Wednesday 14 November 2012

"What's going on in that lab?" asked Derek Warren, chief administrator for Cottonwood Hospital, as

"What's going on in that lab?" asked Derek Warren, chief administrator for Cottonwood Hospital, as he studied the prior month’s reports. "Every month the lab teeters between a profit and a loss. Are we going to have to increase our lab fees again?"
     "We can't," replied Lois Ankers, the controller. "We're getting lots of complaints about the last increase, particularly from the insurance companies and governmental health units. They're now paying only about 80% of what we bill. I'm beginning to think the problem is on the cost side."
     To determine if lab costs are in line with other hospitals, Mr. Warren has asked you to evaluate the costs for the past month. Ms. Ankers has provided you with the following information:

a.
Two basic types of tests are performed in the lab—smears and blood tests. During the past month, 3,100 smears and 800 blood tests were performed in the lab.
b.
Small glass plates are used in both types of tests. During the past month, the hospital purchased 15,500 plates at a cost of $59,520. This cost is net of a 4% purchase discount. A total of 2,100 of these plates were unused at the end of the month; no plates were on hand at the beginning of the month.
c.
During the past month, 2,100 hours of labor time were used in performing smears and blood tests. The cost of this labor time was $22,785.
d. The lab’s variable overhead cost last month totaled $16,170.

     Cottonwood 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 $4 each and are disposed of after the test is completed.
Labor:
Each smear should require 0.4 hours to complete, and each blood test should require 0.8 hours to complete. The average cost of this lab time is $11.3 per hour.
Overhead:
Overhead cost is based on direct labor-hours. The average rate of variable overhead is $7.2 per hour.

Required:
1.
Compute the materials price variance for the plates purchased last month, and compute a materials quantity variance for the plates used last month. (Input all amounts as positive values. Leave no cells blank - be certain to enter "0" wherever required. Indicate the effect of each variance by selecting "F" for favorable, "U" for unfavorable, and "None" for no effect (i.e., zero variance). Omit the "$" sign in your response.)

  Materials price variance     F
  Materials quantity variance     U


2. For labor cost in the lab:

a.
Compute a labor rate variance and a labor efficiency variance. (Input all amounts as positive values. Leave no cells blank - be certain to enter "0" wherever required. Indicate the effect of each variance by selecting "F" for favorable, "U" for unfavorable, and "None" for no effect (i.e., zero variance). Omit the "$" sign in your response.)

  Labor rate variance     F
  Labor efficiency variance     U


b.
In most hospitals, three-fourths of the workers in the lab are certified technicians and one-fourth are assistants. In an effort to reduce costs, Cottonwood Hospital employs only one-half certified technicians and one-half assistants. Would you recommend that this policy be continued?
No

3a.
Compute the variable overhead rate and efficiency variances. (Input all amounts as positive values. Leave no cells blank - be certain to enter "0" wherever required. Indicate the effect of each variance by selecting "F" for favorable, "U" for unfavorable, and "None" for no effect (i.e., zero variance). Omit the "$" sign in your response.)

  Variable overhead rate variance     U
  Variable overhead efficiency variance     U


3b.
Is there any relation between the variable overhead efficiency variance and the labor efficiency variance?
Yes


Explanation: 1.
The standard quantity of plates allowed for tests performed during the month would be:

  Smears 3,100  
  Blood tests 800  
  
  Total 3,900  
  Plates per test ×3  
  
  Standard quantity allowed 11,700  
  



The variance analysis for plates would be:

Standard Quantity Allowed
for Actual Output,
at Standard Price
Actual Quantity of
Input, at
Standard Price
Actual Quantity
of Input,
at Actual Price
(SQ × SP) (AQ × SP) (AQ × AP)
11,700 plates ×
$4 per plate
13,400 plates ×
$4 per plate
= $46,800 = $53,600 $59,520
Materials quantity

variance = $6,800 U

15,500 plates ×

$4 per plate

= $62,000    

Materials price variance
= $2,480 F

Note that all of the price variance is due to the hospital’s 4% quantity discount. Also note that the $6,800 quantity variance for the month is equal to nearly 15% of the standard cost allowed for plates. This variance may be the result of using too many assistants in the lab.

2.
a.
The standard hours allowed for tests performed during the month would be:

  Smears: .4 hour per test × 3,100 tests 1,240  
  Blood tests: .8 hour per test × 800 tests 640  
  
  Total standard hours allowed 1,880  
  



The variance analysis of labor would be:

Standard Hours Allowed
for Actual Output,
at Standard Rate
Actual Hours
of Input,
at Standard Rate
Actual Hours
of Input,
at Actual Rate
(SH × SR) (AH × SR) (AH × AR)
1,880 hours ×
$11.3 per hour
2,100 hours ×
$11.3 per hour
= $21,244    = $23,730 = $22,785
Labor efficiency variance
= $2,486 U
Labor rate variance
= $945 F

Spending Variance = $1,541 U


2.
b.
The policy probably should not be continued. Although the hospital is saving $0.45 per hour by employing more assistants relative to the number of senior technicians than other hospitals, this savings is more than offset by other factors. Too much time is being taken in performing lab tests, as indicated by the large unfavorable labor efficiency variance. And, it seems likely that most (or all) of the hospital's unfavorable quantity variance for plates is traceable to inadequate supervision of assistants in the lab.

3a.

The variable overhead variances follow:

Standard Hours Allowed
for Actual Output,
at Standard Rate
Actual Hours
of Input,
at Standard Rate
Actual Hours
of Input,
at Actual Rate
(SH × SR) (AH × SR) (AH × AR)
1,880 hours ×
$7.20 per hour
2,100 hours ×
$7.20 per hour
= $13,536     = $15,120 $16,170
Variable overhead
efficiency variance
= $1,584 U
Variable overhead
rate variance
= $1,050 U

Spending variance = $2,634 U


3b.
Yes, the two variances are related. Both are computed by comparing actual labor time to the standard hours allowed for the output of the period. Thus, if there is an unfavorable labor efficiency variance, there will also be an unfavorable variable overhead efficiency variance.

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