# Variance Analysis in the Hospitals

Subject: Administration and Regulation 4 936 4 min College

Variance analysis is a tool used in all organizations, for-profit and non-profit alike. In healthcare, there are several major factors to be considered that affect budget variance. The size of the hospital and the actual utilization of healthcare services are the main factors that affect budget estimations and actual costs (Dove & Forthman, 1995). Variance analysis begins by specifying an appropriate total cost model, identifying the definitional relationship, and highlighting the difference between two sets of results. Cost totals are estimated to be different for each of the individual components and in total.

## Methods of Variance Analysis

When performing a variance analysis using the cost method, the total cost is separated into two subgroups. These subgroups include direct and indirect costs (Berger, 2011). If an activity involves the manufacturing of a good, there are also fixed and variable costs. The cost method is efficient in calculating and analyzing costs comparative to the volume of production.

Budgets are constructed using previous variance reports as well as standard costing defined by estimated operating rates (Druri, 2017). The standard costing method helps to identify the quantity of the materials used in the production or provision of a service, as well as labor expenses associated with the effort. This method is best used in production plants due to relatively standardized material costs, labor, and the uniformity of products (Druri, 2017). It is highly efficient at representing production quantity standards and helps in forecasting and adapting to market changes and price standards. The main variables in this method materials, labor, and overhead quantity of production.

The standard costing method is used to outline achievable goals for departments and base the budgets for these departments on product costs. This method deals with variables over which an organization has control. When constructing a variance report using the standard costing method, each element, material, labor, and overhead quantity for every service and line of product has a predetermined cost. Such a variance report involves the following (Ebisike, 2012):

• The setting of standards of quality of production. These standards are used to achieve the uniformity of product, and thus, the uniformity of cost.
• Estimation of actual costs involved in the production or service performance.
• Comparative analysis of actual and standard costs. The variance is calculated by deducting the actual costs from the standard costs.
• Variance analysis. During this stage, every individual variance is investigated to determine the appropriate action to eliminate or reduce variance.

One of the main purposes of management is control over the processes and expenses associated with them. Variance analysis is one of the essential tools to facilitate that function. Some variances are caused by internal issues and are controllable, while others may be caused by external factors, over which the company has little to no control.

Based on the vector of the issue (internal or external), managers can make decisions to either eliminate, reduce, or adapt to the issue. Hospitals typically use a post-factum flexible budget variance analysis, which uses the volume of treated patients as its primary characteristic (Dove & Forthman, 1995). Budgets are calculated using a predicted volume of patients.

## Hospital Variance Analysis

Here is an example of hospital variance analysis in a simplified form:

 Expenses Actual expenses Budget expenses Variance Salaries (regular payments) \$43.000 \$38.000 -\$5.000 Salaries (overtime compensation) \$700 \$900 \$200 FICA (for regular payments) \$3.000 \$2.700 -\$300 FICA (for overtime compensation) \$280 \$250 -\$300 Insurance payments \$90 \$80 -\$10 Other related expenses \$140 \$160 \$20 Total Employment Cost \$47.210 \$42.090 -\$5.120 Medical and patient care supplies \$2.000 \$1.800 -\$200 Office-related expenses \$450 \$550 \$100 Educational seminar expenses \$135 \$50 -\$85 Non- capital equipment \$250 \$75 -\$175 Repair and maintenance costs \$30 \$70 \$40 Other related expenses \$0 \$50 \$50 Interdepartmental expenses \$600 \$550 -\$50 Total material a supply costs \$3.465 \$3.145 -\$320 Total Operating Cost \$50.675 \$45.235 -\$5.440

As it is possible to see, there is a discrepancy between the budgeted and the actual numbers for salaries and materials. In this case, the total employment cost is 47.210, and the total material and supply cost is 3.465, amounting to 50.675 in total operating costs. At the same time, total budgeting costs are at 45.235. The resulting discrepancy is circa 12%. For a hospital, there are several reasons for such a variance to occur. Some of the most common reasons are as follows (Hox, Moerbeek, & Schoot, 2017):

• The expected patient influx was larger than predicted, which resulted in the hospital hiring additional employees or paying the existing ones to work overtime.
• There was a viral outbreak among hospital employees, which resulted in a larger amount of sick leaves.
• Employee turnover rates peaked, resulting in additional expenses associated with hiring and training new employees.

As for discrepancies in materials and equipment, the primary causes for variances are as follows (Hox et al., 2017):

• Differentiations in the projected and actual amount of activities associated with the consumption of these resources (examinations, lab tests, surgeries, X-ray scans, etc.).
• Differentiation between estimated and actual prices paid for the resources consumed.
• Differentiation between estimated and actual volumes of material consumed.

## Conclusions

As it is possible to see, variance analysis is a very important tool of control in business management. It is used to measure business efficiency and detect problem spots in the production cycle as well as overall organizational performance. The results can be utilized to formulate future budgets, depending on past results. In addition, the presence of variances can be a sign of corporate theft. Therefore, accounting for variances is very important for the efficient functioning of a healthcare facility.

## References

Berger, A. (2011). Standard costing, variance analysis and decision-making. Munchen, Germany: GRIN Verlag.

Dove, H. G., & Forthman, T. (1995). Helping financial analysts communicate variance analysis. Healthcare Financial Management, 49(4), 52-54.

Druri, C. (2017). Management and cost accounting (10th ed.). New York, NY: Cengage.

Ebisike, O. A. (2012). Real estate accounting made easy. New York, NY: Wiley.

Hox, J. J., Moerbeek, M., & Schoot, R. (2017). Multilevel analysis: Techniques and applications (3rd ed.). New York, NY: Routledge.