Charles Russell, the Chief of Pathology of Lomita Hospital, recently had received a memorandum from the Chairman of the Finance Committee of the hospital's Board of Trustees. The memorandum had been sent to all chiefs of service, and had expressed concern that the results of the most recent period’s operations were considerably worse than budgeted. The main reason for the problem in Dr. Russell’s department seemed to be in the Clinical Pathology Lab. Dr. Russell, along with several other chiefs, had been asked to make a presentation at the next board meeting concerning the role that his department had played in the hospital's poor performance.
In reviewing the budgeted and actual results in the Clinical Pathology Lab, Dr. Russell discovered that almost all of the department's variation from its budget could be attributed to four test types. For reasons of simplicity, he decided to base his presentation to the board on these only.
Since the hospital was operating under a diagnosis-based (DRG) form of reimbursement, it was paid on a per-case basis. The budgeted number of tests, by type, for each DRG had been determined prior to the beginning of the year when the hospital had implemented some clinical protocols. The physicians in Dr. Russell’s department had assisted in developing the protocols by working with physicians in other departments to specify the appropriate kind and number of lab tests for each DRG. However, although the hospital’s case mix to date was more or less as anticipated, the attending physicians had been ordering more tests from the clinical pathology lab than the protocols had stipulated. The result was an increase in the volume of activity in the lab.
Exhibit 1 contains the original budget for these four test types: CBCs, differentials, routine urinalyses, and platelet counts. It also shows the budgeted variable expense per test for the four resources needed to complete a test and report the results: physician time, technician time, regent use, and other supply use. Using these budgeted figures, the unit variable expense had been calculated for each test type. This figure then had been multiplied by the anticipated number of tests to give total variable expenses by test. The lab’s fixed expenses were then added to the total variable expenses obtain the total budget for the accounting period.
Dr. Russell had asked his staff assistant, Asher Hawkins, to use the actual data for the period, as the basis for a report on results for the year. This report was to contain a complete breakdown of the reasons why the lab’s actual expenses diverged from the budgeted ones. The report would be used by Dr. Russell for his presentation to the Board of Trustees.
As Exhibits 1 and 2 indicate, the budget for the period was $401,550. Instead, however, the Department actually had incurred expenses of $414,950, which did not seem like much of a difference to Mr. Hawkins. However, after preparing a flexible budget (Exhibit 3), he had become . . .
- Be sure you understand how Exhibits 2 and 3 were prepared. Do you agree with Mr. Hawkins' analyses so far?
- Besides changes in the number of tests, what are the reasons why actual results might have diverged from budget?
- Calculate the variance associated with each of the reasons you gave in Question 2. How, if at all, might this information be used by Dr. Russell in managing the Department? How might it be used by the hospital's administration?
- What information concerning cases, costs, and revenues would you suggest Dr. Russell see on a regular basis?