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, 650 blood tests and 2,800 smears were performed in the lab.

2. Small glass plates are used in both types of tests. During the past month, the hospital purchased 14,000 plates at a cost of $40,880. 1,800 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, 1,800 hours of labor time were recorded in the lab at a cost of $19,260.

4. The lab’s variable overhead cost last month totaled $13,320.

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 $3.00 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 $11.00 per hour.

Overhead: Overhead cost is based on direct labor-hours. The average rate for variable overhead is $6.90 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	Material price variance=AQ*(SR-AR)
	If the answer is positive,variance is favorable.Otherwise,unfavorable
	Where
	AQ=Actual number of glasses purchased=14000 plates
	SR=Standard Rate per glass=$3
	AR=Actual rate per glass=40880/14000=$2.92
	Material price variance=14000*(3-2.92)=1120=$ 1120 Favorable
	Material Quantity variance=SR*(SQ-AQ)
	If the answer is positive,variance is favorable.Otherwise,unfavorable
	Where
	SR=$3
	SQ=Standard Quantity=Total tests*Plates per test=(650+2800)*3=3450*3=10350 Plates
	AQ=Actual quantity used=14000-1800=12200 plates
	Material Quantity variance=3*(10350-12200)=-5550=$ 5550 Unfavorable
2
a.	Labor rate variance=ALH*(SR-AR)
	If the answer is positive,variance is favorable.Otherwise,unfavorable
	Where
	ALH=Actual labor hours=1800 Hours
	SR=Standard labor rate per hour=$11
	AR=Actual labor rate per hour=Actual labor cost/ALH=19260/1800=$ 10.70
	Labor rate variance=1800*(11-10.70)=540=$ 540 Favorable
	Labor efficiency variance=SR*(SLH-ALH)
	If the answer is positive,variance is favorable.Otherwise,unfavorable
	Where
	SR=Standard labor rate per hour=$11
	SLH=Standard labor hours
	Blood test		650*0.8	520
	Smears		2800*0.4	1120
	Standard labor hours			1640
	ALH=Actual labor hours=1800 Hours
	Labor efficiency variance=11*(1640-1800)=-1760=$ 1760 Unfavorable
b.	This policy should be discontinued since there is an adverse labor efficiency variance of $1760.
	Budgeted labor hours are 1640 hours.But actual labor hours taken are 1760 hours.
3-a.	Variable overhead rate variance=ALH*(SR-AR)
	If the answer is positive,variance is favorable.Otherwise,unfavorable
	Where
	ALH=Actual labor hours=1800 Hours
	SR=Standard variable overhead rate per hour=$6.90
	AR=Actual variable rate per hour=Actual variable overhead/ALH=13320/1800=$ 7.4
	Variable overhead rate variance=1800*(6.9-7.4)=-900=$ 900 Unfavorable
	Variable overhead efficiency variance=SR*(SLH-ALH)
	If the answer is positive,variance is favorable.Otherwise,unfavorable
	Where
	SR=Standard variable overhead rate per hour=$6.90
	SLH=Standard labor hours
	Blood test		650*0.8	520
	Smears		2800*0.4	1120
	Standard labor hours			1640
	ALH=Actual labor hours=1800 Hours
	Variable overhead efficiency variance=6.90*(1640-1800)=-1104=$1104 Unfavorable
3-b.	Variable overhead efficiency variance and Labor efficiency variance shows the efficiency of workers.