What is the Direct Material Usage Variance?The direct material usage variance is the difference between the actual and expected unit quantity needed to manufacture a product. The variance is used in a standard costing system, usually in conjunction with the purchase price variance. These variances are useful for identifying and correcting anomalies in the production and procurement systems, especially when there is a rapid feedback loop. Standards for raw materials are typically set by the engineering department and recorded in a bill of materials for each product. Show
The variance is most commonly used in a production environment, but can also be used in a services business where hours worked can be compared to a budgeted level. How to Calculate the Direct Material Usage VarianceThe calculation of this variance is as follows: (Actual usage - Standard usage) x Standard cost per unit = Direct material usage variance In a larger manufacturing operation, it is best to calculate this variance at the individual product level, since it reveals little actionable information at an aggregate level. The resulting information is used by the production manager and purchasing manager to investigate and correct problems. Example of the Direct Material Usage VarianceABC International expects to use five yards of thread in its production of a tent, but actually uses seven yards. This results in an unfavorable direct material usage variance of two yards of thread. What Causes a Direct Material Usage VarianceA usage variance can arise from any of the following issues:
The following questions have been designed to test your knowledge of all areas covered within Part 8 of Business Accounting Volume 2, tenth edition. Once you have completed the test, click on 'Submit Answers for Grading' to get your results. If your lecturer has requested that you send your results to them, please complete the Routing Information found at the bottom of your graded page and click on the 'E-Mail Results' button. Please do not forward your results unless your lecturer has specifically requested that you do so. This activity contains 28 questions.Answer choices in this exercise appear in a different order each time the page is loaded. Learning Objective
Question: In the dialogue at the beginning of the chapter, the president of Jerry’s Ice Cream was concerned about significant cost overruns for direct materials. We cannot simply explain these costs by saying that “we paid too much for materials” or “too many materials were used in production.” Variances must be calculated to identify the exact cause of the cost overrun. What variances are used to analyze the difference between actual direct material costs and standard direct material costs? Answer: The difference between actual costs and standard (or budgeted) costs is typically explained by two separate variances: the materials price variance and materials quantity variance. The materials price varianceThe difference between actual costs for materials purchased and budgeted costs based on the standards. is the difference between actual costs for materials purchased and budgeted costs based on the standards. The materials quantity varianceThe difference between the actual quantity of materials used in production and budgeted materials that should have been used in production based on the standards. is the difference between the actual quantity of materials used in production and budgeted materials that should have been used in production based on the standards. To this point, we have provided the data for Jerry’s Ice Cream necessary to calculate standard costs. However, you must also have the actual materials cost and materials quantity data to calculate the variances described previously. The actual data for the year are as follows:
Recall from Figure 10.1 "Standard Costs at Jerry’s Ice Cream" that the direct materials standard price for Jerry’s is $1 per pound, and the standard quantity of direct materials is 2 pounds per unit. Figure 10.4 "Direct Materials Variance Analysis for Jerry’s Ice Cream" shows how to calculate the materials price and quantity variances given the actual results and standards information. Review this figure carefully before moving on to the next section where these calculations are explained in detail. Figure 10.4 Direct Materials Variance Analysis for Jerry’s Ice Cream Note: AQP = Actual quantity of materials purchased. AP = Actual price of materials. AQU = Actual quantity of materials used in production. SP = Standard price of materials. SQ = Standard quantity of materials for actual level of activity. *Standard quantity of 420,000 pounds = Standard of 2 pounds per unit × 210,000 actual units produced and sold. **$420,000 standard direct materials cost matches the flexible budget presented in Note 10.18 "Review Problem 10.2". † $88,000 unfavorable materials price variance = $528,000 – $440,000. Variance is unfavorable because the actual price of $1.20 is higher than the expected (budgeted) price of $1. ‡ $(21,000) favorable materials quantity variance = $399,000 – $420,000. Variance is favorable because the actual quantity of materials used in production of 399,000 pounds is lower than the expected (budgeted) quantity of 420,000 pounds. Direct Materials Price Variance CalculationQuestion: The materials price variance answers the question, did we spend more or less on direct materials than expected? If the variance is unfavorable, we spent more than expected. If the variance is favorable, we spent less than expected. How is the materials price variance calculated? Answer: As shown in Figure 10.4 "Direct Materials Variance Analysis for Jerry’s Ice Cream", the materials price variance is the difference between the actual quantity of materials purchased at the actual price and the actual quantity of materials purchased at the standard price: Key EquationMaterials price variance = (AQP × AP) – (AQP × SP) Materials price variance=(AQP×AP) −(AQP×SP)=(440,000×$1.20)−(440,000×$1 .00)=$88,000 unfavorable Alternative Calculation. Since we are holding the actual quantity constant and evaluating the difference between actual price and standard price, the materials price variance calculation can be simplified as follows: Key EquationMaterials price variance = (AP – SP) × AQP Materials price variance=(AP−SP)×AQP=($1.20−$1.00)×440,000 =$88,000 unfavorable Note that both approaches—the direct materials price variance calculation and the alternative calculation—yield the same result. When labeling the variances calculated in this chapter, notice that all positive variances are unfavorable and all negative variances are favorable (i.e., unfavorable cost variances increase expected costs and favorable cost variances decrease expected costs). As you calculate variances, you should think through the variance to confirm whether it is favorable or unfavorable. For example, the materials price variance calculation presented previously shows the actual price paid for materials was $1.20 per pound and the standard price was $1. Clearly, this is unfavorable because the actual price was higher than the expected (budgeted) price. Direct Materials Quantity Variance CalculationQuestion: The materials quantity variance answers the question, did we use more or fewer direct materials in production than expected? If the variance is unfavorable, we used more than expected. If the variance is favorable, we used fewer than expected. How is the materials quantity variance calculated? Answer: As shown in Figure 10.4 "Direct Materials Variance Analysis for Jerry’s Ice Cream", the materials quantity variance is the difference between the actual quantity of materials used in production at the standard price and the standard quantity of materials allowed at the standard price: Key EquationMaterials quantity variance = (AQU × SP) – (SQ × SP) Materials quantity variance =(AQU×SP)−(SQ×SP)=(399,000×$1 .00)−(420,000×$1.00)=($21,000) favorable The standard quantity of 420,000 pounds is the quantity of materials allowed given actual production. For Jerry’s Ice Cream, the standard quantity of materials per unit of production is 2 pounds per unit. Thus the standard quantity (SQ) of 420,000 pounds is 2 pounds per unit × 210,000 units produced and sold. Alternative Calculation. Since we are holding the standard price constant and evaluating the difference between actual quantity used and standard quantity, the materials quantity variance calculation can be simplified as follows: Key EquationMaterials quantity variance = (AQU – SQ) × SP Materials quantity variance=(AQU−SQ)×SP=(399,000−420,000)×$1.00=($21,000) favorable Note that both approaches—the direct materials quantity variance calculation and the alternative calculation—yield the same result. The materials quantity variance calculation presented previously shows the actual quantity used in production of 399,000 pounds is lower than the expected (budgeted) quantity of 420,000 pounds. Clearly, this is favorable because the actual quantity used was lower than the expected (budgeted) quantity. Possible Causes of Direct Materials VariancesQuestion: The managerial accountant at Jerry’s Ice Cream will likely investigate the cause of the unfavorable materials price variance of $88,000. This will lead to discussions with the purchasing department. What might have caused the $88,000 unfavorable materials price variance? Answer: The left panel of Figure 10.5 "Possible Causes of Direct Materials Variances for Jerry’s Ice Cream" contains some possible explanations for this variance. Figure 10.5 Possible Causes of Direct Materials Variances for Jerry’s Ice Cream Whatever the cause of this unfavorable variance, Jerry’s Ice Cream will likely take action to improve the cost problem identified in the materials price variance analysis. This is why we use the term control phase of budgeting to describe variance analysis. Through variance analysis, companies are able to identify problem areas (material costs for Jerry’s) and consider alternatives to controlling costs in the future. Question: Jerry’s Ice Cream might also choose to investigate the $21,000 favorable materials quantity variance. Although this could be viewed as good news for the company, management may want to know why this favorable variance occurred. What might have caused the $21,000 favorable materials quantity variance? Answer: The right panel of Figure 10.5 "Possible Causes of Direct Materials Variances for Jerry’s Ice Cream" contains some possible explanations for this variance. Notice how the cause of one variance might influence another variance. For example, the unfavorable price variance at Jerry’s Ice Cream might have been a result of purchasing high-quality materials, which in turn led to less waste in production and a favorable quantity variance. This also might have a positive impact on direct labor, as less time will be spent dealing with materials waste. Note 10.26 "Business in Action 10.2" illustrates just how important it is to track direct materials variances accurately. Business in Action 10.2The Effect of Rising Materials Costs on Auto Suppliers In the first six months of 2004, steel prices increased 76 percent, from $350 a ton to $617 a ton. For auto suppliers that use hundreds of tons of steel each year, this had the unexpected effect of increasing expenses and reducing profits. For example, a major producer of automotive wheels had to reduce its annual earnings forecast by $10,000,000 to $15,000,000 as a result of the increase in steel prices. Most auto part suppliers operate with very small margins. GR Spring and Stamping, Inc., a supplier of stampings to automotive companies, was generating pretax profit margins of about 3 percent prior to the increase in steel prices. Profit margins have been cut in half since steel prices began rising. These thin margins are the reason auto suppliers examine direct materials variances so carefully. Any unexpected increase in steel prices will likely cause significant unfavorable materials price variances, which will lead to lower profits. Auto part suppliers that rely on steel will continue to scrutinize materials price variances and materials quantity variances to control costs, particularly in a period of rising steel prices. Source: Brett Clanton, “Steel Costs Slam Auto Suppliers,” The Detroit News, June 29, 2004, http://www.detnews.com. Clarification of Favorable Versus UnfavorableQuestion: Why are variances labeled favorable or unfavorable? Answer: The terms favorable and unfavorable relate to the impact the variance has on budgeted operating profit. A favorable varianceA variance that has a positive impact on operating profit. has a positive impact on operating profit. An unfavorable varianceA variance that has a negative impact on operating profit. has a negative impact on operating profit. Companies using a standard cost system ultimately credit favorable variances and debit unfavorable variances to income statement accounts. The appendix to this chapter describes this process in further detail. Key Takeaway
Review Problem 10.3Carol’s Cookies expected to use 1.5 pounds of direct materials to produce 1 unit (batch) of product at a cost of $2 per pound. Actual results are in for last year, which indicates 390,000 batches of cookies were sold. The company purchased 640,000 pounds of materials at $1.80 per pound and used 624,000 pounds in production.
Solution to Review Problem 10.3
Which of the following is not true of direct materials variance?Which of the following is not true concerning direct materials variances? The materials price variance always uses the actual quantity of materials used rather than the actual quantity of materials purchased.
Which of the following is true concerning the materials price variance quizlet?Which of the following is true concerning the materials price variance? It is the difference between the actual and standard unit price of an input multiplied by the number of inputs purchased. (Actual Rate × Actual Hours) − (Standard Rate × Actual Hours).
Which of the following is correct with regard to the actual labor rate used to compute labor variances?Answer and Explanation: The correct answer is option d. Actual costs - (Actual hours x Standard rate). Direct Labor Rate Variance is the difference between Actual cost and Standard cost for Actual hours.
What is the direct materials efficiency variance quizlet?A direct materials efficiency variance indicates whether more or less direct materials were used than was budgeted for the actual output achieved. A variable manufacturing overhead efficiency variance indicates whether more or less of the chosen allocation base was used than was budgeted for the actual output achieved.
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