Because variable and fixed costs behave in a completely different manner, it stands to reason that proper evaluation of variances between expected and actual overhead costs must take into account the intrinsic cost behavior. As a result, variance analysis for overhead is split between variances related to variable overhead and variances related to fixed overhead. In other words, when actual quantity of materials used deviates from the standard quantity of materials allowed to manufacture a certain number of units, materials quantity variance occurs.
However, detailed variance analysis is necessary to fully assess the nature of the labor variance. As will be shown, Blue Rail experienced a very favorable labor rate variance, but this was offset by significant unfavorable labor efficiency. Material quantity variance is favorable if the actual quantity of materials used in manufacturing during a period is lower than the standard quantity that was expected for that level of output. The variable overhead efficiency variance can be confusing as it may reflect efficiencies or inefficiencies experienced with the base used to apply overhead. For Blue Rail, remember that the total number of hours was “high” because of inexperienced labor. These welders may have used more welding rods and had sloppier welds requiring more grinding.
Review the following graphic and notice that more is spent on actual variable factory overhead than is applied based on standard rates. This scenario produces unfavorable variances (also known as “underapplied overhead” since not all that is spent is applied to production). As monies are spent on overhead (wages, utilization of supplies, etc.), the cost (xx) is transferred to the Factory Overhead account. As production occurs, overhead is applied/transferred to Work in Process (yyy). When more is spent than applied, the balance (zz) is transferred to variance accounts representing the unfavorable outcome.
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. With either of these formulas, the actual quantity used refers to the actual amount of materials used to create one unit of product. A number of parties may be held responsible for an unfavorable quantity variance (or take credit for a favorable variance!).
Green Co. established a benchmark standard of utilizing 10 units for every product. However, during a recent production cycle, the actual material consumption per unit amounted to 9. This variance from the standard quantity prompted an exploration of the material quantity variance. Each bottle has a standard material cost of \(8\) ounces at \(\$0.85\) per ounce. They bought \(89,000\) ounces of material at a cost of \(\$74,760\).
How to interpret the Material Quantity Variance?
The material quantity variance is a cost accounting concept that measures the difference between the actual quantity of materials used in production and the standard quantity based on the achieved production level. It evaluates how effectively materials get utilized during manufacturing. The material quantity variance considers actual and standard measures for a specific production level. An adverse or unfavorable material quantity variance occurs when the actual volume of materials used in production exceeds the standard quantity that is expected for the level of output in a period.
LABOR RATE VARIANCE
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- These welders may have used more welding rods and had sloppier welds requiring more grinding.
- Green Co. established a benchmark standard of utilizing 10 units for every product.
- 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 purchased is 20 pounds.
The ultimate motive behind their calculation is to control costs and enhance improvement. They should not be used as tools to find someone to blame or degrade. The material quantity variance is a subset of the quantity variance, since it only applies to materials (or, more accurately, what is a flat rate pricing model pros and cons explained direct materials) that are used in the production process. A material quantity variance is the difference between the actual amount of materials used in the production process and the amount that was expected to be used. The measurement is employed to determine the efficiency of a production process in converting raw materials into finished goods.
Understanding the Material Quantity Variance
The producer must be aware that the difference between what it expects to happen and what actually happens will affect all of the goods produced using these particular materials. Therefore, the sooner management is aware of a problem, the sooner they can fix it. For that reason, the material price variance is computed at the time of purchase and not when the material is used in production. The same calculation is shown using the workers compensation for non outcomes of the direct materials price and quantity variances.
A favorable outcome means you used fewer materials than anticipated, to make the actual number of production units. If, however, the actual quantity of materials used is greater than the standard quantity used at the actual production output level, the variance will be unfavorable. An unfavorable outcome means you used more materials than anticipated to make the actual number of production units. As you’ve learned, direct materials are those materials used in the production of goods that are easily traceable and are a major component of the product.
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 purchased is 20 pounds. This is an unfavorable outcome because the actual price for materials was more than the standard price. As a result of this unfavorable outcome information, the company may consider using cheaper materials, changing suppliers, or increasing prices to cover costs. The standard price of materials purchased by Angro is $2.00 per kg and standard quantity of materials allowed to produce a unit of product is 1.5kg. During December 2020, 5,000 units were produced using 8,000kgs of direct materials.
Multiplying this by the standard price per unit yields a favorable direct material quantity variance of $160. 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. 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 price paid per unit of material is lower than the standard price per unit, the variance will be a favorable variance. A favorable outcome means you spent less on the purchase of materials than you anticipated. If, however, the actual price paid per unit of material is greater than the standard price per unit, the variance will be unfavorable.
- With either of these formulas, the actual quantity used refers to the actual amount of materials used at the actual production output.
- The logic for direct labor variances is very similar to that of direct material.
- The material quantity variance in this example is favorable because the company manufactured the output using a lesser quantity of materials than what was planned in the budget.
- These factors can encompass elements such as material wastage, inconsistencies in production processes, shifts in material quality, and discrepancies in inventory management practices.
Module 10: Cost Variance Analysis
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. AP means the “actual price” of the input used to produce the output. SQ and SP refer to the “standard” quantity and price that was anticipated. Variance analysis can be conducted for material, labor, and overhead.
Direct Materials Quantity Variance
The actual quantity of direct materials at standard price equals $310,500. Where,SQ is the standard quantity allowed,AQ is the actual quantity of direct material used, andSP is the standard price per unit of direct material. Thus, the amount of the quantity variance is multiplied by the standard cost per unit. A separate variance, the rate variance, is used to derive any difference between the actual and standard price per unit. Since variable overhead is consumed at the presumed rate of $10 per hour, this means that $125,000 of variable overhead (actual hours X standard rate) was attributable to the output achieved.
By so doing, the full $719,000 actually spent is fully accounted for in the records of Blue Rail. The production manager was disappointed to receive the monthly performance report revealing actual material cost of $369,000. Material quantity variance represents the difference between the actual and standard quantities of material used for a specific product. Material the contents of a cash basis balance sheet quantity variance is crucial for companies to control costs and adhere to defined standards.
2: Compute and Evaluate Materials Variances
On the other hand, a negative material quantity variance signals that the actual quantity of materials used exceeds the standard amount. This scenario suggests inefficient utilization of materials and can lead to increased material costs. Negative variances might arise due to reasons such as material wastage, quality issues, inaccurate production processes, or unexpected disruptions. In general, the production department of the company is responsible for direct materials quantity variance since it has direct control over the usage of materials. However, other departments may also be accountable if they cause indirect influence to such variance (e.g. low-quality materials acquired by the purchasing department).
The total of both variances equals the total direct materials variance. In this case, the actual quantity of materials used is 0.20 pounds, the standard price per unit of materials is $7.00, and the standard quantity used is 0.25 pounds. This is a favorable outcome because the actual quantity of materials used was less than the standard quantity expected at the actual production output level. As a result of this favorable outcome information, the company may consider continuing operations as they exist, or could change future budget projections to reflect higher profit margins, among other things.
She was formerly a tax consultant with the predecessor firm to Ernst & Young. She frequently speaks on nonprofit, corporate governance–taxation issues and will probably come to speak to your company or organization if you invite her. You may e-mail her with questions you have about Sarbanes-Oxley at email protected. Mark P. Holtzman, PhD, CPA, is Chair of the Department of Accounting and Taxation at Seton Hall University. He has taught accounting at the college level for 17 years and runs the Accountinator website at , which gives practical accounting advice to entrepreneurs.
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