# 8 2 Compute and Evaluate Materials Variances Principles of Accounting, Volume 2: Managerial Accounting

For example, cheaper materials may cause favorable price variances but may cause adverse usage variances as well. When a company makes a product and compares the actual materials cost to the standard materials cost, the result is the total direct materials cost variance. If the actual rate of pay per hour is less than the standard rate of pay per hour, the variance will be a favorable variance. If, however, the actual rate of pay per hour is greater than the standard rate of pay per hour, the variance will be unfavorable. Recall that the standard cost of a product includes not only materials and labor but also variable and fixed overhead. It is likely that the amounts determined for standard overhead costs will differ from what actually occurs.

Indirect labor is included in the manufacturing overhead category, not the direct labor category. Standard costs are established for all direct materials used in the manufacturing process. Direct materials include all materials that can be easily and economically traced to the production of a product. For example, the direct materials necessary to produce a wood desk might include wood and hardware. Indirect materials are not easily and economically traced to a particular product. Examples of indirect materials are items such as nails, screws, sandpaper, and glue.

## Principles of Managerial Accounting

The direct material standards for one unit of NoTuggins are 4.2 feet of flat nylon cord that costs \$0.50 per foot for a total direct material cost per unit of \$2.10. During the period, 600,000 feet of flat nylon cord costing \$330,000 were purchased and used. In this case, the actual price per unit of materials is \$6.00, the standard price per unit of materials is \$7.00, and the actual quantity used is 0.25 pounds.

Take a look at our examples to see both the amount and percentage for unfavorable and favorable variances. To find your variance in accounting, subtract what you actually spent or used (cost, materials, etc.) from your forecasted amount. But after breaking down the variances, you notice that your revenue is greater than predicted, but you spent more on materials than anticipated. Using this information, you can shop around for new vendors and cut down unnecessary expenses. You can measure your total variance (e.g., your budget as a whole) or break it down (e.g., sales revenue). Finding specific variances can give you a more detailed view of your business’s performance and financial health.

The following information is the flexible budget Connie’s Candy prepared to show expected overhead at each capacity level. The variable manufacturing overhead variances for NoTuggins are presented in Exhibit 8-10 below. As you may have noticed, all variances other than the sales volume variance are basically calculated as the difference between actual and flexed income & expenses.

• Although price variance is favorable, management may want to consider why the company needs more materials than the standard of 18,000 pieces.
• Fixed overhead, however, includes a volume variance and a budget variance.
• Doctors know the standard and try to schedule accordingly so a variance does not exist.
• Another variable overhead variance to consider is the variable overhead efficiency variance.
• Some factory overhead costs may be further broken out into their fixed and variable components.

As you’ve learned, management may manage “to the variances” and can manipulate results to meet expectations. To reduce this possibility, performance should be measured on multiple outcomes, not simply on standard cost variances. Even though the answer is a negative number, the variance is favorable because employees https://turbo-tax.org/tax-experts-cpas-for-st-louis-tax-filers/ worked more efficiently, saving the organization money. What we have done is to isolate the cost savings from our employees working swiftly from the effects of paying them more or less than expected. However, variations in costs or prices and usage or efficiency only apply to variable costs or sales.

## Video Illustration 8-2: Computing direct materials variances

The standard overhead rate is the total budgeted overhead of \$10,000 divided by the level of activity (direct labor hours) of 2,000 hours. Notice that fixed overhead remains constant at each of the production levels, but variable overhead changes based on unit output. If Connie’s Candy only produced at 90% capacity, for example, they should expect total overhead to be \$9,600 and a standard overhead rate of \$5.33 (rounded).

However, manufacturing costs were higher than expected at the end of the period. Accordingly, Patty decided to perform a standard cost variance analysis on the variable manufacturing costs. The following is a summary of all direct materials variances (Figure 10.7.1), direct labor variances (Figure 10.7.2), and overhead variances (Figure 10.7.3) presented as both formulas and tree diagrams. Note that for some of the formulas, there are two presentations of the same formula, for example, there are two presentations of the direct materials price variance. While both arrive at the same answer, students usually prefer one formula structure over the other.

## 5 Describe How Companies Use Variance Analysis

As demonstrated in this chapter, standard costs and variance analysis are tools used to project manufacturing product costs and evaluate production performance. Standard costs variance analysis is used to determine the variances between the standard amounts projected for manufacturing costs and the actual amounts incurred. Any variance between the standard amounts allowed and actual amounts incurred should be investigated. This result is interpreted as the organization paid \$30,000 more for materials used in production than they planned. This direct materials price variance could indicate a purchasing issue, such as the purchasing department paying more than the agreed-upon amount (purchase order amount). Or the cause could be a supplier or sourcing issue in which the material can be sourced cheaper elsewhere.

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Therefore, if the theater sells 300 bags of popcorn with two tablespoons of butter on each, the total amount of butter that should be used is 600 tablespoons. Management can then compare the predicted use of 600 tablespoons of butter to the actual amount used. If the actual usage of butter was less than 600, customers may not be happy, because they may feel that they did not get enough butter.

## Variance Analysis Template

Once the top section is complete, the amounts from the top section can be plugged into the formulas to compute the variable manufacturing overhead efficiency (quantity) and rate (price) variances. All standard cost variances are computed using the actual production quantity. The goal is to determine how much should have been incurred to produce the actual quantity of units produced and compare that to how much was actually incurred to produce the actual quantity of units produced. The direct labor variances for NoTuggins are presented in Exhibit 8-7. Refer to the total direct labor variance in the top section of the template. Total standard quantity is calculated as standard quantity per unit times actual production or 0.25 direct labor hours per unit times 150,000 units produced equals 37,500 direct labor hours.

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For example, the direct labor necessary to produce a wood desk might include the wages paid to the assembly line workers. Indirect labor is labor used in the production process that is not easily and economically traced to a particular product. Examples of indirect labor include wages paid to the production supervisor or quality control team. While they are a part of the production process, it would be difficult to trace these wages to the production of a single desk.

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