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:

1. Two types of tests are performed in the lab—blood tests and smears. During the past month, 1,450 blood tests and 4,300 smears were performed in the lab.

2. Small glass plates are used in both types of tests. During the past month, the hospital purchased 21,500 plates at a cost of $53,105. 3,300 of these plates were unused at the end of the month; no plates were on hand at the beginning of the month.

3. During the past month, 3,300 hours of labor time were recorded in the lab at a cost of $37,785.

4. The lab’s variable overhead cost last month totaled $29,370.

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 $2.60 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 $12.50 per hour.

Overhead: Overhead cost is based on direct labor-hours. The average rate for variable overhead is $8.40 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

1.

Materials price variance	$       2,795	F
Materials quantity variance	$       2,470	U

Materials price variance = Actual quantity purchased x (Actual price - Standard price) = 21500 x ($2.47 - $2.60) = $2795 Favorable

Actual rate = $53105/21500 = $2.47 per plate

Materials quantity variance = Standard price x (Actual quantity used - Standard quantity allowed for actual output) = $2.60 x (18200 – 17250) = $2470 Unfavorable

Actual quantity used = 21500 - 3300 = 18200

Standard quantity allowed for actual output = (1450 + 4300) tests x 3 plates per test = 5750 x 3 = 17250 plates

2a.

Labor rate variance	$       4,455	F
Labor efficiency variance	$       5,250	U

Labor rate variance = Actual direct labor hours x (Actual rate - Standard rate) = 3300 x ($11.45 - $12.50) = $4455 Favorable

Actual rate = $37785/3300 hours = $11.45

Labor efficiency variance = Standard rate x (Actual direct labor hours used - Standard direct labor hours allowed for actual output) = $12.50 x (3300 - 2880) = $5250 Unfavorable

Standard direct labor hours allowed for actual output = (1450 tests x 0.8 hours) + (4300 tests x 0.40 hours) = 1160 + 1720 = 2880 hours

2b. No.

Employing more junior staff in place of senior staff resulted in a reduction in costs and thus a favorable labor rate variance however the efficiency was adversely affected thereby resulting in a higher unfavorable labor efficiency variance.

3a.

Variable overhead rate variance	$       1,650	F
Variable overhead efficiency variance	$       3,528	U

Variable overhead rate variance = Actual direct labor hours x (Actual rate - Standard rate) = 3300 x ($8.90 - $8.40) = $1650 Unfavorable

Actual rate = $29370/3300 hours = $8.90

Variable overhead efficiency variance = Variable overhead standard rate x (Actual hours - Standard hours) = $8.40 x (3300 - 2880) = $3528 Unfavorable

3b. Yes.

The variable overhead efficiency variance and the labor efficiency variance are both determined by the direct labor hours and hence both are unfavorable in this scenario.