International Research Journal of Applied Finance ISSN 2229 – 6891

January, 2012 Case Study Series

Mercy Hospital: A Case Analysis

Mark McCartney
Saginaw Valley State University
319 Curtiss Hall, 7400 Bay Road
University Center, Michigan 48710, USA
mwmccar@svsu.edu

Ronald Marden
Appalachian State University

Lawrence Kickham
Saginaw Valley State University

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Prof. Mark McCartney, Saginaw Valley State University, mwmccar@svsu.edu

Case ID. 030101
International Research Journal of Applied Finance ISSN 2229 – 6891
January, 2012 Case Study Series
Abstract
This is a case study which describes an account (names, other facts changed to preserve
anonymity) in which an internal auditor in a hospital setting, due to personal biases and a lack
of objectivity, performed a substandard audit of a capital asset acquisition and violated
several standards of the International Standards for the Professional Practice of Internal
Auditing as well as the Institute of Internal Auditors (IIA) Code of Ethics. Students use the
Standards and Code of Ethics to form conclusions regarding shortcomings of this audit. The
International IIA Standards and Code of Ethics are online and easily read, with the Standards
being twenty one pages in length and the Code of Ethics being two pages. The case is
designed to be taught in one class period. Students are exposed to actual standards and
required to employ the standards in their analysis of the case.

Case Description
This is a case study involving internal auditing in a hospital setting. It describes an account
(names, other facts changed to preserve anonymity) in which an internal auditor, due to
personal biases and a lack of objectivity, performed a substandard audit of a capital asset
acquisition and violated several standards of the International Standards for the Professional
Practice of Internal Auditing as well as the Institute of Internal Auditors (IIA) Code of Ethics.
Students make use of the International Standards and Code of Ethics to form conclusions
regarding shortcomings of this audit. It is designed to be taught in one class period, with
students taking time outside of the classroom to read the Standards and Code of Ethics as a
basis for analyzing the information presented. The most recent version of the International
Standards for the Professional Practice of Internal Auditing (The Institute of Internal
Auditors, 2010) as well as the most recent version of the IIA Code of Ethics (The Institute of
Internal Auditors, 2009) are easily read in one evening, with the Standards being twenty one
pages in length and the most recent Code of Ethics being two pages. Students are exposed to
actual standards and required to employ the standards their analysis of the case.

Mercy Hospital - Background

Mercy Hospital is a leading health-care provider and one of the oldest hospitals in the region.
The 300-bed, acute-care facility is known for its quality of care and respected for their
expertise and innovation in the delivery of health care. As a leader in cardiac, trauma,
surgical, orthopedic, neurologic, vascular and cancer care, Mercy Hospital offers patients the
latest treatments by providing its medical staff, comprising more than 600 physicians, with
the most advanced technology available. Mercy Hospital is one of eight individual hospitals
comprising a hospital network located across seven states ranging from Pennsylvania to
Mississippi. The eight hospitals have a network headquarters which provides many of the
financial functions including internal audit services. Collectively, the hospitals are members
of the Mercy Health Network. Management at each hospital is decentralized except all of the
hospitals participate in a consortium to purchase medical supplies for a more competitive
price than otherwise would be available.

64-Slice CT Scanner
The 64-Slice CT Scanner is a new imaging medical device that helps physicians diagnose and
treat a variety of medical conditions by providing a more anatomically detailed image of the
patient’s organs. Older CT scanners have been used for years to study internal organs, bones,
soft tissue and blood vessels. They are particularly useful in trauma situations to identify
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injuries to the heart and vessels, liver, kidneys or other internal organs. The scanner is also
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used to plan for surgery and monitor the treatment of tumors for cancer patients.

Prof. Mark McCartney, Saginaw Valley State University, mwmccar@svsu.edu

Case ID. 030101
International Research Journal of Applied Finance ISSN 2229 – 6891
January, 2012 Case Study Series
Heart related maladies are all too common. The United States Center for Health and Human
Services reported that in the USA for the years 2007-2008, over 5 million people arrived in
emergency rooms complaining of chest pain (United States National Center for Health
Statistics, 2010, p. 2). The new 64-Slice CT Scanner is judged to be faster and more reliable
for diagnosing chest pain. It can evaluate a heart patient by capturing thousands of images of
the heart in less than 5 seconds or capture images of the whole body in less than 30 seconds.
The cost of these machines is generally expected to range from $1.5 to $2 million.
Bidding on the 64-Slice CT Scanner can be a very competitive and costly commitment by
vendors. They insist that Board approval be granted for the machine before final bids are
submitted. The list price and other costs associated with the CT scanner are shown in Table 1.
Table 1 Here

The Audit Process

Mercy Hospital’s capital-asset procurement process for any single acquisition over $100,000
is to have a formal proposal submitted to the board of directors (BOD) who vote on its
approval. If the proposal is approved, the funds are transferred to the respective hospital for
eventual disbursement. The internal auditors are charged with following up within one year
of acquisition to check the propriety of the purchase and disbursal of funds. Recently, a
proposal for a new CT Scanner was submitted by Mercy Hospital’s controller. The other
hospitals were told to "wait and see" until the internal auditors could inspect the
documentation of the acquisition and the operating effectiveness and efficiency of the new
process before being allowed to submit their own proposals. Mercy’s proposal was the one of
the larger proposals submitted over the past several years at a total of $1.625 million dollars
plus approximately $25,000 for the labor and other necessary expenditures to remove the old
equipment to permit the installation of the new scanner. The cost of the new scanner by itself
was listed in the proposal at $1.3 million.
The internal auditor assigned to the acquisition was Jack Jones. Jack had been with the
network for over three years performing mostly operational audits (on existing processes),
reviewing internal controls, payroll and travel expenses. Jack believed that the procedures
associated with this capital-asset audit would be simple and routine.
This was not Jack's first visit to Mercy Hospital. In fact, Jack had performed an audit on the
hospital’s payroll and travel expenditures only a year ago. Jack's recollection of the
experience was not a pleasant one. He had several "confrontations" with the controller,
mostly as a result of clashing personalities. While all the expense issues were easily resolved,
Jack felt there was still an adversarial relationship between them and he was “on guard” for
any “preemptive strikes” this time around.
It was a long drive to Mercy Hospital so when Jack arrived a little late the day of his audit he
was greeted by the controller with a perceived air of indifference and promptly led to a
secluded and windowless office room. The controller calmly explained that he was extremely
busy and would answer any questions at the end of the day. Jack merely nodded his head and
sat down in front of several tall piles of invoices that the controller had furnished and
represented the documentation supporting the purchase, set up, and testing of this new
technology. Jack was somewhat surprised, fully expecting to see only a handful of invoices,
but did not ask for any explanations. As Jack began looking through the myriad of statements
and canceled checks he soon found one particular invoice near the top of the first pile which
indicated that the actual price paid for just the machine itself was only $902,000!
Jack's first reaction was to call the director of auditing. When he found that the director was
out for the day and could not be reached, he decided to call the VP of Operations at corporate
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headquarters. Jack was critical of the controller in describing the seriousness of his suspicions
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based on this preliminary information. Jack didn't realize that there was a scheduled BOD's

Prof. Mark McCartney, Saginaw Valley State University, mwmccar@svsu.edu

Case ID. 030101
International Research Journal of Applied Finance ISSN 2229 – 6891
January, 2012 Case Study Series
meeting that day and that the news would be passed on to the Board. The Board members
were outraged over the alleged misuse of the funds and possible fraud.
Jack was unaware that the controller was soon being lambasted by the chair of the BODs in a
private conference call. Seconds after the call, the controller walked up to Jack and had only
two words to say—“Get out." Jack was flabbergasted; he called back to Network’s Home
Office only to receive a rather icy response from the Chair of the BOD's secretary suggesting
that he return immediately. As Jack got into his car and drove back to the home office he
wondered what he had done so wrong.

Postscript
Three days later Jack was called in to the director of internal audit's office. The director told
the story of how he personally visited Mercy Hospital the next day after Jack's visit and
performed the capital-asset audit himself. The director found that there were a number of
reasonable explanations for the differences in the original proposal and the actual
expenditure. To begin with, the companies who sold the machine would not talk about
discounting the price until they knew that the funds were available. Once the proposal was
approved and the funds were authorized for disbursement, only then did the competing
vendors begin slashing their prices because of competition for the sale. This is what drove the
cost of the machine down from $1,300,000 to $902,000. Other accessories and services
provided by the vendor reduced the initial list price even further by some $57,000. Training
and warranty costs were not subject to discounting. However, there were several factors that
mitigated some of these savings.
A more accurate summary of the sale price was provided without the renovation and
additional hospital personnel costs, and other outside consultants that proved necessary to
fully comply with all safety and documentation requirements is shown in Table 2.
Table 2 Here
It would take close to a month before the new machine became operational because no one
really knew how difficult it was going to be to remove the old machine which had been
embedded in the concrete floor (to minimize vibration). It was decided that to save time and
costs, the new machine would be set up in a new room adjacent to the room for the older
scanner. The new space would have to be renovated and new electrical connections installed.
Since the hospital could not afford to shut down for any extended length of time, the new
space had to be renovated before the older machine could be dismantled. Then, while the
new equipment was being tested, the old scanner had to be kept running in its temporary
location. During the time that both machines were running, machine operators and supporting
personnel were asked to work double shifts in order to test and become familiar with the new
scanner before closing down the old machine. This took longer than expected because
Mercy’s technicians were not familiar with the new machine and had some difficulty with
even minor start-up problems. Therefore, for the first two weeks, special outside consultants
were hired to operate the scanner at the proper specifications. These additional and
unexpected outlays were costly and brought the total to just under $1.4 million ($1.17 million
and $230,000 for the renovations and other expenditures) which was still lower than the
original estimate of $1.65 million. Even though the list price came in at a reasonable
$902,000 (saving $398,000 and other discounts provided additional savings of $57,000), the
renovations amounted to $230,000 and exceeded the original estimated renovation costs of
$25,000. The director went on to explain to Jack that the reason for the abnormally large
number of invoices was due to the renovation cost, additional labor cost associated with the
new machine, and the cost of running both machines during the transition. As it turns out,
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Mercy’s controller actually did a commendable job in overseeing the project and keeping
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accurate records of the disbursements. In fact, the controller created a specialized installation

Prof. Mark McCartney, Saginaw Valley State University, mwmccar@svsu.edu

Case ID. 030101
International Research Journal of Applied Finance ISSN 2229 – 6891
January, 2012 Case Study Series
guide that will probably save hundreds of thousands of dollars when the remaining hospitals
install more of these machines. When the director was finished, he told Jack that unless he
changed his attitude and re-considered what it means to be a professional internal auditor, he
was likely to remain a payroll auditor for the rest of his career. The director told Jack to go
back and read a basic internal audit text on interviewing techniques, the Code of Ethics and
the Standards for Professional Practice. Jack still didn't understand. What was the director
trying to say?

Required
1. Discuss the possible violations Jack may have committed according to the Institute of
Internal Auditors (IIA) International Standards for the Professional Practice of
Internal Auditing and Code of Ethics.
2. Comment on Jack's interviewing techniques. What could Jack have done differently?
What did Jack forget to do?

How to Present the Case

Students should be asked to read the case and discuss or research the required question(s).
Refer them to the Institute of Internal Auditors website and the Standards and Code of Ethics.
Ask students to refer to the Standards and Code in answering the first case question. With
regard to the second question, refer students to an internal auditing textbook to research audit
interview techniques and goals.

Table 1: List Price and Ancillary Costs of 64-Slice CT Scanner

Warranty
Qty Description Period List Price
1 64 Fast Whole Body CT Scanner $1,300,000
64 Long Couch
CT Accessory Kit, Console
Media for DVD-Ram Drive, Cable 5EE
Floor Epoxy Kit
1 PGP Study Split, Worklist Mgt Specs $15,000
1 Gating/Fast Rotation- Cardio and Monitor $100,000
1 C100 Station & Software Package $145,000

1 Voltage Regulator $20,000

1 Universal Power Supply $10,000
Rigging/Installation $21,000
Shipping $14,000
Capital Acquisition Costs $1,625,000

CT-Course for TechBioMed Training $20,000

Warranty coverage-13 hour day 12 $5,000
Additional 6 months 6 $60,000
SiteTraining and Warranty Costs $85,000

Hospital Price 18 $1,710,000

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Prof. Mark McCartney, Saginaw Valley State University, mwmccar@svsu.edu

Case ID. 030101
International Research Journal of Applied Finance ISSN 2229 – 6891
January, 2012 Case Study Series

Table 2: CT-Scanner and Ancillary Cost, Original List Price and Updated Bid Price
Warranty
Qty Description Period List Price Bid Price
1 64 Fast Whole Body CT Scanner $1,300,000 $902,000
64 Long Couch
CT Accessory Kit, Console
Media for DVD-Ram Drive, Cable 5EE
Floor Epoxy Kit
1 PGP Study Split, Worklist Mgt Specs $15,000 $10,000
1 Gating/Fast Rotation- Cardio and Monitor $100,000 $90,000
1 C100 Station & Software Package $145,000 $103,000

1 Voltage Regulator $20,000 $20,000

1 Universal Power Supply $10,000 $10,000
Rigging/Installation $21,000 $21,000
Shipping $14,000 $14,000
Capital Acquisition Costs $1,625,000 $1,170,000

CT-Course for TechBioMed Training $20,000 $20,000

Warranty coverage-13 hour day 12 $5,000 $5,000
Additional 6 months 6 $60,000 $60,000
SiteTraining and Warranty Costs $85,000 $85,000

Hospital Price 18 $1,710,000 $1,255,000

Note* PO must be received no later than 60
days from the bid date (modified amounts from
year 2008)

References
The Institute of Internal Auditors. (2010). International Standards for the Professional
Practice of Internal Auditing. Retrieved from http://www.theiia.org/guidance/standards-
and-guidance
The Institute of Internal Auditors. (2009). Code of Ethics. Retrieved from
http://www.theiia.org/guidance/standards-and-guidance
Sawyer, Lawrence B. (2005). Sawyer’s Internal Auditing. Altamonte Springs, FL: The
Institute of Internal Auditors
United States National Center for Health Statistics. (2010, September). Emergency
Department Visits for Chest Pain and Abdominal Pain: United States, 1999-2008. (Data
Brief No. 43). Retrieved from http://www.cdc.gov/nchs/data/databriefs/db43.pdf 6
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Prof. Mark McCartney, Saginaw Valley State University, mwmccar@svsu.edu

Case ID. 030101