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, 750 blood tests and 3,000 smears were performed in the lab.

Small glass plates are used in both types of tests. During the past month, the hospital purchased 15,000 plates at a cost of $48,450. 2,000 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, 2,000 hours of labor time were recorded in the lab at a cost of $21,600.

The lab’s variable overhead cost last month totaled $15,200.

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 $3.40 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 $11.20 per hour.

Overhead: Overhead cost is based on direct labor-hours. The average rate for variable overhead is $7.10 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. (Input all amounts as positive values. Indicate the effect of each variance by selecting "F" for favorable, "U" for unfavorable, and "None" for no effect (i.e, zero variance).)

2. For labor cost in the lab:

a. Compute a labor rate variance and a labor efficiency variance. (Input all amounts as positive values. Indicate the effect of each variance by selecting "F" for favorable, "U" for unfavorable, and "None" for no effect (i.e, zero 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?

	Yes
	No

3-a. Compute the variable overhead rate and efficiency variances. (Input all amounts as positive values. Indicate the effect of each variance by selecting "F" for favorable, "U" for unfavorable, and "None" for no effect (i.e, zero variance).)

3-b. Is there any relation between the variable overhead efficiency variance and the labor efficiency variance?

	Yes
	No

Answer 1

1.Material Price Variance = (Standard Price – Actual Price)*Actual Quantity Purchased

=(3.40-Actual Price)*Actual Quantity Purchased

= 3.40*15,000–48,450

= 2,550 F

Materials Quantity Variance = (Standard Quantity – Actual Quantity)*Standard Price

= (3*3750 – 13,000)*3.4

= 5,950 U

2.Labor Rate Variance = (Standard rate – Actual rate)*Actual Hours

=(11.20 – Actual rate)*2,000

= 11.20*2,000 – Actual Cost

= 800 F

Labor Efficiency Variance = (Standard Hours – Actual Hours)*Standard rate

= (1,800 – 2,000)*11.2

= 2,240 U

Note: Standard Hours = 0.8*750 + 0.4*3,000 = 1,800

2.b. No, as it will lead to risk of life for patients and will bring a bad name to the hospital.

3. a. Variable Overhead Rate Variance = (Standard rate – Actual rate)*Actual Hours

= (7.10-Actual rate)*Actual Hours

= 7.10*2,000 – 15,200

= 1,000 U

Variable Overhead Efficiency Variance = (Standard Hours – Actual Hours)*Standard rate

= (1,800 –2,000)*7.10

= 1,420 U

3-b. Yes, since variable overheads are based on labour hours only.