Question

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	$	56,100	$	56,100
Aides		32,700		32,700
Pharmacy		245,700		262,800
Laboratory		113,200		120,100
Depreciation		27,900		27,900
Laundry		180,400		193,930
Administration		26,800		26,800
Lease (equipment)		40,000		40,000

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	Fixed
Aides	Fixed
Pharmacy	Mixed
Laboratory	Mixed
Depreciation	Fixed
Laundry	Variable
Administration	Fixed
Lease (equipment)	Fixed

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 4,500 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:

the fixed cost per patient day is reduced

Answer 1

	4,000 Patient Days	4,300 Patient Days
Salaries, nurses	56,100	56,100	Fixed
Aides	32,700	32,700	Fixed
Pharmacy	245,700	262,800	Mixed
Laboratory	113,200	120,100	Mixed
Depreciation	27,900	27,900	Fixed
Laundry	180,400	193,930	Variable
Administration	26,800	26,800	Fixed
Lease (equipment)	40,000	40,000	Fixed
Total	722,800	760,330
Variable cost varies directly with the number of patient days while fixed cost remains constant
Using high low method, variable cost per patient day = Difference in costs/Difference in patient days
	Laboratory	Pharmacy
Hence, variable cost per patient day	23	57
Fixed cost = Total cost - variable cost	21200	17700
3.Charge = Variable cost + Fixed cost/Number of patient days
=(23+57+45.1)+(56100+32700+27900+26800+40000+21200+17700)/4200
178.052381	per patient day
Variable = (23+57+45.1) per patient day	125.1	per patient day
Fixed = (56100+32700+27900+26800+40000+21200+17700)/4200	52.952381	per patient day
4.Charge	174.52222	per patient day
Because fixed costs remains constant
and per patient day is reduced