A. Material Price Variance MPV = (AP – SP) AQ where: MPV = Material price variance AQ = Actual quantity of materials purchased AP = Actual unit price of materials SP = Standard unit price of materials Decision Rule: AP > SP Unfavorable AP < SP Favorable
B. Material Price Variance Journal Entry (Recorded at Time of Purchase) Raw Materials (AQ x SP) XXX Materials Price Variance [(AP-SP)AQ] XXX or XXX Accounts Payable (AQ x AP) XXX
C. Material Quantity Variance MQV = (AQ – SQ) SP where: MQV = Material quantity variance SP = Standard unit price of materials AQ = Actual quantity of materials put into production SQ = Standard quantity allowed for the output produced Decision Rule: AQ > SQ Unfavorable AQ < SQ Favorable
D. Material Quantity Variance Journal Entry (Recorded when materials are put into production) Work in Process (SQ x SP) XXX Materials Quantity Variance [(AQ-SQ)SP] XXX or XXX Raw Materials (AQ x SP) XXX
E. Labor Rate Variance LRV = (AR – SR) AH where: LRV = Labor rate variance AH = Actual labor hours worked AR = Actual labor rate SR = Standard labor rate Decision Rule: AR > SR Unfavorable AR < SR Favorable
F. Labor Efficiency Variance LEV = (AH – SH) SR where: LEV = Labor efficiency variance SR = Standard labor rate AH = Actual labor hours worked SH = Standard hours allowed for the output produced Decision Rule: AH > SH Unfavorable AH < SH Favorable
G. Journal Entry for Direct Labor Variances Work in Process (SH x SR) XXX Labor Rate Variance [(AR-SR)AH] XXX or XXX Labor Efficiency Variance [(AH-SH)SR] XXX or XXX Wages Payable (AH x AR) XXX
H. Controllable Overhead Variance Flexible budget level of overhead for the actual level of production Decision Rule: Actual > Flexible budget Unfavorable Actual < Flexible budget Favorable Actual overhead Controllable overhead variance = -
I. Overhead Volume Variance Overhead applied to production using standard overhead rate Decision Rule: Flexible budget > O/H applied Unfavorable Flexible budget < O/H applied Favorable Flexible budget level of overhead for actual level of production Overhead volume variance = -
The fact that a variance is favorable does not mean that it should not be investigated. Indeed, a favorable variance may be indicative of poor management decisions. For example:
A favorable material price variance may be arisen from purchasing goods of inadequate quality for production.
A favorable overhead volume variance could mean that excessive inventory has been produced beyond customer demand.
C. Process Improvements and Unfavorable Variances
Production workers suggest a change in the manufacturing process so that the standard for labor time per unit is reduced from 4 to 3 hours. If the company does not need to increase production and keeps the same number of workers, an unfavorable labor efficiency variance will arise.
The Theory of Constraints tells us that production departments in front of bottleneck departments should not produce excess work-in-process inventory.
Evaluation in terms of standard cost variances could result in this dysfunctional behavior.
For example, rather than lay off workers, a department with a temporary demand slump may produce excess units simply to avoid an unfavorable labor efficiency variance.
E. Variance Analysis and Performance Evaluation
Responsibility accounting states that managers should only be held accountable for variance that they can control.
Unfavorable variances do not imply poor performance. For example, an unfavorable labor efficiency variance could result from the purchase of inferior goods (which by the way resulted in a favorable material price variance).