1. Assuming McCullough uses only one predetermined overhead rate, calculate — Hospital job-order costing system assign costs its patients direct materials include variety

McCullough Hospital uses a job-order costing system to assign costs to its patients. Its direct materials include a variety of items such as pharmaceutical drugs, heart valves, artificial hips, and pacemakers. Its direct labor costs (e.g., surgeons, anesthesiologists, radiologists, and nurses) associated with specific surgical procedures and tests are traced to individual patients. All other costs, such as depreciation of medical equipment, insurance, utilities, incidental medical supplies, and the labor costs associated with around-the-clock monitoring of patients are treated as overhead costs.

Historically, McCullough has used one predetermined overhead rate based on the number of patient-days (each night that a patient spends in the hospital counts as one patient-day) to allocate overhead costs to patients. Recently a member of the hospital’s accounting staff has suggested using two predetermined overhead rates (allocated based on the number of patient-days) to improve the accuracy of the costs allocated to patients. The first overhead rate would include all overhead costs within the Intensive Care Unit (ICU) and the second overhead rate would include all Other overhead costs. Information pertaining to the hospital’s estimated number of patient-days, its estimated overhead costs, and two of its patients—Patient A and Patient B—is provided below:

Required:

1. Assuming McCullough uses only one predetermined overhead rate, calculate:

a. The predetermined overhead rate.

b. The total cost, including direct materials, direct labor and applied overhead, assigned to Patient A and Patient B.

2. Assuming McCullough calculates two overhead rates as recommended by the staff accountant, calculate:

a. The ICU and Other overhead rates.

b. The total cost, including direct materials, direct labor and applied overhead, assigned to Patient A and Patient B.

3. What insights are revealed by the staff accountant’s approach?

SOLUTION

1. a. The first step is to calculate the total estimated overhead costs in ICU and Other:

ICU: Using the equation Y = a + bX, the estimated total overhead cost would be calculated as follows:

Y = $3,200,000 + ($236 per patient-day) (2,000 patient-days)

	Estimated fixed overhead	$3,200,000
	Estimated variable overhead: $236 per patient-day × 2,000 patient-days	472,000
	Estimated total overhead cost	$3.672,000

Other: Using the equation Y = a + bX, the estimated total overhead cost would be calculated as follows:

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Y = $14,000,000 + ($96 per patient-day) (18,000 patient-days)

	Estimated fixed overhead	$14,000,000
	Estimated variable overhead: $96 per patient-day × 18,000 patient-days	1,728,000
	Estimated total overhead cost	$15.728,000

The second step is to combine the estimated overhead costs in ICU and Other ($3,672,000 + $15,728,000 = $19,400,000) to enable calculating the predetermined overhead rate as follows:

Estimated total overhead (a)	$19,400,000
Estimated total patient-days (b)	20,000	patient-days
Predetermined overhead rate (a) ÷ (b)	$970	per patient-day
	b. The total cost assign to Patients A and B is computed as follows:

	Patient A	Patient B
Direct materials	$ 4,500	$ 6,200
Direct labor	25,000	36,000
Overhead applied ($970 per patient-day × 14 patient days; ($970 per patient-day × 21 patient days)	13,580	20,370
Total cost	$43,080	$62,570
2.	a. The overhead rate in ICU is computed as follows:

Y = $3,200,000 + ($236 per patient-day) (2,000 patient-days)

	Estimated fixed overhead	$3,200,000
	Estimated variable overhead: $236 per patient-day × 2,000 patient-days	472,000
	Estimated total overhead cost	$3,672,000

The predetermined overhead rate is computed as follows:

	Estimated total overhead (a)	$3,672,000
	Estimated total patient-days (b)	2,000	patient-days
	Predetermined overhead rate (a) ÷ (b)	$1,836	per patient-day

The overhead rate in Other is computed as follows:

Y = $14,000,000 + ($96 per patient-day) (18,000 patient-days)

	Estimated fixed overhead	$14,000,000
	Estimated variable overhead: $96 per patient-day × 18,000 patient-days	1,728,000
	Estimated total overhead cost	$15,728,000

The predetermined overhead rate is computed as follows:

	Estimated total overhead (a)	$15,728,000
	Estimated total patient-days (b)	18,000	patient-days
	Predetermined overhead rate (rounded) (a) ÷ (b)	$873.78	per patient-day

The total cost assigned to Patient A:
Direct materials		$ 4,500
Direct labor		25,000
ICU ($1,836 per patient-day × 0 patient-days)	$ 0
Other ($873.78 per patient day × 14 patient-days) (rounded to nearest dollar)	12,233	12,233
Total cost assigned to Patient A		$41,733

	The total cost assigned to Patient B:
	Direct materials		$ 6,200
	Direct labor		36,000
	ICU ($1,836 per patient-day × 7 patient-days)	$12,852
	Other ($873.78 per patient day × 14 patient-days) (rounded to nearest dollar)	12,233	25,085
	Total cost assigned to Patient B		$67,285
3.	Relying on just one predetermined overhead rates overlooks the fact that some departments are more intensive users of overhead resources than others. As the name implies, patients in the ICU require more intensive (and expensive) care than other patients in other departments. Broadly, speaking, relying on only one overhead rate, will most likely over cost patients with less severe illnesses and under cost patients with more severe illnesses.