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, 1,050 blood tests and 3,500 smears were performed in the lab.

2. Small glass plates are used in both types of tests. During the past month, the hospital purchased 17,500 plates at a cost of $58,800. 2,500 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, 2,500 hours of labor time were recorded in the lab at a cost of $27,625.

4. The lab’s variable overhead cost last month totaled $20,250.

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 $3.50 each and are disposed of after the test is completed.

Labor: Each blood test should require 0.6 hours to complete, and each smear should require 0.30 hours to complete. The average cost of this lab time is $11.70 per hour.

Overhead: Overhead cost is based on direct labor-hours. The average rate for variable overhead is $7.60 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

Cost card
Particulars	Standard cost for actual production	Particulars	Actual cost
Quantity & hour	Rate($/plate & $/hr)	Amount	Quantity & hour	Rate($/plate & $/hr)	Amount
Direct Material-Plates	13650.00	3.50	$                47,775	Material purchased	17,500.00	3.36	$                    58,800.00
	[+(1050+3500)*3]			Material used	15,000.00	3.36	$                    50,400.00
				Closing material	2,500.00	($58,800/17500 )	$                      8,400.00
Direct labour	1680.00	11.70	$                19,656	Direct labour	2,500.00	11.05	$                    27,625.00
	[(1050*0.6)+(3500*0.3)]					($27,625/2500 hr)
Variable overhead	1680.00	7.60	$                12,768	Variable overhead	2,500.00	8.10	$                    20,250.00
						($20,250/2500 hr)

	Computation of variances:
1	Material Price variance = (Standard rate - Actual rate) * Actual quantity purchase
	Material Price variance = ($3.5 - $3.36) X 17500 Plate   = $2450 (Favourable)
	Material efficiency variance = (Standard Quantity - Actual Quantity used) * Standard rate
	Material efficiency variance = (13650 Plate   - 15000 Plate ) X $3.5 = $-4725 (Unfavourable)
2	Labor Rate variance = (Standard rate - Actual rate) * Actual hours
	Labor Rate variance = ($11.7/hr - $11.05/hr) X 2500 hr = $1625 (Favourable)
	Labor efficiency variance = (Standard Hours - Actual Hours) * Standard rate
	Labor efficiency variance = (1680 hr - 2500 hr) X $11.7/hr = $-9594 (Unfavourable)
3	Variable Overhead rate variance = (Standard rate - Actual rate) * Actual hour used
	Variable Overhead rate variance = ($7.6/hr - $8.1/hr) X 2500 hr = $-1250 (Unfavourable)
	Variable overhead efficiency variance = (Standard hour - Actual hour) * Standard rate
	Variable overhead efficiency variance = (1680 hr - 2500 hr) X $7.6/hr = $-6232 (Unfavourable)

2b)The Hospital is required to employ more senior technicians as their efficiency variance is unfavorable in the case of Labour variance calculation. Therefore the current policy should be stopped.

3b)There is a relation between Labour efficiency variance and Variable overhead variance as the both are calculated to measure the efficiency of the organisation by taking standard & actual hour of labour as well as variable overhead.  

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