Question

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 4,200 patient days of activity. During February, the activity was 4,500 patient days. Costs for these two levels of activity output are as follows: 4,200 Patient 4,500 Patient Days Days Salaries, nurses $ 55,000 32,000 $ 55,000 32,000 Aides Pharmacy 235,700 251,300 Laboratory 120,300 127,200 25,000 Depreciation 25,000 Laundry 20,160 21,600 Administration 27,000 27,000 Lease (equipment) 36,000 36,000

Question options

1. Fixed, mixed, variable

4. the fixed cost per patient day is reduced, the total fixed costs have changed, the variable cost per patient day decreases

Answer 1

1. Classification of Each Cost. Based on behavior, costs are categorized as either fixed, variable or mixed. Fixed costs are those which do not change with the level of activity within the relevant range. Variable costs change in direct proportion to the level of production/activity. Mixed costs or semi-variable costs have properties of both fixed and variable costs due to the presence of both variable and fixed components in them. Particulars Salaries, Nurses Aides Pharmacy Laboratory Depreciation Laundry Administration Lease (equipment) Cost Fixed Fixed Mixed Mixed Fixed Variable Fixed Fixed 2. Separation of Mixed Cost using High-Low Method. Laboratory Variable Cost = Change in Cost Change in patient days = (127200 - 120300)/(4500 - 4200) = 6900/300 Variable Cost = $23 per patient day. Fixed Cost = 127200 - 4500*23) = 127200 - 103500 Fixed Cost = $ 23,700 Pharmacy Variable Cost = Change in Cost Change in patient days = (251300-235700)/(4500 - 4200) = 15600/300 Variable Cost = $ 52 per patient day. Fixed Cost = 251300 - (4500*52) = 251300 - 234000 Fixed Cost = $ 17,300 3. Calculation of Charge per Patient per Day (4300 Patient days). Amount ($) $55,000 $32.000 $25,000 $27,000 $36,000 Particulars Fixed Salaries, Nurses Aides Depreciation Administration Lease (Equipment) Mixed Pharmacy Laboratory Total Fixed Cost Divide by No. of Patient Days Fixed Charges per Patient Day (A) $17,300 $23 700 $216,000 4300 $50.23 Variable Laundry ($20,160/4200) Pharmacy Laboratory $4.80 $52.00 $23.00 Variable Charges per Patient Day (B) $79.80 Total Charges per Patient Day (A+B) $130.03 4. Calculation of Charge per Patient per Day (4800 Patient days). Amount ($) Particulars Fixed Salaries, Nurses Aides Depreciation Administration Lease (Equipment) Mixed Pharmacy Laboratory Total Fixed Cost Divide by No. of Patient Days $55,000 $32,000 $25,000 $27,000 $36,000 $17,300 $23,700 $216,000 4800 Fixed Charges per Patient Day (A) $45.00 Variable Laundry ($20,160/4200) Pharmacy Laboratory $4.80 $52,00 $23.00 Variable Charges per Patient Day (B) $79.80 Total Charges per Patient Day (A+B) $124.80 The main reason for the decrease of the charges per patient day (From $130.03 to $124.80) is the reduction in Fixed Cost per Patient Day. The main characteristic of the Fixed Cost is that it does not change with change in activity level, it remains the same with the relevant range. However, the Fixed Cost per unit decreases with an increase in the level of production/activity. The reason for the decrease in Fixed Cost per unit is that now the same total fixed cost is spread over more number of units with an increase in production/activity level.