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I'm Larry Walther.
This is principlesofaccounting.com, Chapter 22.
And in this chapter, we're considering tools for
enterprise performance evaluation.
Now turning our attention to the examination of variances.
I'm going to split this module into two separate videos.
The first of these will deal with variance calculations,
related to material and labor.
Now remember that standard costs are compared to actual costs.
And deviations between those are termed variances.
Favorable variances result when actual costs are less than standard costs, and
vice versa.
These variance analyses can be conducted for material, labor, and
overhead components.
When total costs differ from total standard costs,
management should perform more analysis to determine the root cause of the variances.
The overall framework for
considering variance analysis is actually quite simple.
If actual costs are less than standard costs,
we say we have a favorable variance.
And, conversely,
if actual costs are greater than standard costs, we have an unfavorable variance.
But variance analysis digs deeper than this.
It's not sufficient to simply say we spent more or less than standard.
We need to determine the causes for that difference.
Looking first at direct material variances, the total variance compares
actual direct material cost to the standard direct material cost.
But can be further divided into a materials price variance.
Which is the difference between the standard price for materials purchased and
the actual amount paid for those materials.
By formula, standard price minus actual price.
That's the per unit difference that we're paying times the actual quantity we
purchased and used, would give us the materials price variance.
Whereas the materials quantity variance speaks to the usage.
It compares the standard quantity of materials that should have been used
to produce the actual quantity of output.
And it measures the difference at the standard price.
By formula, standard quantity that should've been used,
minus the actual quantity that was used,
times the standard price per unit gives us the material quantities variance.
This next illustration will further demonstrate this point.
The actual cost is the actual quantity times the actual price.
The standard cost is the standard quantity times the standard price.
The difference between those two is the total materials variance.
But we can further divide this in terms of looking at the price variance and
quantity variance.
The difference between the actual cost and the actual use,
times the standard price gives us the price variance.
And here at the top of the screen, I'm repeating that calculation.
Standard price, minus actual price, times actual quantity.
The quantity variance compares the actual use at standard price
to the standard cost.
Or in other words,
standard quantity, minus actual quantity, times the standard price.
Let's operationalize these formulas with an example.
This example is exactly like in your textbook for Blue Rail Manufacturing.
Blue Rail manufactures a fence for railing section that requires steel tubing or
steel pipe to produce.
And for the period in question, Blue Rail produced 3,400 units of output.
Now each unit of output should have required one and
a quarter pieces of material.
In other words, we should have used 4,250 pieces of pipe.
And each piece of pipe had a standard price of $80 per unit.
So the standard cost of our materials,
we should have used 4,250 pieces of pipe, and it should have cost $80 per piece.
That's a total of $340,000, is the standard cost of our materials.
Compare that to the actual, we actually used 4,100 pieces of pipe, but
we paid $90 per piece.
So our actual cost was $369,000.
If you compare simply the actual expenditure of $369,000 to
the standard cost.
You can see that we would have a 29,000 unfavorable variance.
We spent more than we anticipated.
But breaking it down further, we divide it into the materials price variance.
We saw that we paid $90, when we anticipated, or
had the standard price of $80.
So we paid $10 per piece of pipe more than we should have.
And we used 4,100 pieces of pipe.
So on the one hand, we have a $41,000 unfavorable material price variance,
we're paying more than we should have, but we used less.
We used 4,100 pieces of pipe, when the standard was 4,250.
Times the standard price per unit of $80,
gave us a $12,000 favorable material quantity variance.
This reviews the illustration in the bubble in the top-left.
We actually spent $369,000 compared to the $340,000
standard cost, a $29,000 total material variance, unfavorable.
We've broken that down between the material price variance, and
a material quantity variance.
These variance require journal entries.
Variance amounts are debited for unfavorable outcomes, and credited for
favorable outcomes.
So debits are a bad thing in this case, credits are a good thing.
Raw material inventory should only carry the standard price of materials.
And work in process should reflect the standard costs of the standard quantity
that should be used.
Let's see how this works for Blue Rail.
The material purchased, we're going to record into the inventory account
at the standard cost of $80 a unit, or $328,000 total.
Whereas the work in process, we're going to debit for 340,000 for
the standard cost that went into production.
This next illustration will probably clarify the effects of these entries.
The green box material, we're going to credit the accounts payable for
the actual amount we spent.
We're going to debit direct materials for the standard cost.
And the 41,000 unfavorable variance is debited to a material price
variance account.
Then when we charge the material to work in process, we debit work in process for
the standard cost of 340.
Even though there was only 328,000 in the raw material account.
The other 12,000 is our favorable quantity variance.
We're maintaining our accounting for
our inventory in our work in process at standard costs.
The differences are being thrown off into favorable or
unfavorable variance accounts as shown.
Direct labor has a very similar model.
The total variances found by comparing actual labor costs to standard direct
labor costs.
We break this down to a labor rate variance,
which compares the standard rate for labor times the actual rate for the labor.
And we multiply by that the actual hours worked.
And then our labor efficiency variance looks to the number
of hours that were used.
The standard hours that should have been used,
compared to the actual hours, times the standard rate.
So this is really very much,
almost identical to the material price variance in terms of the setup.
Once you've conquered the materials variance formulas and
calculations, you've fairly well conquered the labor calculations as well.
Here's the framework.
The actual cost for labor, the actual hours worked, times the actual rate.
Compared to the standard cost, the standard hours that should have been used,
times the standard rate.
The difference is the total variance which we can break
down between the rate variance and the efficiency variance.
If we look at actual hours times standard rate, and
compare that to the actual cost, we'll get a rate variance.
It's simply the difference in the hourly rate times the actual hours worked.
The efficiency variance compares the standard hours, versus the actual hours,
times the standard rate.
Again, the sum of those two variances equals the total variance.
So let's see how this is gonna work for Blue Rail.
Here, Blue Rail produced 3,400 sections of output.
They should've used three hours per section of welding time.
So our standard hour should have been 10,200 hours, and
our standard rate was $18 an hour.
Our standard cost of labor, in other words, should have been $183,600.
But down below you can see we actually spent less than that, only $175,000.
So if we break this out between the two variances,
the labor rate variance is a very favorable $50,000.
That's the $4 an hour difference between standard and actual labor rate.
Times the 12,500 hours actually worked.
The efficiency was terrible, however, but
we used 12,500 hours instead of the standard 10,200, times the standard rate,
gave us an unfavorable labor efficiency variance of $41,400.
As it turns out, if you review the facts in your book,
Blue Rail hired inexperienced labor and was able to pay them less.
However, they appeared to be somewhat inefficient.
They took more hours to do what was necessary.
So this reviews that then.
We've got the actual cost was $175,000 the standard cost was $183,6000.
Our total variance, 8,600 favorable, divided between the rate variance and
the efficiency variance.
And so here's the journal entry for the labor rate variances.
I'm debiting work in process for the standard cost of 183,600.
I'm crediting wages payable for the actual expenditure of 175,000.
You see I've spent less than I anticipated, or less than was standard.
Those differences are charged to the respective unfavorable debit and
favorable credit variance accounts related to efficiency and rate variances.
And so this is a very comprehensive accounting model.
It fleshes out, it actually pushes into the general ledger,
those components that management would want to monitor to
determine the variances from standard.
And the cause of those, and in some cases, take necessary corrective action.
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