John Fleming, chief administrator for Valley View Hospital, is concerned about t

Question

John Fleming, chief administrator for Valley View Hospital, is concerned about the costs for tests in the hospital’s lab. Charges for lab tests are consistently higher at Valley View than at other hospitals and have resulted in many complaints. Also, because of strict regulations on amounts reimbursed for lab tests, payments received from insurance companies and governmental units have not been high enough to cover lab costs.

Mr. Fleming has asked you to evaluate costs in the hospital’s lab for the past month. The following information is available:

Two types of tests are performed in the lab—blood tests and smears. During the past month, 850 blood tests and 3,200 smears were performed in the lab.

Small glass plates are used in both types of tests. During the past month, the hospital purchased 16,000 plates at a cost of $36,480. 2,200 of these plates were unused at the end of the month; no plates were on hand at the beginning of the month.

During the past month, 2,200 hours of labor time were recorded in the lab at a cost of $23,980.

The lab’s variable overhead cost last month totaled $17,160.

Valley View Hospital has never used standard costs. By searching industry literature, however, you have determined the following nationwide averages for hospital labs:

Plates: Three plates are required per lab test. These plates cost $2.40 each and are disposed of after the test is completed.

Labor: Each blood test should require 0.8 hours to complete, and each smear should require 0.40 hours to complete. The average cost of this lab time is $11.40 per hour.

Overhead: Overhead cost is based on direct labor-hours. The average rate for variable overhead is $7.30 per hour.

Required:

1. Compute a materials price variance for the plates purchased last month and a materials quantity variance for the plates used last month.

2. For labor cost in the lab:

a. Compute a labor rate variance and a labor efficiency variance.

b. In most hospitals, one-half of the workers in the lab are senior technicians and one-half are assistants. In an effort to reduce costs, Valley View Hospital employs only one-fourth senior technicians and three-fourths assistants. Would you recommend that this policy be continued?

3-a. Compute the variable overhead rate and efficiency variances.

3-b. Is there any relation between the variable overhead efficiency variance and the labor efficiency variance?

Explanation / Answer

Solution 1:

Standard price of plates (SP) = $2.40

Actual price of plates (AP) = $36,480 / 16000 = $2.28

Standard Qty of plates for actual lab test performed (SQ) = (850+3200)*3 = 12150

Actual Qty of Plates consumed = 16000 – 2200 = 13800

Material Price Variance = (SP – AP) * AQ purchased = ($2.40 – $2.28) * 16000 = $1,920 F

Material Quantity variance = (SQ - AQ) * SP = (12150 - 13800) * $2.40 = $3,960 U

Solution 2a:

Standard rate of direct labour (SR) = $11.40/hour

Standard hours for lab test (SH) = (850*0.8) + (3200*0.40) = 1960 Hrs

Actual Direct labor cost = $23980

Actual Direct labor hours (AH) = 2200

Actual rate of direct labor (AR) = 23980/2200 = $10.90 /Hr

Labor rate variance = (SR – AR) * AH = ($11.40 – $10.90) * 2200 = $1,100 F

Labor efficiency variance = (SH – AH) * SR = (1960 – 2200) * $11.40 = $2,736 U

Solution 2b:

In most hospital ratio of senior technicians and assistants are 50:50, however valley view hospital employs only on fourtht senior technician and three fourth assistants. Due to this policy our overall average direct labor rate is reduced from standard rate but efficiency of labor decreases and resulting in unfavorable efficiency variance of $2,736 while labor rate variance is favorable only $1,100. Therefore we will not recommend this policy, valley view must employe more senior techicians.

Solution 3a:

Standard rate of variable overhead (SR) = $7.30/hour

Standard hours for lab test (SH) = (850*0.8) + (3200*0.40) = 1960 Hrs

Actual variable overhead cost = $17160

Actual Direct labor hours (AH) = 2200

Actual rate of Variable overhead (AR) = $17,160/2200 = $7.80 /Hr

Variable overhead rate variance = (SR – AR) * AH = ($7.30 – $7.80) * 2200 = $1,100 U

Variable overhead efficiency variance = (SH – AH) * SR = (1960 – 2200) * $7.30 = $1,752 U

Solution 3b:

There is relation between variable overhead efficiency variance and labo efficiency variance as both are based on direct labor hours. If direct labor efficiency variance improve, variable overhead efficiency variance also improves. hence both are postively co-related.

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