Appendix 8A. General Ledger Entries to Record Variances. Direct Materials Variances. Direct Labour Variances

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1 Appendix 8A General Ledger Entries to Record Variances Although standard costs and variances can be computed and used by management without being formally entered into the accounting records, most organizations prefer to make formal entries. Formal entries tend to give variances a greater emphasis than informal, off-the-record computations. This emphasis gives a clear signal of management s desire to keep costs within the limits that have been set. In addition, formal use of standard costs simplifies the book-keeping process enormously. Inventories and cost of goods sold can be valued at their standard costs eliminating the need to keep track of the actual cost of each unit. Closing entries made at the end of the accounting period help adjust the financial statements to reflect actual costs. Direct Materials Variances To illustrate the general ledger entries needed to record standard cost variances, we will return to the data contained in the Review Problem at the end of Chapter 8. The entry to record the purchase of direct materials would be as follows: Raw materials (18 kg at $500 per kg) ,000 Materials price variance (18 kg at $100 per kg U) ,800 Accounts payable (18 kg at $600 per kg) ,800 Note that the price variance is recognized when purchases are made, rather than when materials are actually used in production. This permits the price variance to be isolated early, and it also permits the materials to be carried in the inventory account at standard cost. As direct materials are later drawn from inventory and used in production, the quantity variance is isolated as follows: KNOW CC14 A : Explain the cost flows in a standard costing system. APPLY CC15 A : Prepare journal entries to record standard costs and variances. Work in process (12 kg at $500 per kg) ,000 Materials quantity variance (2 kg U at $500 per kg) ,000 Raw materials (14 kg at $500 per kg) ,000 Thus, direct materials enter into the work-in-process account at standard cost, in terms of both price and quantity. Note that both the price variance and the quantity variance above are unfavourable (U) and are debit entries. If these variances had been favourable (F), they would have appeared as credit entries, as in the case of the direct labour rate variance shown below. Direct Labour Variances Referring again to the cost data in the Review Problem at the end of Chapter 8, the general ledger entry to record the incurrence of direct labour cost would be: Work in process (3,600 hours at $20 per hour) ,000 Labour efficiency variance (400 hours U at $20 per hour) ,000 Labour rate variance (4,000 hours at $0.50 per hour F) ,000 Wages payable (4,000 hours at $19.50 per hour) ,000 1

2 2 Appendix 8A Thus, as with direct materials, direct labour costs enter into the work-in-process account at standard cost, both in terms of the rate and in terms of the hours allowed for the actual production of the period. Variable Manufacturing Overhead Variances Variable manufacturing overhead variances generally are not recorded in the accounts separately; rather, they are determined as part of the general analysis of overhead, which is discussed in Chapter 9. Cost Flows in a Standard Cost System The flows of costs through the company s accounts are illustrated in Exhibit 8A 1. Note that entries into the various inventory accounts are made at standard cost not actual cost. The differences between actual and standard costs are entered into special accounts that accumulate the various standard cost variances. Ordinarily, these standard cost variance accounts are closed out to cost of goods sold at the end of the period. Unfavourable variances increase cost of goods sold, and favourable variances decrease cost of goods sold. Exhibit 8A 1 Cost Flows in a Standard Cost System* Accounts Payable AQ 3 AP 10,800 Raw Materials AQ 3 SP AQ 3 SP 9,000 7,000 Work in Process Direct Materials Price Variance (U) AP. SP AP, SP (F) 1,800 Direct Materials Quantity Variance (U) AQ. SQ SQ 3 AQ (F) 1,000 SQ 3 SP 6,000 72,000 Wages Payable AQ 3 AP 78,000 Labour Rate Variance (U) AR. SR SR. AR (F) 2,000 Labour Efficiency Variance (U) AH. SH SH. AH (F) 8,000 *The authors would like to thank Professor Rick French for suggesting this exhibit.

3 General Ledger Entries to Record Variances 3 Application Competency Summary for Appendix 8A Application Competency Deliverable Source Documents and Key Information Steps Knowledge Competency Record the flow of costs in standard costing. CC15 A Key Information Account debits, credits and balances Report/Document Updated account ledgers Various Accounts in the General Ledger Direct materials, direct labour, variable overhead and work-in-process transactions Performance Report Price and quantity variances 1. Post entries to direct materials, accounts payable, wages payable, and work in process at standard costs. 2. Debit (credit) unfavourable (favourable) variances to the respective variance accounts. Cost flows in a standard costing system CC14 A 3. Close the variance accounts to the cost of goods sold account. BRIEF EXERCISE 8 6 Recording Variances in the General Ledger (CC14 A, 15 A ) Bliny Corporation makes a product with the following standard costs for direct material and direct labour: Brief Exercise for Appendix 8A Direct material: 2.00 metres at $3.25 per metre $6.50 Direct labour: 0.40 hours at $12.50 per hour $5.00 During the most recent month, 5,000 units were produced. The costs associated with the month s production of this product were as follows: Material purchased: 12,000 metres at $3.45 per metre $41,400 Material used in production: 10,500 metres Direct labour: 1,980 hours at $12.20 per hour $24,156 The standard cost variances for direct material and direct labour have been computed to be: Materials price variance: 12,000 metres at $0.20 per metre U $2,400 U Materials quantity variance: 500 metres at $3.25 per metre U $1,625 U Labour rate variance: 1,980 hours at $0.30 per hour F $594 F Labour efficiency variance: 20 hours at $12.50 per hour F $250 F 1. Prepare the general ledger entry to record the purchase of materials on account for the month. 2. Prepare the general ledger entry to record the use of materials for the month. 3. Prepare the general ledger entry to record the incurrence of direct labour cost for the month.

4 4 Appendix 8A Exercises for Appendix 8A EXERCISE 8 7 Material and Labour Variances; Journal Entries (CC9, 10, 14 A, 15 A ) Genola Fashions began production of a new product on June 1. The company uses a standard cost system, establishing the following standards for one unit of the new product: Direct materials feet $5 per foot $35.00 Direct labour hours 8 per hour During June, the following activity was recorded relative to the new product: a. Purchasing acquired 30,000 feet of material at a cost of $4.60 per foot. b. Production used 24,000 feet of the material to manufacture 3,000 units of the new product. c. Production reported 5,000 hours of labour time worked directly on the new product; the cost of this labour time was $43, For materials: a. Compute the direct materials price and quantity variances. b. Prepare journal entries to record the purchase of materials and the use of materials in production. 2. For direct labour: a. Compute the direct labour rate and efficiency variances. b. Prepare a journal entry to record the incurrence of direct labour cost for the month. 3. Post the entries you have prepared to the following T-accounts: Raw Materials Accounts Payable?? Bal.? 138,000 Materials Price Variance Wage Payable 43,000 Materials Quantity Variance Labour Rate Variance Work in Process Labour Efficiency Variance Materials used? Labour cost? EXERCISE 8 8 Variances and Journal Entries (CC9, 10, 14 A, 15 A ) A company has the following standard costs: Direct materials: 7 kilograms at $4 per kilogram $28 Direct labour: 6 hours at $7 per hour $42 9,500 kilograms of materials and 8,500 hours of labour, costing $39,750 and $58,200, respectively, were used to produce 1,500 units.

5 General Ledger Entries to Record Variances 5 1. What amounts would be debited to work in process for materials and labour? 2. What would be the entry to record the materials quantity variance? That is, is it a debit or a credit, and of what amount? 3. Calculate total direct labour cost variance. Identify and calculate the two components of this total labour variance. (Adapted CGA-Canada) EXERCISE 8 9 Variance Journal Entries (CC8, 9, 14 A, 15 A ) Consider the following data compiled by Roachen Ltd. for 15,000 units of finished product: Actual material purchases on account (2,250 $6) $13,500 Materials issued to production ,050 units Standard material cost per unit purchased $ 3.75 Standard quantity allowed for actual production ,200 units Prepare journal entries to recognize price variances at the time of purchase, and quantity variances at the time of issue. (Adapted CGA-Canada)