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:

1. 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.

2. 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.

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

4. 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?

Answer 1

Requirement 1: Compute material price and quantity variance as follows

Material Price Variance           = Actual Quantity Purchased × (Actual Price − Standard Price)

                                                = 16,000 plates × (($36,480 ÷ 16,000) − $2.40)

                                                = $1,920 Favorable

Material Quantity Variance = Standard Price × (Actual Quantity Used − Standard Quantity)

                                                = $2.40 × ((16,000 – 2,200) – 12,150)

                                                = $3,960 Unfavorable

Note: Compute standard quantity allowed as follows

Particulars	Units
Blood Tests	850
Smears	3,200
Totals	4050
Plates per test	×    3
Standard quantity allowed	12,150

Requirement 2a: Compute labor rate and efficiency variance as follows

Labor Rate Variance              = Actual Hours × (Actual Rate − Standard Rate)

                                                = 2,200 Hours × (($23,980 ÷ 2,200) − $11.40)

                                                = $1,100 Favorable

Labor Efficiency Variance      = Standard Rate × (Actual Hours − Standard Hours)

                                                = $11.40 × (2,200 Hours – 1,960 Hours)

                                                = $2,736 Unfavorable

Total labor variance = $1,636 Unfavorable ($2,736 – $1,100)

Note

Particulars	Tests	Hours per Test	Total
Blood Tests	850	0.80	680
Smears	3,200	0.40	1,280
Total standard labor hours allowed			1,960

Requirement 2b:

The new policy of employing one-fourth senior technicians and three-fourths assistants should not be continued because of unfavorable and large efficiency variance which is the result of inadequate supervision of large number of assistants when compared to lower number of assistants in the earlier policy.

Requirement 3a: Compute variable overhead rate and efficiency variance as follows

Variable overhead Rate Variance       = Actual Hours × (Actual Rate − Standard Rate)

                                                            = 2,200 Hours × (($17,160 ÷ 2,200) − $7.30)

                                                            = $1,100 Favorable

Variable Overhead Efficiency Variance         = Standard Rate × (Actual Hours − Standard Hours)

                                                                        = $7.30 × (2,200 Hours – 1,960 Hours)

                                                                        = $1,752 Unfavorable

Total variable overhead variance = $652 Unfavorable ($1,752 – $1,100)

Requirement 3b:

Labor efficiency and variable overhead variance are closely related because both are computed using the actual labor hours and standard hours allowed for actual production.