Problem 3.32

Cost Behavior, High-Low Method, Pricing Decision

St. Teresas Medical Center (STMC) offers a number of specialized medical services, including neuroscience, cardiology, and oncology. STMCs 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 Days	4,500 Patient Days
Salaries, nurses	$ 55,000	$ 55,000
Aides	32,000	32,000
Pharmacy	235,700	251,300
Laboratory	120,300	127,200
Depreciation	25,000	25,000
Laundry	20,160	21,600
Administration	27,000	27,000
Lease (equipment)	36,000	36,000

Required:

Classify each cost as fixed, variable, or mixed, using patient days as the activity driver.

Use the high-low method to separate the mixed costs into fixed and variable.

The administrator of the orthopedic center estimated that the center will average 4,300 patient days per month. If the center is to be operated as a nonprofit organization, how much will it need to charge per patient day? How much of this charge is variable? How much is fixed?

Suppose the orthopedic center averages 4,800 patient days per month. How much would need to be charged per patient day for the center to cover its costs? Explain why the charge per patient day decreased as the activity output increased.