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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, 1,800 blood tests and 2,400 smears were performed in the lab.

Small glass plates are used in both types of tests. During the past month, the hospital purchased 12,000 plates at a cost of $56,400. 1,500 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, 1,150 hours of labor time were recorded in the lab at a cost of $21,850.

The lab’s variable overhead cost last month totaled $7,820.

Valley View Hospital has never used standard costs. By searching industry literature, however, you have determined the following nationwide averages for hospital labs:

Plates: Two plates are required per lab test. These plates cost $5.00 each and are disposed of after the test is completed.

Labor: Each blood test should require 0.3 hours to complete, and each smear should require 0.15 hours to complete. The average cost of this lab time is $20 per hour.

Overhead: Overhead cost is based on direct labor-hours. The average rate for variable overhead is $6 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?

Expert Answer

 

1.

Material Price Variance

Item Actual Qty Std Cost Actual Cost Variance
Plates 10500 5 4.7 3150
Material Qty Variance
Item Std Price Std Qty Actual Qty Variance
Plates 5 8400 10500 -10500
Stq Qty = No. of Lab test performed * std. qty of material used
Stq Qty = (1800+2400)*2
Stq Qty = 8400
2.a. Labor Rate Variance
Item Actual Hr Actual Rate Amount Std Hr Std Rate Amount Variance
Labor 1150 19 21850 900 20 18000 3850
Std Hr = No. of Lab test performed * Std Hrs erquired per test
Std Hr = =1800*0.3+2400*0.15
Std Hr = 900
2.a. Labor Efficiency Variance
Item Actual Hr Std Rate Amount Std Hr Std Rate Amount Variance
Labor 1150 20 23000 900 20 18000 5000
2.b.Labor efficiency variance is calculated as the difference between the actual labor hours used to produce an item and the standard amount that should have been used, multiplied by the standard labor rate. If the variance outcome is unfavorable, there will likely to be a review by management to see if the underlying process can be improved to reduce the number of labour hours required. Since Valley View Hospital labour efficiency is favourable as compared to industry standards, we recommend that the current policy should be continued.
3.a. Variable Overhead Rate Variance
Item Actual Hr Actual Rate Amount Std Hr Std Rate Amount Variance
Labor 1150 6.8 7820 900 6 5400 2420 (A)
3.a. Variable Overhead Efficiency Variance
Item Std Hr Std Rate Amount Actual Hr Std Rate Amount Variance
Labor 900 6 5400 1150 6 6900 -1500
3.b. If the direct labor is not efficient at producing the good output, there will be an unfavorable labor efficiency variance. That inefficiency will likely cause additional variable manufacturing overhead—resulting in an unfavorable variable.
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