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: a. Two types of tests are performed in the lab-blood tests and smears. During the past month, 1,800 blood tests and 2,400 smears were performed in the lab. b. Small glass plates are used in both types of tests. During the past month, the hospital purchased 12,000 plates at a cost of $56,400. 1,500 of these plates were unused at the end of the month; no plates were on hand at the beginning of the month. c. During the past month, 1,150 hours of labor time were recorded in the lab at a cost of $21,850. d. The lab's variable overhead cost last month totaled $7,820. Valley View Hospital has never used standard costs. By searching industry literature, however, you have determined the following nationwide averages for hospital labs: Plates: Two plates are required per lab test. These plates cost $5.00 each and are disposed of after the test is completed. Labor: Each blood test should require 0.3 hours to complete, and each smear should require 0.15 hours to complete. The average cost of this lab time is $20 per hour. Overhead: Overhead cost is based on direct labor-hours. The average rate for variable overhead is $6 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

1.

Standard Price per plate = $5

Quantity Purchased = 12,000 plates

Actual Price per Plate = $56,400 / 12,000 plates

= $4.7

Standard Number of plates required for lab tests = (No. of blood tests + no. of smear) * Plates required for one lab test

= (1,800 + 2,400) * 2

= 8,400 plates

Actual plates used = Quantity of plates purchased - N. of plates unused at the end of the month

= 12,000 - 1.500

= 10,500 plates

Material Price Variance = (Standard Price - Actual Price) * Quantity purchased

= ($5 - $4.70) * 12,000

= $3,600 (F)

Material Quantity Variance = (Standard Quantity - Actual Quantity) * Standard Price

= (8,400 - 10,500) * $5

= $10,500 (U)

2. (a)

Standard Labor rate = $20 per labor hour

Actual Labor Time = 1,150 hours

Actual Labor rate = Labor cost / Labor Hours

= $21,850 / 1,150 hours

= $19 per labor hour

Standard Labor Hours = (No. of blood test * Standard time for 1 blood test) + (No.of smear * Standard time for 1 smear)

= (1,800 * 0.3 hours) + (2,400 * 0.15 hours)

= 540 hours + 360 hours

= 900 hours

Labor Rate Variance = (Standard Rate - Actual Rate) * Actual Hours

= ($20 - $19) * 1,150 hours

= $1,150 (F)

Labor Efficiency Variance = (Standard Hours - Actual Hours) * Standard Rate

= (900 hours - 1,150 hours) * $20

= $5,000 (U)

2. (b)

The policy of Valley view hospital is not recommended because hiring of assistants in place of senior technicians to control labor cost can seriously affect the quality of the tests performed in the Valley View Hospital and build a negative image in the industry. Current policy can reduce the cost in the short term will will have severe consequences in the long run business.

3. (a)

Variable Overhead cost is based on Direct Labor Hours

Standard Hours = 900 hours

Actual Hours = 1,150 hours

Standard Rate for Variable Overhead = $6 per hour

Actual Variable Overhead rate per hour = Actual Overhead cost / Actual labor hours

= $7,820 / 1,150 hours

= $6.80 per hour

Variable Overhead Rate Variance = (Standard Rate - Actual Rate) * Actual Hours

= ($6 -$6.80) * 1,150 hours

= $920 (U)

Variable Overhead Efficiency Variance = (Standard Hours - Actual Hours) * Standard Rate

= (900 hours - 1,150 hours) * $6

= $1,500 (U)

3. (b)

The variable overhead efficiency variance is directly proportional to the labor efficiency variance because both the variance captures the deviation from the budgeted costs due to difference in standard labor hours for the job and the actual hours consumed for the job.