On a plain piece of paper answer the following case according tospecifications. Twenty-five points will be awarded for correctanalysis of the case:

Washington County Hospital is located in a well-known summerresort area. The county populations doubles during the summermonths, and hospital activity increases correspondingly. A newadministrator has decided to implement a responsible budgetingsystem. The system was announced when the quarterly costreport was presented to departmental heads. Previously, costdata were infrequently supplied to department heads. Excerptsof the announcement of the new program follow:

The new administrator has adopted a responsibility budgetingsystem. From now on you will receive quarterly reportscomparing actual with budgeted costs for your department. Thereports will highlight the variances so that you can zero in ondepartures from budget. Responsible budgeting means that youare accountable for keeping you department's costs withinbudget. Variations from budget will help you identify whichcosts are out of line, and the size of the variance will indicaterelative importance of the deviations.

The new administrator constructed the annual budget for 2007 andset quarterly budgets at one-fourth the annual budget. The newadministrator compiled the budget by analyzing costs for the pastthree years with a dramatic increase this past year. Theanalysis showed that all costs increased each year. Theadministrator considered setting the budget at the average amountfor the past three years, hoping that the new system would helpreduce costs. He finally decided, however, to set the budgetat 3% below last year's annual costs.

Required:

(a) Comment on the method used to set the budget.

(b) What do budget variances mean? Is the administrator interpreting this information correctly? Explain.

(c) Explain specifically whatmistakes the administrator made and what corrective action would you advise him to do as the newbudgeting expert employee in this organization.