At DenimWorks this is the number of good aprons physically produced. If DenimWorks produces 100 large aprons and 60 small aprons during January, the production and the finished goods inventory will begin with the cost of the direct materials that should have been used to make those aprons. Keep in mind that the standard cost is the cost allowed on the good output.
( Variances and journal entries relating to direct materials:
If the accountant recognizes that this type of variance is based on an incorrect standard, then there should be a journal entry to adjust the standard cost of the inventory item. This type of adjustment is only likely to arise if there is an ongoing program of actively investigating why variances are occurring. When less is spent than applied, the balance (zz) represents the favorable overall variances. Favorable overhead variances are also known as “overapplied overhead” since more cost is applied to production than was actually incurred. Standard costing can technically be combined with any of the costing systems described in Chapters 4, 5, and 6.
4 Direct Labor Variances
The price and quantity variances are generally reported by decreasing income (if unfavorable debits) or increasing income (if favorable credits), although other outcomes are possible. Examine the following diagram and notice the $369,000 of cost is ultimately attributed to work in process ($340,000 debit), materials price variance ($41,000 debit), and materials quantity variance ($12,000 credit). This illustration presumes that all raw materials purchased are put into production.
Recording Manufacturing Overhead Transactions
Favorable variances result when actual costs are less than standard costs, and vice versa. The following illustration is intended to demonstrate the very basic relationship between actual cost and standard cost. AQ means the “actual quantity” of input used to produce the output.
Direct Labor: Standard Cost, Rate Variance, Efficiency Variance
So the allocation of fixed overhead matches a variable cost pattern in that it varies with production volume. Thus the cost driver-allocated of fixed overhead figure is more fictitious than the static budget figure. That static budget knows better than to treat fixed overhead as if it were a variable cost. The logic from previous cost variances about how to judge favorability as we move from the more hypothetical number (i.e. more rightward) to the more actual number (i.e. more leftward) continues to work. The difference between the two goes to the direct materials quantity variance. That line of the journal entry is a debit, meaning the variance is unfavorable.
- But, a closer look reveals that overhead spending was quite favorable, while overhead efficiency was not so good.
- Variance analysis should also be performed to evaluate spending and utilization for factory overhead.
- You might view this account as containing the cost of the products in the finished goods warehouse.
- In addition to this decline in productivity, you also find that some of the denim is of such poor quality that it has to be discarded.
- The diagram above correctly shows the static budget’s fixed overhead cost as being more leftward (or less hypothetical) than the allocated fixed overhead cost.
3.1 Cost Variances and Flexible Budgets
The yield variance reflects the variation between standard finished goods output (given inputs) and the actual finished goods output (given inputs). The inventory valuation question determines which costs are considered inventory, an asset, and which costs are considered expense. This expense gets transferred to WIP because it reflects direct labor cost, which is a product cost and needs to inventoried. Sales volume variance is actionable because it reflects the overall volume of sales.
Notice that the raw materials inventory account contains the actual quantity of direct materials purchased at the standard price. Accounts payable reflects the actual cost, and the materials price variance account shows the unfavorable variance. Unfavorable variances are recorded as debits and favorable variances are recorded as credits.
For the flexible budget, I used the same assumptions as the static budget but changed the volume to 110 units (compare cells F3 and G3). Variance analysis moves incrementally from one extreme to the other, comparing just one standard-versus-actual result at a time. This leads to variances that capital losses tell you how much of total budget variance is due to each cause. Variance analysis, to be successful, has to subdivide variances in such a way that each variance figure identifies a course of action that would repeat the variance next period (if favorable) or avoid it (if unfavorable).
If you have a low allocated fixed cost figure, it likely means you underutilized the capacity you bought with a fixed cost, and that wasted capacity is unfavorable. But you produced a very low volume with that factory, leading to very low consumption of the cost driver, leading to a very low allocated fixed overhead cost figure. That amounts to wasting at least part of the factory’s productive capacity that you paid $100,000 for. Thus, it is also unfavorable from the perspective of unused capacity.
Accounts payable reflects theactual cost, and the materials price variance account shows theunfavorable variance. Unfavorable variances are recorded as debitsand favorable variances are recorded as credits. Variance accountsare temporary accounts that are closed out at the end of thefinancial reporting period. We show the process of closing outvariance accounts at the end of this appendix. In a standard costing system, the costs of production, inventories, and the cost of goods sold are initially recorded using the standard costs. In the case of direct materials, it means the standard quantity of direct materials that should have been used to make the good output.
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