# \$30

## Example 17A: Variance Analysis

Our variance analysis example and practice exercise use the flexible budget approach. A flexible budget is one that is created using budgeted revenue and/or budgeted cost amounts. A flexible budget is adjusted, or flexed, to the actual level of output achieved (or perhaps expected to be achieved) during the budget period. A flexible budget thus looks toward a range of activity or volume (versus only one level in the static budget).

Examples of how the variance analysis works are contained in Figure 17–1 (the elements), in Figure 17-2 (the composition), and in Figures 17–3 and 17–4 (the calculations). Study these examples before undertaking the Practice Exercise.

We have restated Exhibit 17–2 in a worksheet format for purposes of this example. The new format appears as follows. (The numbers have not changed.)

 Actual Cost \$920,000 Less: Flexible Budget 990,000 Price Variance (favorable) \$ 70,000 Budgeted Cost \$937,500 Less: Flexible Budget 990,000 Quantity Variance (unfavorable) − \$52,500 Net Variance (favorable) \$ 17,500

Assumptions (refer to Exhibit 17-2)

divided by

# Therapy Minutes (Activity Level)

equals

Cost per Therapy Minute

Actual

(1) \$920,000

(3) 330,000

(5) \$2.79

Budgeted

(2) \$937,500

(4) 312,500

(6) \$3.00

## Practice Exercise 17–1

Exhibit 17–2 presents the Variance Analysis for hospital rehab services for the third quarter. For our practice exercise we will duplicate this report for the fourth quarter. We are able to reformat the information in Exhibit 17–2 into a worksheet as follows. The fourth quarter assumptions appear below the worksheet.

 Actual Cost Less: Flexible Budget Price Variance (favorable) Budgeted Cost Less: Flexible Budget Quantity Variance (unfavorable) Net Variance (unfavorable)

Assumptions

divided by

# Therapy Minutes (Activity Level)

equals

Cost per Therapy Minute

Actual

(1) \$950,000

(3) 350,000

(5) \$2.71

Budgeted

(2) \$930,000

(4) 310,000

(6) \$3.00

## Required

• 1. Set up a worksheet for the fourth quarter like that shown in Exhibit 17–2 for the third quarter.
• 2. Insert the Fourth Quarter Input Data (per assumptions given above) on the worksheet.
• 3. Complete the “Actual Cost,” “Flexible Budget,” and “Budgeted Cost” sections at the top of the worksheet.
• 4. Compute the Price Variance and the Quantity Variance in the middle of the worksheet.
• 5. Indicate whether the Price and the Quantity Variances are favorable or unfavorable for the fourth quarter.

## Optional

Can you compute how the \$950,000 actual overhead costs and the \$930,000 budgeted overhead costs were calculated?

## Assignment Exercise 17–1: Variance Analysis

Greenview Hospital operated at 120% of normal capacity in two of its departments during the year. It operated 120% times 20,000 normal capacity direct labor nursing hours in routine services and it operated 120% times 20,000 normal capacity equipment hours in the laboratory. The lab allocates overhead by measuring minutes and hours the equipment is used; thus equipment hours.

Assumptions:

For Routine Services Nursing:

•  20,000 hours × 120% = 24,000 direct labor nursing hours.
•  Budgeted Overhead at 24,000 hours = \$42,000 fixed plus \$6,000 variable = \$48,000 total.
•  Actual Overhead at 24,000 hours = \$42,000 fixed plus \$7,000 variable = \$49,000 total.
•  Applied Overhead for 24,000 hours at \$2.35 = \$56,400.

For Laboratory:

•  20,000 hours × 120% = 24,000 equipment hours.
•  Budgeted Overhead at 24,000 hours = \$59,600 fixed plus \$11,400 variable = \$71,000 total.
•  Actual Overhead at 24,000 hours = \$59,600 fixed plus \$11,600 variable = \$71,200 total.
•  Applied Overhead for 24,000 hours at \$3.455 = \$82,920.

## Required

• 1. Set up a worksheet for applied overhead costs and volume variance with a column for Routine Services Nursing and a second column for Laboratory.
• 2. Set up a worksheet for actual overhead costs and budget variance with a column for Routine Services Nursing and a second column for Laboratory.
• 3. Set up a worksheet for volume variance and budget variance totaling net variance with a column for Routine Services Nursing and a second column for Laboratory.
• 4. Insert input data from the Assumptions.
• 5. Complete computations for all three worksheets.

## Example 17B

Review the “Sensitivity Analysis Overview” section and Figure 17–5 in Chapter 17.

## Assignment Exercise 17–2: Three-Level Revenue Forecast

Three eye-ear-nose-and-throat physicians decide to hire an experienced audiologist in order to add a new service line to their practice.* They ask the practice manager to prepare a three-level volume forecast as a first step in their decision-making.

Assumptions: for the base level (most likely) revenue forecast, assume \$200 per procedure times 4 procedures per day times 5 days equals 20 procedures per week times 50 weeks per year equals 1,000 potential procedures per year.

For the best case revenue forecast, assume an increase in volume of one procedure per day average, for an annual increase of 250 procedures (5 days per week times 50 weeks equals 250). (The best case is if the practice gains a particular managed care contract.)

For the worst case revenue forecast, assume a decrease in volume of 2 procedures per day average, for an annual decrease of 500 procedures. (The worst case is if the practice loses a major payer.)

*Audiologists were designated as “eligible for physician and other prescriber incentives” as discussed elsewhere. Thus the new service line was a logical move.

## Required

Using the above assumptions, prepare a three-level forecast similar to the example in Figure 17–5and document your calculations.

## Practice Exercise 17–II

Closely study the chapter text concerning target operating income.

The necessary inputs for target operating income include the following:

•  Desired (target) operating income amount = \$20,000
•  Unit price for sales = \$500
•  Variable cost per unit = \$300
•  Total fixed cost = \$10,000

Compute the required revenue to achieve the target operating income and compute a contribution income statement to prove the totals.

## Assignment Exercise 17–3: Target Operating Income

Acme Medical Supply Company desires a target operating income amount of \$100,000, with assumption inputs as follows:

•  Desired (target) operating income amount = \$100,000
•  Unit price for sales = \$80
•  Variable cost per unit = \$60
•  Total fixed cost = \$60,000

Compute the required revenue to achieve the target operating income and compute a contribution income statement to prove the totals.

## Assignment Exercise 18–1: Estimate of Loss

You are the practice manager for a four-physician office. You arrive on Monday morning to find the entire office suite flooded from overhead sprinklers that malfunctioned over the weekend. Water stands ankle-deep everywhere. The computers are fried and the contents of all the filing cabinets are soaked. Your own office, where most of the records were stored, has the worst damage.

The practice carries valuable papers insurance coverage for an amount up to \$250,000. It is your responsibility to prepare an estimate of the financial loss so that a claim can be filed with the insurance company. How would you go about it? What would your summary of the losses look like?

## Assignment Exercise 18–2: Estimate of Replacement Cost

The landlord carries contents insurance that should cover the damage to the furnishings, equipment, and to the computers, and the insurance company adjuster will come tomorrow to assess the furnishings and equipment damage. However, your boss is sure that the insurance settlement will not cover replacement costs. Consequently, you have been instructed to prepare an estimate of what has been lost and/or damaged plus an estimate of what the replacement cost might be. How would you go about it? What would your summary of these losses look like?

## Assignment Exercise 18–3: Benchmarking

Review the chapter text about benchmarking.

## Required

• 1. Select an organization: either from the Case Studies in Chapters 2728 or from one of the Mini-Case Studies in Chapters 2931.
• 2. Prepare a list of measures that could be benchmarked for this organization. Comment on why these items are important for benchmarking purposes.
• 3. Find another example of benchmarking for a healthcare organization. The example can be an organization report or it can be taken from a published source such as a journal article.

|