Question

1. Cost Behavior, High-Low Method, Pricing Decision

   St. Teresa's Medical Center (STMC) offers a number of specialized medical services, including neuroscience, cardiology, and oncology. STMC's strong reputation for quality medical care allowed it to branch out into other services. It is now ready to expand its orthopedic services and has just added a free-standing orthopedic clinic offering a full range of outpatient, surgical, and physical therapy services. The cost of the orthopedic facility is depreciated on a straight-line basis. All equipment within the facility is leased.

   Since the clinic had no experience with in-patient orthopedic services (for patients recovering from hip and knee replacements, for example), it decided to operate the orthopedic center for two months before determining how much to charge per patient day on an ongoing basis. As a temporary measure, the clinic adopted a patient-day charge of $190, an amount equal to the fees charged by a hospital specializing in orthopedic care in a nearby city.

   This initial per-day charge was quoted to patients entering the orthopedic center during the first two months with assurances that if the actual operating costs of the new center justified it, the charge could be less. In no case would the charges be more. A temporary policy of billing after 60 days was adopted so that any adjustments could be made.

   The orthopedic center opened on January 1. During January, the center had 4,000 patient days of activity. During February, the activity was 4,300 patient days. Costs for these two levels of activity output are as follows:

   	4,000 Patient Days		4,300 Patient Days
   Salaries, nurses	$	54,400	$	54,400
   Aides		30,000		30,000
   Pharmacy		239,600		256,400
   Laboratory		92,300		97,700
   Depreciation		27,500		27,500
   Laundry		192,000		206,400
   Administration		24,500		24,500
   Lease (equipment)		39,700		39,700

   Required:

   1. Classify each cost as fixed, variable, or mixed, using patient days as the activity driver. Assume that the Pharmacy & Laboratory are “in house” and that the Laundry is “shipped out” to a third party vendor.

   Salaries, nurses
   Aides
   Pharmacy
   Laboratory
   Depreciation
   Laundry
   Administration
   Lease (equipment)

   2. Use the high-low method to separate the mixed costs into fixed and variable.

   	Laboratory:	Pharmacy:
   Variable	$ per patient day	$ per patient day
   Fixed	$	$

   3. The administrator of the orthopedic center estimated that the center will average 4,200 patient days per month. If the center is to be operated as a nonprofit organization, determine the amount it will need to charge per patient day? Round your interim calculations and final answers to the nearest cent.

   $ Charge per patient day

   How much of this charge is variable?

   $ Variable charge per patient day

   How much of the charge per patient day is fixed?

   $ Fixed charge per patient day

   4. Suppose the orthopedic center averages 4,600 patient days per month. How much would need to be charged per patient day for the center to cover its costs? Round your answer to the nearest cent.

   $ per patient day

   The main reason why the charge per patient day decreased as the activity output increased is because

Answer 1

1. Classify each cost as fixed, variable, or mixed, using patient days as the activity driver. Assume that the Pharmacy & Laboratory are “in house” and that the Laundry is “shipped out” to a third party vendor.

Salaries, nurses	Fixed cost	In each level it does not change
Aides	Fixed cost	In each level it does not change
Pharmacy	Mixed cost
Laboratory	Mixed cost
Depreciation	Fixed cost	In each level it does not change
Laundry	Variable cost	Does nit change in per unit level
Administration	Fixed cost	In each level it does not change
Lease (equipment)	Fixed cost	In each level it does not change

.

2. Use the high-low method to separate the mixed costs into fixed and variable.

.	Laboratory:	Pharmacy:
Variable	$18 per patient day	$56 per patient day
Fixed	$20300	$15600

.

Under high low method , cost function is = Y = A + Bx

Y = total mixed cost

A = Fixed cost

B = variable cots per unit

X =level of activities

B = ( cost @ highest activities - cost @ lowest activities ) / (highest activities - lowest activities )

.

Laboratory

cost @ highest activities = 97700

cost @ lowest activities = 92300

highest activities = 4300 patient days

lowest activities = 4000 patient days

.

B = (97700 - 92300 ) / ( 4300 - 4000 ) = 5400 / 300 = $18 per patient days

Variable cost per units = $18

Y = a + bx, so a = Y - bx

Y = cost @ highest activities = 97700 (mixed cost )

B = variable cost = 18

X = 4300

A = 97700 - ($18 * 4300 ) = 20300

Fixed cost = $20300

.

Pharmacy

cost @ highest activities = 256400

cost @ lowest activities = 239600

highest activities = 4300 patient days

lowest activities = 4000 patient days

.

B = (256400 - 239600 ) / ( 4300 - 4000 ) = 16800 / 300 = $56 per patient days

Variable cost per units = $56

Y = a + bx, so a = Y - bx

Y = cost @ highest activities = 256400 (mixed cost )

B = variable cost = 56

X = 4300

A = 256400 - ($56 * 4300 ) = 15600

Fixed cost = $15600

.

3. The administrator of the orthopedic center estimated that the center will average 4,200 patient days per month. If the center is to be operated as a nonprofit organization, determine the amount it will need to charge per patient day? Round your interim calculations and final answers to the nearest cent.

$ Charge per patient day

.

It is non profit organization, so need to recover total cost per patient days

Charge per patient day = total cost per patient days = Total cost / 4200 patient says

Total cost for 4200 patient

Salaries, nurses	54400
Aides	30000
Pharmacy	15600 + (56 * 4200) = 250800
Laboratory	20300 + (18*4200) =95900
Depreciation	27500
Laundry	206400/4300*4200 =201600
Administration	24500
Lease (equipment)	39700
Total cost	$734400
patient days	4200
Cost per patient days	734400 / 4200 =174.86

.

$174.86 Charge per patient day

.

How much of this charge is variable?

.

Pharmacy - variable	$56
Laboratory	$18
Laundry	$48 (206400/4300)
variable cost per units	$122

.

$122 Variable charge per patient day

.

How much of the charge per patient day is fixed?

.

Total cost per patient day - variable cost per patient day = Fixed charge per patient day

Fixed charge per patient day = 174.86 - 122 = 52.86

$52.86 Fixed charge per patient day

.

4. Suppose the orthopedic center averages 4,600 patient days per month. How much would need to be charged per patient day for the center to cover its costs? Round your answer to the nearest cent.

.

Total cost for 4600 patient

Salaries, nurses	54400
Aides	30000
Pharmacy	15600 + (56 * 4600) = 273200
Laboratory	20300 + (18*4600) =103100
Depreciation	27500
Laundry	48*4600 =220800
Administration	24500
Lease (equipment)	39700
Total cost	$773200
patient days	4600
Cost per patient days	773200/ 4600 =168.09

.

$168.09 per patient day

.

The main reason why the charge per patient day decreased as the activity output increased is because

.

Because, the fixed cost per units will decrease if activity level increase, because fixed cost total is not change with activity level. So if a total cost structure include fixed cost, if activity increase, cost per units will decrease.