Question

PROBLEM 2-20 Plantwide versus Multiple Predetermined Overhead Rates: Service Industry LO2-1, LO2-2, LO2-3, LO2-4 McCullough Hospital uses a job-order costing system to assign costs to its patients. Its direct mate- rials include a variety of items such as pharmaceutical drugs, heart valves, artificial hips, and pace- makers. Its direct labor costs (e.g., surgeons, anesthesiologists, radiologists, and nurses) associated with specific surgical procedures and tests are traced to individual patients. All other costs, such as depreciation of medical equipment, insurance, utilities, incidental medical supplies, and the labor costs associated with around-the-clock monitoring of patients are treated as overhead costs. eh has used one predetermined overhead rate based on the number of patient-days (each night that a patient spends in the hospital counts as one patient-day) to allocate overhead costs to patients. Recently a member of the hospital's accounting staff has suggested using two predetermined overhead rates allocated based on the number of patient-days) to improve of the costs allocated to patients. The first overhead rate would include all overhead costs within the Intensive Care Unit (ICU) and the second overhead rate would include all Other overhead costs. Information pertaining to the hospital's estimated number of patient-days, its estimated overhead costs, and two of its patients—Patient A and Patient B-is provided below: ICU Other Total 2,000 18,000 20,000 $3,200,000 $14,000,000 $17,200,000 Estimated number of patient-days ... Estimated fixed overhead cost....... Estimated variable overhead cost per patient-day .................. $236 Patient A $4,500 $25,000 14 Patient B $6,200 $36,000 Direct materials ....................................... Direct labor Total number of patient-days (including ICU)......... Number of patient-days spent in ICU ................ 0 7 Required: 1. Assuming McCullough uses only one predetermined overhead rate, calculate: a. The predetermined overhead rate. b. The total cost, including direct materials, direct labor and applied overhead, assigned to Patient A and Patient B. 2. Assuming McCullough calculates two overhead rates as recommended by the staff accoun- tant, calculate: a. The ICU and Other overhead rates. b. The total cost, including direct materials, direct labor and applied overhead, assigned to Patient A and Patient B. 3. What insights are revealed by the staff accountant's approach?

Answer 1

1.

a. Predetermined overhead rate = Estimated total overhead cost / Estimated number of patient days

Predetermined overhead rate = $17,200,000+(2000*$236+18,000*$96) / 20,000

Predetermined overhead rate = $17,200,000+472,000+1,728,000 / 20,000

Predetermined overhead rate = $19,400,000 / 20,000 = $970 per number of patient days

b.

	Patient A	Patient B
Direct material	$4,500	$6,200
Direct labor costs	25,000	36,000
Applied overhead	13,580 (14*$970)	20,370 (21*$970)
Total costs	$43,080	$62,570

2.

Predetermined overhead rate (ICU) = $3,200,000+2,000*$236 / 2,000 = $1,836

Predetermined overhead rate (Other) = $14,000,000+18,000*$96 / 18,000 = $873.78

	Patient A	Patient B
Direct material	$4,500	$6,200
Direct labor costs	25,000	36,000
Applied overhead	12,233 (14*$873.78)	25,085 (21-7*$873.78 + 7*$1,836)
Total costs	$41,733	$67,285

3.

The staff accountant's approach shows more accurate results than the traditional approach as overhead costs are assigned based on number of patient days spent in ICU and number of patient days excluding ICU since overhead cost incurred in ICU will be different from overhead cost incurred in others.