Standard Costs and Variance Analysis Principles of Managerial Accounting

Actual manufacturing data are collected after the period under consideration is finished. Actual data includes the exact number of units produced during the period and the actual costs incurred. The actual costs and quantities incurred for direct materials, direct labor, and variable manufacturing overhead are reported in Exhibit 8-1. In this case, the actual price per unit of materials is \(\$9.00\), the standard price per unit of materials is \(\$7.00\), and the actual quantity used is \(0.25\) pounds. If the actual quantity of materials used is less than the standard quantity used at the actual production output level, the variance will be a favorable variance. A favorable outcome means you used fewer materials than anticipated, to make the actual number of production units.

Video Illustration 8-3: Computing direct labor variances

By closely monitoring these variances, companies can identify opportunities for cost savings and performance improvements, ensuring they remain competitive in the market. Each bottle has a standard material cost of \(8\) ounces at \(\$0.85\) per ounce. Calculate the material price variance and the material quantity variance. An unfavorable outcome means the actual costs related to materials were more than the expected (standard) costs. If the outcome is a favorable outcome, this means the actual costs related to materials are less than the expected (standard) costs.

Get Your Question Answered by a Financial Professional

The designation of a variance as material is a good way to decide which variances should be brought to the attention of management, and which can be safely ignored. When making this decision, a financial analyst might not use a single materiality level for all variances. Instead, if management has designated a particular area as being especially important, then even quite small variances might be flagged for their attention. A variance is considered what is depreciation to be material if it exceeds a certain percentage or dollar amount. This approach to the material variance is commonly used by auditors, who (for example) may ask to see explanations of all variances exhibiting a change of at least $25,000 or 15% from the preceding year. A variation on the concept is to consider a transaction material if its presence or absence would alter the decisions of a user of a company’s financial statements.

Clarification of Favorable Versus Unfavorable

1. The quantity standard establishes how much of an input is needed to make a product or provide a service.
2. However, manufacturing costs were higher than expected at the end of the period.
3. As with material variances, there are several ways to perform the intrinsic labor variance calculations.
4. When discussing direct labor, price is referred to as rate, and quantity is referred to as efficiency.
5. Or, one can perform the algebraic calculations for the price and quantity variances.

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. Indirect materials are included in the manufacturing overhead category, not the direct materials category. Connie’s Candy paid \(\$2.00\) per pound more for materials than expected and used \(0.25\) pounds more of materials than expected to make one box of candy. Connie’s Candy paid $2.00 per pound more for materials than expected and used 0.25 pounds more of materials than expected to make one box of candy. Another element this company and others must consider is a direct materials quantity variance.

Example: How to Calculate Direct Materials Quantity Variance

For example, prices of raw materials like metals or agricultural products can vary significantly based on market conditions, affecting the actual price paid compared to the standard price. As an example of the quantity variance, ABC International uses 5,000 pounds of steel during a month of production, https://www.business-accounting.net/ when the bill of materials for the items produced indicate that only 4,200 pounds should have been used. Since the standard price of steel is $20 per pound, ABC can value this variance at $16,000. Thus, the amount of the quantity variance is multiplied by the standard cost per unit.

17: Introduction to Material Variances

A cost driver, typically the production units, drives the variable component of manufacturing overhead. As with any variable cost, the per unit cost is constant, but the total cost depends on the quantity produced or another cost driver. The focus of this section is variable manufacturing overhead since it has both a quantity and price standard.

Material Variance Related to Materials

It isdefined as the difference between the actual quantity of materialsused in production and budgeted materials that should have beenused in production based on the standards. If the actual quantity used is greater than the standard quantity, the variance is unfavorable. This means that the company has used excessive materials in producing its output. The variable manufacturing overhead variances for NoTuggins are presented in Exhibit 8-10.

Refer to the total variable manufacturing overhead variance in the top section of the template. Total standard quantity is calculated as standard quantity of the cost driver per unit times actual production, or 0.25 direct labor hours per unit times 150,000 units produced equals 37,500 direct labor hours. The standard variable manufacturing overhead rate per direct labor hour was established as $3.

Note that unfavorable variances (negative) offset favorable (positive) variances. A total variance could be zero, resulting from favorable pricing that was wiped out by waste. A good manager would want to take corrective action, but would be unaware of the problem based on an overall budget versus actual comparison.

In a movie theater, management uses standards to determine if the proper amount of butter is being used on the popcorn. They train the employees to put two tablespoons of butter on each bag of popcorn, so total butter usage is based on the number of bags of popcorn sold. 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.

The variable components may consist of items like indirect material, indirect labor, and factory supplies. Fixed factory overhead might include rent, depreciation, insurance, maintenance, and so forth. As a result, variance analysis for overhead is split between variances related to variable overhead and variances related to fixed overhead. A favorable materials quantity variance indicates savings in the use of direct materials.