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: 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. 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. During the past month, 1,150 hours of labor time were recorded in the lab at a cost of $21,850. 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

Solution 1:

Standard plates for actual test = (1800+2400)*2 = 8400 Plates

Actual plates purchased = 12000

Plates consumed = 12000 - 1500 = 10500 plates

Standard price of plate = $5

Actual price per Plate = $56,400 / 12000 = $4.70

Direct material price variance = (SP - AP) * AQ purchased = ($5 - $4.70) * 12000 = $3,600 F

Direct material quantity variance = (SQ - AQ) * SP = (8400 - 10500) * $5 = $10,500 U

Solution 2a:

Standard rate of labor = $20

Actual rate of labor = $21,850 / 1150 = $19 per hour

Standard hours of labor = (1800*0.3) + (2400*0.15) = 900 hours

Actual hours of labor = 1150 hours

labor rate variance = ($20 - $19) * 1150 = $1,150 F

Labor efficiency variance = (SH - AH) * SR = (900 - 1150) * $20 = $5,000 U

Solution 2b:

In most hospital one half workers 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, this resulting in to favorable direct labor variance of $1,150 but is also results in unfavourable labor efficiency variance of $5,000. Due to junior staff, time taken is much higher than standard time. Therefore we should not recommend this policy be continued. Company should employ staff as per standard norms.

Solution 3a:

Standard rate of variable overhead = $6

Actual rate of labor = $7,820 / 1150 = $6.80 per hour

Standard hours of labor = (1800*0.3) + (2400*0.15) = 900 hours

Actual hours of labor = 1150 hours

Variable overhead rate variance = ($6 - $6.80) * 1150 = $920 U

Variable overhead efficiency variance = (SH - AH) * SR = (900 - 1150) * $6 = $1,500 U

Solution 3b:

Variable overhead efficiency variance and labor efficiency variance both are based on actual direct labor hours and standard direct labor hours. If one variance is favourable, other is also favourable or vice versa. Therefore both variance are postively corelated.