Cost System Choices, Budgeting, and Variance Analyses for Sacred Heart Hospital

The Two Cost Systems

Sacred Heart Hospital (SHH) faces skyrocketing nursing costs, all of which relate to its two biggest nursing service linesthe Emergency Room (ER) and the Operating Room (OR). SHH's current cost system assigns total nursing costs to the ER and OR based on the number of patients serviced by each line. Total hospital annual nursing costs for these two lines are expected to equal $300,000. The table below shows expected patient volume for both lines.

Measure	ER			OR			Total
Number of patients (ER visits or OR surgeries)		1,000			1,000			2,000
Number of vital signs checks		2,000			4,000			6,000
Number of nursing hours		10,000			5,000			15,000

Required:

1. Using the current cost system, calculate the hospital-wide rate based on number of patients.

$fill in the blank 1 per patient

2. Calculate the amount of nursing costs that the current cost system assigns to the ER and to the OR.

The nursing cost, assigned to the ER	$fill in the blank 2
The nursing cost, assigned to the OR	$fill in the blank 3

3. Using the results from Requirement 2, calculate the cost per OR nursing hour under the current cost system. $fill in the blank 4 per OR hour

After discussion with several experienced nurses, Jack Bauer (SHHs accountant) decided that assigning nursing costs to the two service lines based on the number of times that nurses must check patients vital signs might more closely match the underlying use of costly hospital resources. Therefore, for comparative purposes, Jack decided to develop a second cost system that assigns total nursing costs to the ER and OR based on the number of times nurses check patients vital signs. This system is referred to as the vital-signs costing system. The earlier table also shows data for vital signs checks for lines.

4. Using the vital-signs costing system, calculate the hospital-wide rate based on the number of vital signs checks. $fill in the blank 5 per vital signs check

5. Calculate the amount of nursing costs that the vital-signs costing system assigns to the ER and to the OR.

The vital-signs cost, assigned to the ER	$fill in the blank 6
The vital-signs cost, assigned to the OR	$fill in the blank 7

6. Using the results from Requirement 5, calculate the cost per OR nursing hour under the vital-signs costing system. $fill in the blank 8 per OR hour

Budgeting and Variance Analysis

In an effort to better plan for and control OR costs, SHH management asked Jack to calculate the flexible budget variance (i.e., flexible budget costs - actual costs) for OR nursing costs, including the price variance and efficiency variance. Given that Jack is interested in comparing the reported costs of both systems, he decided to prepare the requested OR variance analysis for both the current cost system and the vital-signs costing system. In addition, Jack chose to use each cost systems estimate of the cost per OR nursing hour as the standard cost per OR nursing hour. Jack collected the following additional information for use in preparing the flexible budget variance for both systems:

Actual number of surgeries performed = 950 Standard number of nursing hours allowed for each OR surgery = 5 Actual number of OR nursing hours used = 5,000 Actual OR nursing costs = $190,000

Enter a favorable variance as a negative amount, and an unfavorable variance as a positive amount. If there is no variance, enter "0" and select "No variance" from the dropdown.

7. For the OR service line, use the information above and the cost per OR nursing hour under the current cost system to calculate the

a. flexible budget variance. (Hint: Use your answer to Requirement 3 as the standard cost per OR nursing hour for the current cost system.) $fill in the blank 9

FavorableUnfavorableNo variance

b. price variance. $fill in the blank 11

FavorableUnfavorableNo variance

c. efficiency variance. $fill in the blank 13

FavorableUnfavorableNo variance

8. For the OR service line, use the information above and the cost per OR nursing hour under the vital-signs costing system to calculate the

a. flexible budget variance. (Hint: Use your answer to Requirement 6 as the standard cost per OR nursing hour for the vital signs cost system.) $fill in the blank 15

FavorableUnfavorableNo variance

b. price variance. $fill in the blank 17

FavorableUnfavorableNo variance

c. efficiency variance. $fill in the blank 19

FavorableUnfavorableNo variance

Discussion of Reported Costs and Variances from the Two Systems

9. Consider SHHs need to control its skyrocketing costs, Jacks discussion with experienced nurses regarding their use of hospital resources, and the reported costs that you calculated from each cost system. Based on these considerations, which cost system (current or vitalsigns) should Jack choose? Briefly explain the reasoning behind your choice.

a.

Vital signsCurrent

costing system should more accurately allocate costs to service lines because its cost allocation base.

b.

BothCurrentVital signs

uses only one cost driver and

both are equallyvital signs are morecurrent system is more

cost effective.

c. The more accurate

vital signscurrent

system should generate a more accurate estimate of the cost per nursing hour, which affects the budgeting process, because the portion of costs allocated to each service line, ER.

10. What does each of the calculated variances suggest to Jack regarding actions that he should or should not take with respect to investigating and improving each variance? Also, briefly explain why the variances differ between the two cost systems.

a. The overall current systems OR flexible budget variance ($47,500) is very

large and unfavorablelarge and favorablesmall and favorablezero

, suggesting that the subvariances (price variance and efficiency variance) should be calculated.

b. The current systems OR price variance ($40,000) is very large and unfavorable, suggesting that the nursing hiring manager negotiated a

badgood

price and that nursing hour pay cuts might be necessary.

c. The current systems OR efficiency variance ($7,500) is

moderate and unfavorablelarge and favorablelarge and unfavorablezero

, suggesting that the operating room manager used too many OR nursing hours for the actual number of surgeries performed.

d. The overall vital signs OR flexible budget variance is

moderate and unfavorablelarge and favorablelarge and unfavorablezero

, and suggests that nothing needs to be investigated further.

e. The vital signs OR price variance ($10,000) is

large and unfavorablelarge and favorablesmall and favorable

large and favorable, suggesting that the nursing hiring manager negotiated a good price.

f. The vital signs OR efficiency variance ($10,000) is

large and unfavorablelarge and favorablesmall and favorablezero

, suggesting that the operating room manager used too many OR nursing hours for the actual number of surgeries performed. In addition, it would be unwise had Jack decided to end the variance analysis after seeing that the flexible budget variance was zero. Only after continuing on with the analysis to calculate the price and efficiency variances would Jack realize that the zero flexible budget variance was the result of two large offsetting variances, both of which likely require further investigation and attention.

g. Overall, the two cost systems produce

differentsame

reported costs of the two service lines, ER and OR. The current system assigns nursing costs equally because the ER and OR have the same number of patients. Alternately, the vital-signs system assigns

twicethrice

as much of the nursing costs to the OR because the OR requires

twicethrice

as many vital signs checks of its patients as the ER does of its patients. In addition, the two systems produce

differentsame

estimates of the cost incurred by the hospital per OR nursing hour. When used as the standard costs in the budgeting process, these

differentsame

reported costs, lead to very different flexible budget variances and price and efficiency variances for the OR service line. Therefore, the managerial accountant should be very careful when constructing a cost system and be sure that the chosen allocation bases are as accurate as possible to match the underlying resource consumption patterns of the business environment. Choosing different cost allocation bases usually will result in differences in reported service line costliness and various variances, which can have ramifications for numerous managers (e.g., purchasing managers responsible for price variances, production managers responsible for efficiency variances, other managers responsible for making service line mix decisions, etc.)