# 8 3 Compute and Evaluate Labor Variances Principles of Accounting, Volume 2: Managerial Accounting

Even though a company uses a standard cost system in its accounting, the company’s external financial statements must comply with the historical cost principle. In other words, the external financial statement cannot simply report what the costs should have been (the standard cost). This means that the debit or credit balance in the Materials Usage Variance account must be included in the external financial statements. An adverse material usage variance indicates higher consumption of material during the period as compared with the standard usage. Direct Material Usage Variance is the measure of difference between the actual quantity of material utilized during a period and the standard consumption of material for the level of output achieved. Similarly, poorer quality materials may be more difficult to work with; this may lead to an adverse labour efficiency variance as the workforce takes longer than expected to complete the work.

Material price and usage variances are essential indicators of a company’s efficiency in managing its material costs. Understanding how to calculate these variances and the different types of material variances can help you identify areas where you can improve your material management process. By identifying the causes of material variances, you can take corrective action to reduce costs and improve your bottom line.

• 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.
• MUV is favorable when the actual quantity of direct materials used is less than the total standard quantity allowed for the actual output.
• Because Direct Materials Inventory reports the standard cost of the actual materials on hand, we reduce the account balance by \$870 (290 yards used \$3 standard cost per yard).
• Fortunately, consequences such as these will occur in the same period as the mix variance and are therefore more likely to be identified and the problem resolved.
• If the manufacturer uses more direct materials than the standard quantity of materials for the products actually manufactured, the company will have an unfavorable direct materials usage variance.
• A favorable outcome means you used fewer hours than anticipated to make the actual number of production units.

We compute the material yield variance by holding the mix constant at the standard amount. The computations for labor mix and yield variances are the same as those for materials. If there is no mix, the yield variance is the same as the quantity (or usage) variance.

## Determine the actual material quantity

When the mix and yield variances are considered, it is clear that the positive usage variance is caused by a change in the mix of inputs. It will need to be considered what impact this change of mix has had on the quality of the finished product and ultimately on sales. Again, this should be considered where information concerning this has been provided in the question.

• The combination of the two variances can produce one overall total direct labor cost variance.
• Under the standard costing system, you record inventory at its standard quantity and use a separate account to show variances.
• Because the company actually used 290 yards of denim, we say that DenimWorks did not operate efficiently.
• An adverse material usage variance indicates higher consumption of material during the period as compared with the standard usage.
• Figure 8.3 shows the connection between the direct materials price variance and direct materials quantity variance to total direct materials cost variance.

The total direct labor variance is also found by combining the direct labor rate variance and the direct labor time variance. By showing the total direct labor variance as the sum of the two components, management can better analyze the two variances and enhance decision-making. If the actual hours worked are less than the standard hours at the actual production output level, the variance will be a favorable variance. A favorable outcome means you used fewer hours than anticipated to make the actual number of production units. If, however, the actual hours worked are greater than the standard hours at the actual production output level, the variance will be unfavorable. An unfavorable outcome means you used more hours than anticipated to make the actual number of production units.

Looking at the individual variances, Gamma has a very small favourable variance. Beta has a large favourable variance and Alpha has a large adverse variance. Kappa Co has used relatively less of the more expensive material Beta, and relatively more of the cheaper material Alpha. Overall, the savings from using less Beta have outweighed the additional cost of the extra Alpha, thus resulting in a favourable total mix variance. The debits and credits would be reversed for favorable materials quantity variances. You’re most likely to run into an unfavorable materials quantity variance because of one of the following issues.

The yield variance can be calculated using a similar table approach to the mix variance. To save time in the exam, copy down the mix variance table – but take care to make sure it is then set up correctly as there are some differences. The standard cost per kg of Alpha is \$2, of Beta is \$5 and of Gamma is \$1. From this it can be seen that the more Beta used, the more expensive the final product will be. If the outcome is unfavorable, the actual costs related to labor were more than the expected (standard) costs.

## Fundamentals of Direct Labor Variances

For Kappa Co it is worth noting that the standards set are not the responsibility of the production manager. Also, as they are out of date (they were calculated five years ago), this could be contributing to the variances calculated. Again, remember to clearly state if the variance is adverse or favourable. It may be possible for the production manager to deviate from this standard mix and use slightly different proportions of each input material.

If more materials were used than the standard quantity, or if a price greater than the standard price was paid, the variance is unfavorable. Less material has been utilized (9,000 KG) than the standard quantity (10,000 KG) therefore resulting in a favorable material usage variance rather than adverse. Always make sure you mention such interdependencies when discussing variances in exam questions. In general, it can be assumed in exam questions that the production manager is responsible for the mix of input materials used. It can be tempting for production managers to change the product mix in order to make savings; these savings may lead to greater bonuses for them at the end of the day.

## What Causes a Direct Material Usage Variance

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. If more than 600 tablespoons of butter were used, management would investigate to determine why.

## common causes of materials quantity variance

If the actual rate of pay per hour is less than the standard rate of pay per hour, the variance will be a favorable variance. If, however, the actual rate of pay per hour is greater than the standard rate of pay per hour, the variance will be unfavorable. The materials quantity variance leveraged buyout analysis is one of several cost accounting metrics that manufacturers review to measure manufacturing efficiency. Keeping an eye on variances helps manufacturers identify and remedy issues as they crop up. Calculate the material price variance and the material quantity variance.

The labor mix variance measures the impact of changes in the labor mix on labor costs. Under the standard costing system, you record inventory at its standard quantity and use a separate account to show variances. Prepare a journal entry once you finish the materials quantity variance calculation. A materials quantity variance compares the actual and expected direct material used in manufacturing a product. You have an unfavorable materials quantity variance when you use more material than expected. The same calculation is shown using the outcomes of the direct materials price and quantity variances.

Fresh PLC purchased 10,000 KG of sodium fluoride at the cost of \$20,000 (\$2 per KG) out of which it utilized 9,000 KG during the period.

If you’re using the wrong credit or debit card, it could be costing you serious money. Our experts love this top pick, which features a 0% intro APR for 15 months, an insane cash back rate of up to 5%, and all somehow for no annual fee. For the remainder of our explanation, we will use a common format for calculating variances. The amounts for each column are computed in the order indicated in the headings. In other words, it is the difference between what the material did cost and what it should have cost. Textbook content produced by OpenStax is licensed under a Creative Commons Attribution-NonCommercial-ShareAlike License .

Finish the materials quantity variance calculation by multiplying the difference of the standard and actual quantities by the standard cost. 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. In a movie theater, management uses standards to determine if the proper amount of butter is being used on the popcorn.

## What are Net Purchases in Accounting/Business?

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.