatory detoxification (also

known as outpatient detoxification) is designed to safely

detoxify patients from drugs and alcohol without a hospital

admission. Ambulatory detoxification as an outpatient

treatment has the advantage of causing minimal disruption to

a patient’s normal day-to-day life.

MEDICAID FOR BEHAVIORAL HEALTH SERVICES

Ohio is one of the few states that includes behavioral health

services in its Medicaid benefits package, although it is not

required to do so by federal law. States that cover behavioral

health services must clearly define which services are

covered by Medicaid. To facilitate receiving payment for

Medicaid patients, the types of services Bridgestone offers

are consistent with those defined as covered services by the

state of Ohio.

When a Medicaid client receives mental health and/

or alcohol and drug addiction services, the local Alcohol,

Drug Addiction and Mental Health (ADAMH) Board,

Alcohol and Drug Addiction Services (ADAS) Board or the

Community Mental Health (CMH) Board pays the provider.

The Board is then reimbursed for 60% of the cost by the

federal government, which flows to the Boards through

the Ohio Department of Mental Health (ODMH) and the

Ohio Department of Alcohol and Drug Addiction Services

(ODADAS) via an interagency with the Ohio Department

of Job and Family Services (ODJFS). The remaining 40%

Medicaid match comes from both state and local sources.

The Medicaid reimbursement rates for each service

type and the respective level of service expected for the

upcoming year are used in preparing the Center’s annual

budget and quarterly budget as presented in Exhibit 1 and

Exhibit 2, respectively. Since there is modest fluctuation

in the demand for services from quarter to quarter, the

quarterly budget is 25% of the annual budget. Although

Medicaid reimbursement is the primary source of revenue

for Bridgestone, a minimal amount of revenue is generated

from private pay customers.

SERVICE CONSULTING PLUS, LLC

As identified earlier, Bridgestone has experienced significant

financial stress, and the Executive Director, Thomas, was

inquisitive about how to stabilize financial operations above a

break-even level. As well, he would like to gain the ability to

measure and monitor the Center’s continuing performance.

Faced with the lack of internal personnel who could help

with this issue, Thomas contacted Service Consulting Plus,

LLC, a local consulting firm with a reputation for working

with nonprofit organizations. The firm is owned and operated

by Sheryl Marshall, who is also an accounting professor

at Cleveland State University. Her firm specializes in the

management of governmental and nonprofit organizations.

At the end of their initial meeting to discuss the situation at

Bridgestone, Thomas stressed that he didn’t simply want to hire

Sheryl to get the job done for the current year, but rather that

he wanted to learn how to measure and monitor the financial

performance of Bridgestone on an ongoing basis. With this in

mind, Sheryl explained that Cost-Volume-Profit (CVP) analysis

would be useful to Thomas after he gathered some basic

information about costs, revenues, and units of service. She

explained that CVP is a fundamental management accounting

tool that is useful for planning, control, and decision making.

It explores important relationships between costs, volume or

activity levels, and profit.

Sheryl asked Thomas to provide her with Bridgestone’s

annual budgetary income statement in a contribution margin

format. She explained that this format is the basic foundation

for CVP analysis since it presents revenues and expenses

based on their variable or fixed behavior in relation to service

activity (namely, volume of services). Sheryl’s understanding

of Bridgestone’s operating environment and the contribution

margin income statement will enable to provide suggestions

regarding how to increase profitability. The three key

suggestions include a focus on maintaining targeted service

volume, reducing discretionary fixed costs, and offering off-

campus programs to companies and nonprofits.

SERVICE VOLUME Sheryl’s prior experience consulting for health centers that

rely on Medicaid reimbursement for revenue has taught

her the importance of achieving projected levels of service

volume in order to maintain profit targets. Missing the

projected levels of service will cause centers to pass up

potential revenue and contribution margin. Service levels

underscore the importance of monitoring the volume of

delivered service and to ensure that it doesn’t fall behind

the planned volume when Medicaid is involved. Thus, it’s

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not only important to focus on the achieved contribution

margin and bottom line, it’s also important to ensure that the

planned level of volume in achieved.

The importance of meeting the project volume is further

highlighted because Medicaid rates don’t increase and, as a

result, aren’t a means of increasing revenue. Further, annual

Medicaid funding is capped, so attempting to increase

volume over time to increase revenues isn’t possible.

DISCRETIONARY FIXED COSTS Sheryl mentions that another area to focus on to achieve

profit targets is a reduction in discretionary fixed costs. In

order to use this avenue, it’s necessary to understand the

difference between committed fixed costs and discretionary

fixed costs. Every organization has some costs to which it is

committed, for example, costs for facilities, equipment, long-

term debt arrangements, or organizational strategy. Lease

payments, interest payments on long-term debt, property

taxes, and salaries of key personnel may only change if a

major shift in the scope of operations occurs. These costs

are viewed as committed fixed. The lease payments or

interest payments, for example, have to be made in order

for the organization to stay in operation. A failure to pay a

lease payment may result in the loss of an asset or a failure

to pay interest to bondholders may result in the bondholders

taking over the business. Depreciation, while an allocation of

historic costs, usually follows a pattern set at the time of the

asset acquisition.

Discretionary fixed costs, on the other hand, are set

because management has decided to incur these costs to meet

organizational goals. These costs may vary at the discretion

of management. Managers, in the short-run for example,

could vary advertising, travel, employee training, office

supplies, or research and development costs. In dire times,

these costs could be decreased, and in abundant times they

could be increased. Usually the discretionary fixed costs may

be changed to meet short-run cost concerns, but it’s usually

unwise to reduce all discretionary completely or for long

periods of time. Who would want to work for an organization

that reduced its training costs to zero year after year just to

improve the bottom line? While reducing advertising costs in

the short-run might not hurt revenues, what about the long-

run effects on revenues? Perhaps out-of-state travel could

be trimmed in the short-run, but would the failure to attend

national professional meetings out-of-state eventually have an

unfavorable effect on organizational performance?

In the Bridgestone Behavioral Health Center case,

depreciation or rent may be committed while others (such as

salaries and benefits, consulting fees, transportation, office

supplies, and other) may be discretionary. Sheryl encourages

Thomas to identify which fixed costs are discretionary and

which are committed. He then can make a modest reduction

in the discretionary fixed costs to achieve Bridgestone’s profit

objective. This will also give him an idea of how “discretionary”

the identified fixed costs are in reality and whether the level can

be reduced in the long-term or short-term.

OFF-CAMPUS PROGRAMS Other behavioral health centers that Sheryl has consulted

for have increased revenue by offering off-campus programs

to corporations, governmental departments, or other

nonprofit corporations. Possibilities include employee

assistance programs (EAP) to deal with alcohol or other drug

disorders or behavioral health counseling or other kinds of

programs. According to the United States Department of

Health and Human Services, mental illness causes more

days of work loss and work impairment than many other

chronic condition, such as diabetes, asthma, and arthritis.1

Approximately 217 million days of work are lost annually

due to productivity decline related to mental illness and

substance abuse disorders, costing Unites States employers

$17 billion each year.

To provide services such as these, the idea is to use

Bridgestone talent, but at the client’s premises or a location

selected by the client (to ensure anonymity). These

would be companies that could pay for these services.

If the services are used on a regular basis, they could be

a supplemental and steady source of revenue with high

contribution margins. Really large companies may be able to

afford EAP or counseling programs, but smaller ones can’t, so

this type of contract would be attractive to boost employee

benefits at a minimum cost. The cost to these companies

could be a variable one (based on usage) without incurring

the fixed cost of hiring permanent staff to do the counseling.

It could be an advantage to Bridgestone because the Center

is already incurring the fixed salary expense of the counselor.

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1 U.S. Department of Health and Human Services. Mental Health: A Report of the Surgeon General — Executive Summary. Rockville, MD: U.S. Department of Health and Human Services, Substance Abuse and Mental Health Services Administration, Center for Mental Health Services, National Institutes of Health, National Institute of Mental Health; 1999. Available online at: http://www.surgeongeneral. gov/library/mentalhealth/home.html.

Various services that could be offered include:

• Support management in addressing issues of

productivity and absenteeism that may be caused by

mental health or substance abuse problems.

• Support effective supervisory practices

• Assist employees with deteriorating performance

relating to behavioral or other health problems

• Address work-related issues influencing disability or

return to work

• Assist in the identification of stress-related problems

that may be a result of work organization

• Assist the organization in its response to drug-free

workplace policies and regulations and disaster and

terrorism preparedness as it relates to psychosocial issues

• Serve as an internal consultant to management

regarding issues of employee behavioral health.

REQUIREMENT

In business memo format addressed to Dr. Thomas Russell,

Executive Director of Bridgestone Behavioral Health Center,

describe why the Center is appearing to barely break even

and what might cause decreases in financial performance.

What recommendations would you offer to Dr. Russell for

improving the current operation of the Center and how he

can effectively monitor the Center’s future performance?

Included in your memo should be a discussion about the

following points:

ISSUES FOR DISCUSSION

1. What is the weighted average contribution margin (WACM)

percentage for Bridgestone’s next annual budget?

2. What does a high weighted average contribution margin

(WACM) percentage mean for the management of

Bridgestone?

3. Is Bridgestone able to plan for breakeven or a modest

over-recovery of expenses (or profit) for the next year? If

the Center achieves breakeven or a modest over-recovery

and you are concerned about events that could cause a

potential loss, what would you try to change? (You may

consider both on- and off-campus programs.)

4. A useful component of CVP analysis is the margin of

safety for service revenue that can be calculated as a dollar

amount ($) or as a percentage (%). What is Bridgestone’s

project margin of safety for next year? Interpret your

answer in terms of what it means to Dr. Russell.

5. Fixed costs can be discretionary or committed. Using

your judgment based on the discussion in the case,

identify which costs are likely to be discretionary.

Assuming that management is able to decrease

discretionary fixed costs by 10%, what would be the

impact on Bridgestone’s break-even point revenues?

6. As Bridgestone operates during the next year, do some

services deserve more attention than others? (Hint: What

is their relative contribution to the WACM % and to the

total contribution margin? Which services?)

7. How can the budgetary weighted average contribution

margin (WACM) percentage be used to help control the

actual operations of Bridgestone?

8. If a budgetary weighted average contribution margin

(WACM) percentage has been developed with an

expected level of revenue and a planned fixed cost and the

budgetary WACM percentage is in fact achieved in the

next (future) time period, could the organization still face

losses if the total revenue drops below the budgeted level

or total fixed costs increase beyond the budgeted levels?

Can you explain how losses still might occur even though

the planned WACM percentage is being realized in the

future time period?

9. Can you demonstrate with numeric examples how

financial losses might occur? Describe the effects of the

following three possible scenarios:

a. What is the financial impact if Bridgestone’s group

counseling unit of service volume decreases by 10%

during the first quarter?

b. What is the financial impact if Bridgestone’s

reimbursement rate for group counseling service

decreases by 10% during the first quarter?

c. What would be the financial impact, if any, if the total

quarterly revenue remains the same but the quarterly

Medicaid Revenue for Case Management decreases

by $48,000 (600 units of service at $80 per unit) while

quarterly Medicaid Revenue for Group Counseling

increases by $48,000 (1,600 units of service at $30

per unit)? Note the change in volume changes total

revenues, total variable costs, and contribution margin.

Assume the unit price of Private Pay services in Group

Counseling is the same as for Medicaid Services ($30

per unit of service).

d. What is the financial impact if Bridgestone’s fixed costs

increase by 1% during the first quarter?

I M A E D U C AT I O N A L C A S E J O U R N A L V O L . 3 , N O . 4 , A R T. 1 , D E C E M B E R 2 0 1 07

10. What are your overall recommendations for Bridgestone’s

management regarding the use of CVP analysis?

11. As accountants, it is common to focus on quantitative

tools such as CVP analysis to increase the profitability of

a business. But it is important for accountants to think

outside of the box to identify avenues of increasing

profitability. What suggestions could you provide to assist

Bridgestone in increasing profitability?

I M A E D U C AT I O N A L C A S E J O U R N A L V O L . 3 , N O . 4 , A R T. 1 , D E C E M B E R 2 0 1 08

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