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 4,300 patient days of activity. During February, the activity was 4,700 patient days. Costs for these two levels of activity output are as follows:

	4,300 Patient Days		4,700 Patient Days
Salaries, nurses	$	55,400	$	55,400
Aides		33,000		33,000
Pharmacy		250,900		272,500
Laboratory		115,100		123,500
Depreciation		25,300		25,300
Laundry		188,340		205,860
Administration		23,800		23,800
Lease (equipment)		32,700		32,700

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 4,400 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 5,100 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:

Answer 1

Classification (Activity) Patient days Salaries, nurses Aides Pharmacy Laboratory Depreciation Laundry Administration Lease Equipment January 4300 Cost per day | $55,400 $12.88 $33.000 $7.67 $250.900 $58.35 $115.100 $26.77 $25,300 $5.88 $188,340 $43.80 $23,800 $5.53 $32,700 $7.60 February 4700 Cost per day $55,400 $11.79 $33,000 $7.02 $272,500 $57.98 $123.500 $26.28 $25,300 $5.38 $205.860 $43.80 $23.800 $5.06 $32,700 $6.96 Fixed Fixed Mixed Mixed Fixed Variable Fixed Fixed Fixed: The expense which are same for both the level of avtivity. Variable: The per day cost is fixed under both level of activity. Mixed: Remaining expense. Working as follows:

High Low Difference (Hogh-Low) (A) Days Difference (4700-4300) B) Per day difference [C=A/B] Laboratory $123,500 $115.100 $8,400 400 $21 Pharmacy $272,500 $250,900 $21,600 400 $54 variable cost per day (D) Total variable cost for 4300 patient days (E) $21 $90,300 S54 $216.000 Total cost for 4300 patient days (F) $115,100 $250,900 Fixed cost (F-E) $24.800 $34.900 variable (S per patient day) Laboratory $21 $24.800 Pharmacy $54 $34.900 Fixed

Working a follows: (Activity) Patient days Salaries frses Aides Pharmacy Laboratory Depreciation Laundry Administration Lease Equipment Total Cost 4400 Variable Per day Total $0.00 $0.00 $54 $237,600 $21 $92,400 $0.00 $43.8 $192,720 $0.00 | $0.00 S522,720 Fixed $55,400 $33,000 $34,900 $24.800 $25,300 Total $55,400 $33,000 $272,500 $117,200 $25,300 $192,720 $23,800 $32,700 $752,620 $23,800 $32,700 $229,900 Chargeper patient =S752,620 4400 =$171.05

Working as follows: (Activity) Patient days Salaries, irses Aides Pharmacy Laboratory Depreciation Laundry Administration Lease Equipment Total Cost 5100 Variable Per day Total $0.00 $0.00 S54 $275,400 $107,100 $0.00 $223,380 $0.00 $0.00 S605,880 Fixed $55,400 $33,000 $34,900 $24,800 $25.300 $0 $23,800 $32,700 $229,900 Total $55.400 $33,000 $310,300 $131,900 $25.300 $192,720 $23,800 $32,700 5805,120 $43 Charge per patient = _$805,120 5100 = $157.87 Note: Due to fixed cost distribute over a higher number of patient days is the main reason for decrease in charge per patient per day.