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, 1,100 blood tests and 3,600 smears were performed in the lab. Small glass plates are used in both types of tests. During the past month, the hospital purchased 18,000 plates at a cost of $58,140. 2,600 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, 2,600 hours of labor time were recorded in the lab at a cost of $28,860. The lab’s variable overhead cost last month totaled $21,320. 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 $11.80 per hour. Overhead: Overhead cost is based on direct labor-hours. The average rate for variable overhead is $7.70 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

	For calculating variances we will first calculate standard costs as follows:
	Particulars	Blood Tests	Smears
	Plates	3 plates @ $3.40/plate	3 plates @ $3.40/plate
	Labor	0.80 hours @ $11.80/hr.	0.40 hours @ $11.80/hr.
	Standard cost are as follows
		Blood Tests	Smears
	Material	10.2	10.2
	Labor	9.44	4.72
	Variable Overhead	6.16	3.08
	Cost/unit	25.8	18
	Calculation of Actual cost & standard costs for given level of activity
		Blood Tests (a)	Smears (b)	Total (c=a+b)
1	Total tests perfomed	1,100.00	3,600.00
2	Plates Required @ 3 plates p.u. (units)	3,300.00	10,800.00	14,100.00
3	Standard Labor hours Required	880.00	1,440.00	2,320.00
4	Standard cost p.u.	25.80	18.00
5	Total standard Cost	28,380.00	64,800.00	93,180.00
6	Standard Material cost	11,220.00	36,720.00	47,940.00
7	Standard Labor cost	10,384.00	16,992.00	27,376.00
8	Standard Overheads	6,776.00	11,088.00	17,864.00
	Actual costs
9	Plates Purchased (No.s)			18,000.00
10	Purchase price of Plates ($)			58,140.00
11	Closing Balance of Plates (No.s)			2,600.00
12	Plates used (No.s)			15,400.00
13	Total Labor Hours			2,600.00
14	Total Labor Cost			28,860.00
15	Total Variable Overhead cost			21,320.00
	Material Price Variances
	Particulars	Calculation		Amount
16	Material Cost Variance	Actual Material cost - Standard Material cost		10,200.00	Unfavorable
17	Material Price Variance for plates purchased	Actual Qty * (Standard Rate - Actual Rate) i.e. 18000*(3.40 - 3.23)		3,060.00	Favorable
18	Materials qty variance for plates used	Standard Rate*(Standard qty - Actual qty) i.e. 3.40*(15400-14100)		4,420.00	Unfavorable
	Labor Cost Variances
	Particulars	Calculation		Amount
19	Total Labor cost variance	Actual Labor cost - Standard Labor cost		1,484.00	Unfavorable
20	Labor Price Variances	Actual Hours * (Actual cost/hour - standard cost/hour) i.e. 2600 *(11.10 - 11.80)		1,820.00	Favorable
21	Labor efficiency variances	Standard Rate* (Actual Hours - standard hours) i.e. 11.80*(2600 - 2320)		3,304.00	Unfavorable
	Variable Overhead Cost Variances
	Particulars	Calculation		Amount
22	Total Overhead Cost Variance	Total Overhead cost - Budgeted overhead cost i.e. 21320 - 17864		3,456.00	Unfavorable
23	Overhead Rate Variance	(Std.rate - Actual rate)*Actual Hours i.e. (7.70 - 8.20)*2600		1,300.00	Unfavorable
24	Overhead Efficiency Variance	Standard Rate* (Actual Hours - standard hours) i.e. 7.70*(2600 - 2320)		2,156.00	Unfavorable

Answers to Theoretical Questions:

1. In my opinion valley view's decision to appoint only 1/4th of senior officials and 3/4th remaining assistants is not a good practice. Although it may save cost in terms of salary paid but it will affect the efficiency and in effect hamper other costs.

2. Labour Efficiency and variable overhead efficiency are interlinked with each other i.e. if the labours are used efficiently then variable overhead costs will also decline. Therefore, variable overhead efficiency and labour efficiency are interlinked to each other.