Exercise 3
Cost Behavior, High-Low Method, Pricing Decision
St. Teresa’s Medical Center (STMC) offers a number of specialized medical services, including
neuroscience, cardiology, and oncology. STMC’s strong reputation for quality medical care
allowed it to branch out into other services. It is now ready to expand its orthopedic services
and has just added a free-standing orthopedic clinic offering a full range of outpatient, surgical,
and physical therapy services. The cost of the orthopedic facility is depreciated on a straight-line
basis. All equipment within the facility is leased.
Since the clinic had no experience with in-patient orthopedic services (for patients recovering
from hip and knee replacements, for example), it decided to operate the orthopedic center fortwo months
before determining how much to charge per patient day on an ongoing basis. As a
temporary measure, the clinic adopted a patient-day charge of $190, an amount equal to the fees
charged by a hospital specializing in orthopedic care in a nearby city.
This initial per-day charge was quoted to patients entering the orthopedic center during the
first two months with assurances that if the actual operating costs of the new center justified it,
the charge could be less. In no case would the charges be more. A temporary policy of billing
after 60 days was adopted so that any adjustments could be made.
The orthopedic center opened on January 1. During January, the center had 4,200 patient
days of activity. During February, the activity was 4,500 patient days. Costs for these two levels of activity
output are as follows:
Salaries, nurses
Aides
Pharmacy
Laboratory
Depreciation
Laundry
Administration
Lease (equipment)
4200 Patient
4,500 Patient
Days
Days
$ 55,000
$ 55,000
32,000
32,000
235,700
251,300
120,300
127,200
25,000
25,000
20,160
21,600
27,000
27,000
36,000
36,000
Required:
1. Classify each cost as fixed, variable, or mixed, using patient days as the activity driver.
2. Use the high-low method to separate the mixed costs into fixed and variable.
3. The administrator of the orthopedic center estimated that the center will average 4,300
patient days per month. If the center is to be operated as a nonprofit organization, how
much will it need to charge per patient day? How much of this charge is variable? How
much is fixed?
4. Suppose the orthopedic center averages 4,800 patient days per month. How much would
need to be charged per patient day for the center to cover its costs? Explain why the charge
per patient day decreased as the activity output increased.