SunQuest Labs

Marc Gillinov, president of SunQuest Labs, was reviewing summary cost reports early in January 2018 when the data for the blood-testing facility caught his eye.

Blood-testing Facility Summary

2016

2017

Variance

Testing Materials

$ 29,000

$34,000

$5,000 U

Direct Labor

455,000

609,000

154,000 U

Lab Overhead

Variable:

Indirect Labor

39,500

10,500

(29,000) F

Utilities

32,720

36,295

3,575 U

Other

12,520

16,695

4,175 U

Fixed:

Supervision

40,000

40,000

Depreciation

25,000

50,000

25,000 U

Lab Rent

72,000

78,000

6,000 U

Other

8,460

14,900

6,440 U

General Burden

73,700

84,500

10,800 U

Total

$787,900

$973,890

$185,990 U

Mr. Gillinov was surprised and a bit disappointed at the cost increases shown. The only area which seemed to have improved was indirect labor. He immediately requested an in-depth investigation. This investigation produced the following information.

The blood-testing facility performs two types of laboratory tests, a basic CBC test (complete blood count), and a more extensive CMP(comprehensive metabolic panel).These tests require different amounts of testing materials, where testing materials are purchased from suppliers as a bundled test kit. A CMP requires more testing material since it is more extensive, The supervisor for the lab explained that CMP tests use two test kits whereas the CBC test used only one test kit, when the lab operated at normal efficiency. An investigation of the records indicated that 145,000 kits had been used in the lab in 2016, and 136,000 kits in 2017.The price of testing kits has gone up due to the use of petroleum byproducts in its manufacture. In 2016, one testing kit actually cost about $.20; the actual cost in 2017 was $.25. The expected cost of one testing kit was $.18 in 2016, this expected cost of one testing kit rose 33% in in 2017.

The amount of direct labor required to perform a CMP is twice as much as that required for a CBC test. The supervisor allowed that, under normal conditions, the lab could perform four CBC tests per labor hour. Since the skill level required to conduct these tests is the same, the work force was regularly rotated between the two tasks, reducing boredom and promoting better labor relations. Union pressure has resulted in steadily rising wage rates. In 2016, the hourly rate averaged $16.00; in 2017 it rose 25%. Poor work scheduling and the unpredictable nature of testing demand the last few years sometimes required the use of a night shift, which received a 10% premium. It is the company's policy to avoid night-shift work whenever possible. A payroll investigation showed that 28,000 hours were paid in 2016, and 30,400 were paid in 2017.

This case (suggested by a similar exercise written by Professor Robert Jaedicke of the Stanford Business School) was written by Professor Jeff Schatzberg of the Eller College of Management at the University of Arizona.

General burden (overhead) is an allocated cost. The costs for accounting, personnel, and other administrative departments are allocated to the various lab facilities on the basis of total labor dollars for indirect labor. Total general overhead for the company was $880,600 in 2016 and $836,500 in 2017. The total indirect labor cost for all production departments was $950,000 in 2016 and $500,000 in 2017.

During 2017, SunQuest purchased a new sterilization system, which helped to automate and expedite the testing process. This resulted in eliminating two workers who were included in indirect labor expense. The decision to install the new system was made using a capital budgeting analysis which assigned a 10-year life to the equipment. A full year's depreciation was taken for 2017.

Lab overhead, both variable and fixed, is also an allocated cost. Since the amount of overhead incurred is largely a function of the level of capacity utilization in the lab, the amount of overhead is allocated to lab facilities based on direct labor hours. For variable factory overhead, the rate in 2016 was $2.50/hr., while in 2017 it was $2.00/hr. For fixed factory overhead, the total budgeted fixed factory overhead was $135,000 in 2016, while in 2017 it was $180,000.

A check of actual lab records showed the following:

2016*

2017*

CBC tests

28,000

40,000

CMP tests

40,000

40,000

*These quantities also represent denominator levels

REQUIRED

1.Prepare the analysis of cost variations between 2016 and 2017 requested by Mr. Gillinov.

2Should the lab manager be commended or criticized for cost center performance?