The occurrences of deviation from standards are very actual quantity is the actual direct material or direct labor used to manufacture the normal and the common reasons of these deviations are explained on direct materials price variance page. Management knows how much the materials will cost and integrates this information into the schedule of expected cash disbursements. The cash payments schedule shows when cash will be used to pay for Accounts Payable.
This reflects the standard cost allocation of fixed overhead (i.e., 10,200 hours should be used to produce 3,400 units). Notice that this differs from the budgeted fixed overhead by $10,800, representing an unfavorable Fixed Overhead Volume Variance. Direct materials are those materials and supplies that are consumed during the manufacture of a product, and which are directly identified with that product. Items designated as direct materials are usually listed in the bill of materials file for a product. The bill of materials itemizes the unit quantities and standard costs of all materials used in a product, and may also include an overhead allocation. The direct materials (DM) variance is computed by comparing the total actual cost and total standard cost of the raw materials.
- Variance analysis should also be performed to evaluate spending and utilization for factory overhead.
- The beginning inventory is estimated to be 1,050 units, which means the number of units that need to be produced during the first quarter of year 2 is 3,800 units.
- It is not sufficient to simply conclude that more or less was spent than intended.
- This means that the company has used excessive materials in producing its output.
- A good manager would want to take corrective action, but would be unaware of the problem based on an overall budget versus actual comparison.
As shown in Exbibit 8-1, Brad projects that the standard variable cost to make one unit of product is $7.35. He estimates that each unit should require 4.2 feet of flat nylon cord that costs $0.50 per foot for total direct material costs per unit of $2.10. Each unit should require 0.25 direct labor hours to assemble at an average rate of $18 per hour for total direct labor costs of $4.50 per unit. Variable manufacturing overhead costs are applied to the product based on direct labor hours. The standard variable manufacturing overhead rate is $3 per direct labor hour.
Practice Video Problem 8-3: Computing manufacturing overhead variances LO4
Therefore, the determination of each quarter’s material needs is partially dependent on the following quarter’s production requirements. The desired ending inventory of material is readily determined for quarters 1 through 3 as those needs are based on the production requirements for quarters 2 through 4. To compute the desired ending materials inventory for quarter 4, we need the production requirements for quarter 1 of year 2. Recall that the number of units to be produced during the first quarter of year 2 is 3,800.
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. Indirect materials are materials that are not easily and economically traced to a particular product. Indirect materials are included in the manufacturing overhead category and not the direct material category. If Big Bad Bikes uses 3.2 pounds of material for each trainer it manufactures and each pound of material costs $1.25, we can create a direct materials budget. Management’s goal is to have 20% of the next quarter’s material needs on hand as the desired ending materials inventory.
( Standard direct labor hours allowed for January production:
Standard costs and quantities are established for each category of direct labor. These standards are then compared to the actual quantities used and the actual price paid for each category of direct labor. When discussing labor, price is referred to as rate instead of price, and quantity is referred to as efficiency instead of quantity. Therefore, the total variance for direct labor is broken down into the direct labor efficiency variance and the direct labor rate variance. A summary of the direct materials, direct labor, and variable manufacturing overhead variances is provided in Exhibit 8-12. This standard costs variance analysis report is the starting point for further investigation and corrective action if appropriate.
Unfortunately, they were unable to manufacture any units before the end of the current year, so the first quarter’s beginning inventory is 0 units. Sales in quarter 2 are estimated at 1,000 units; since 30% is required to be in ending inventory, the ending inventory for quarter 1 needs to be 300 units. With expected sales of 1,000 units for quarter 2 and a required ending inventory of 30%, or 300 units, Big Bad Bikes needs to have 1,300 units available during the quarter. Since 1,300 units needed to be available and there are zero units in beginning inventory, Big Bad Bikes needs to manufacture 1,300 units. As with material variances, there are several ways to perform the intrinsic labor variance calculations.
Video Illustration 8-3: Computing direct labor variances
As mentioned previously, standard rates and quantities are established for variable manufacturing overhead. When discussing variable manufacturing overhead, price is referred to as rate, and quantity is referred to as efficiency. Any variance between the standard costs allowed and the actual costs incurred is caused by a difference in efficiency or a difference in rate. The total variance for variable manufacturing overhead is separated into the variable manufacturing overhead efficiency variance and the variable manufacturing overhead rate variance. The total variances can be calculated in the last line of the top section of the template by subtracting the actual amounts from the standard amounts projected. The standard quantity allowed is 37,500 hours less the actual hours worked of 45,000 hours equals a variance of (7,500) direct labor hours.
AccountingTools
Labor efficiency variance measures the difference between the number of direct labor hours you budgeted and the actual hours your employees work. Compare these two variances to determine how well your small business managed its direct labor costs during a period. The difference between the standard cost of direct labor and the actual hours of direct labor at standard rate equals the direct labor quantity variance.
- The materials price variance of $ 6,000 is considered favorable since the materials were acquired for a price less than the standard price.
- This illustration presumes that all raw materials purchased are put into production.
- A template to compute the standard cost variances related to direct material, direct labor, and variable manufacturing overhead is presented in Exhibit 8-11.
- Direct labor, meaning toe work required to actually make a product, is a critical component of manufacturing costs.
- Without knowing the direct labor cost, a business may overprice its goods and lose customers to competitors.
Variance Analysis
The estimated sales of 3,500 units and the desired ending inventory of 1,350 units (30% of the next quarter’s estimated sales of 4,500) determines that 4,850 units are required during the quarter. The beginning inventory is estimated to be 1,050 units, which means the number of units that need to be produced during the first quarter of year 2 is 3,800 units. 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.
( Actual direct labor rate:
Total variable manufacturing overhead costs per the standard amounts allowed are calculated as the total standard quantity of 37,500 times the standard rate per hour of $3 equals $112,500. During the period, Brad projected he should pay $112,500 for variable manufacturing overhead to produce 150,000 units. This results in an unfavorable variance since the actual rate was higher than the expected (budgeted) rate.
2 Calculations for Direct Materials and Labor
This means that the company has used excessive materials in producing its output. As with direct materials variances, all positive variances are unfavorable, and all negative variances are favorable. The labor rate variance calculation presented previously shows the actual rate paid for labor was $15 per hour and the standard rate was $13.