CASE 6-49 (Page 273)

Refer to the data and accompanying information in the preceding case.

Month Patient Load Administrative cost

January...................................................... 1400..............................................................
13900 February...................................................
500................................................................ 7000
March......................................................... 400..............................................................
6000 April...........................................................
1000................................................................ 10000
May............................................................ 1300..............................................................
11900 June.............................................................
900............................................................. 9200
July.............................................................. 1100..................................................................
10200 August.......................................................
300................................................................... 4100
September................................................ 700............................................................
9400 October......................................................
1200.............................................................. 11100
November................................................ 600.................................................................
8300 December..................................................
1500............................................................... 16100

Required:
1. Use the high-low method to estimate the cost behavior for the clinic’s administrative costs.
Express the cost behavior in formula form (Y = a + bX). What is the variable cost per patient?
Solution:
High-Low Method Formula
y 2− y 1
Variable Cost per unit ¿
x 2−x 1
y 2=denotes total cost at highest level of activity ($ 16,100)
y 1=denotes total cost at lowest level of activity ( $ 4,100)
x 2=number of units at highest level of activity (1,500)
x 1=number of units at lowest level of activity (300)
y 2− y 1
Variable Cost per unit ¿
x 2−x 1
16,100−4,100
=
1,500−300
12,000
=
1,200
= $10
Variable cost per unit = $10 per patient loaded.

Total variable costs for 300 patients are :

=Variable Cost Per Unit x No of Units At Lowest Level
 = 10 x 300
= $3,000
Total variables cost = $3,000

Total cost for August month = $4,100

Fixed cost for 300 patients is :
= Total Cost −Total Variable Cost
= 4,100−3,000
= $ 1,100
Fixed cost for 300 patients = $1,100
The relationship between cost of administrative department (Y axis) and the number of patient
loaded (X axis) for the mixed cost behaviour pattern is mathematically express as:
Y = a + bX
Where :
Y = denotes administrative cost
X = number of patient loaded
a = denotes fixed cost
b = denotes variable cost per patient
So, the cost behaviour in a mathematically expression using High Low Method is:
Y = $1,100 + $10X

2. Build a spreadsheet: Construct an Excel spreadsheet and use the Excel commands to perform a
least-squares regression and estimate the administrative cost behavior. Express the cost behavior
in formula form. What is the variable cost per patient? Compute and interpret the R2 value for the
regression.
Solution :

Variable cost per patient (Slope) = $9.66

Total fixed cost (Intercept) = $795 per month
Coefficient regression (R2) = $0.97

3. Write a memo to the hospital administrator comparing the cost estimates using (a) least-squares
regression, (b) the high-low method, and (c) the scatter diagram and visually fit semivariable-
cost line from the preceding case (requirement (4). Make a recommendation as to which estimate
should be used, and support your recommendation. Make any other suggestions you feel are
appropriate.
Solution:
Memo to Hospital Administrator
Date : 30th July 2015
 To : Administrator of VGH
From :
RE : Concern about (company’s) compliance with comparison of cost estimates. I am concerned
about how we (company) should adopt method for cost estimation. I have determined the fixed
cost, variable cost per unit using three methods i.e. Scatter method using visually fit semi variable
cost line, high-low method and least squares regression method.
The details for each method are shown before :

Sr.No Method Fixed Variable Cost per Unit

Cost
1. Scatter diagram and visually fit semi $6,200 $3.50
variable cost line (Minimum 600 patients
estimated)
2. High-Low $1,100 $10.00
3. Least Square Regression Using Microsoft $795 $9.66
Excel

All the three methods shown above can be used to estimate the fixed cost and variable cost. Each
has its own advantage and disadvantage. The choice of selecting method depends on the
situations at hand.
I have compared all three methods which are shown below :
The scatter graph : considers all the data points in estimation fixed and variable cost. This
method gives an opportunity to review all the data points by drawing it visually fit cost line. This
line helps to identify outliers which are far away from the line compared to other data points. This
line is based on person judgment and guesswork. So the final answer is just the estimations.
High low method : uses historical information from various past reports. It is quick, simple and
easy to estimate fixed and variable cost. This data points does not represent data as a whole which
results in wrong estimation. So the analyst will follow up the additional method for more accurate
result.
Least square regression method : uses mathematical expression for the best possible fit cost
line. This method is more accurate compared to other methods in estimation of fixed and variable
cost. Company uses Least square regression through computer software like Microsoft Excel.
I would like to recommend the scatter graph as high low method and least square regression
method are highly influenced more through outside the relevant range. So both of this method
does not fit into current situation about how administrative cost should behave within relevant
range.
Once the second year of hospital completes, least square regression method within the relevant
range should be used which gives a accurate and uniformity from all the three methods to derive
at future cost.

4. After receiving the memo comparing the three cost estimates, Mahoney called McDonough to
dis- cuss the matter. The following exchange occurred.

Mahoney: “As you know, Megan, I was never in favor of this clinic. It’s going to be a drag on our
administrative staff, and we’d have been far better off keeping the pediatrics operation here in the
hospital.”
McDonough: “I was aware that you felt the clinic was a mistake. Of course, the board of trustees
had other issues to consider. I believe the board felt the clinic should be built to make pediat- ric
care more accessible to the economically depressed area on the other side of the city.”

Mahoney: “That’s true, but the board doesn’t realize how difficult it’s going to make life for us
here in the hospital. In any case, I called to tell you that when you and I report to the board next
week, I’m going to recommend that the clinic be shut down. I want you to support my
recommendation with one of your cost estimates showing that administrative costs will soar at
high activity levels.”

McDonough: “But that estimate was based on the high-low method. It’s not an appropriate
method for this situation.”

Mahoney: “It is an estimate, Megan, and it’s based on a well-known estimation method. This is
just the ammunition I need to make the board see things my way.”

McDonough: “I don’t know, Jeff. I just don’t think I can go along with that.” Mahoney: “Be a
team player, Megan. I’ve got a meeting now. Got to run.”

That night McDonough called to discuss the matter with her best friend, you. What would you
advise her?

Solution :

Yes, it is rightly said that each method has its own advantage and disadvantage. The choice of
selecting method depends on the situation at hand. Firstly the number of patients should be in
between the relevant range. So that patient load would be stable. This will clear the patients
confusion regarding date and time of visiting clinic and emergency room. Certain number of
administrative staff should be fixed within the relevant range. If the number of patients lies below
or above the relevant range, accordingly the administrative staff should be appointed for
temporary basis.

As continuity is concerned, it is board of trustee’s decision on whether to continue or discontinue

the operation in the clinic. Before arriving to any decision, board should gather all the true and
fair information including estimation of administrative cost.

M, the director of cost management has some responsibility towards hospital such as disclosing
all relevant information, true and fairness, integrity, competence, honesty, etc. M, should present
the best possible method in the front of the board trustee’s.

As far as adoption of method is concerned, scatter diagram and least square regression method
should be use. Scatter diagram gives a cost equation that best fits a line to data points and least
square regression method should also be adopted with consideration of relevant range. This will
give you more specific and clear estimation to determine administrative cost. This will reflect the
prediction of future cost, pricing strategies, growth prospectus, cost control, etc.