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8.7. Journal Entries for Direct Labor Variances

If Blue Rail desires to capture labor variances in their general ledger accounting system, the entry might look something like this:

8-31-XX

Work in Process Inventory

183,600

Labor Efficiency Variance

41,400

Labor Rate Variance

50,000

Wages Payable

175,000

To increase work in process for the standard direct labor costs, and record the related efficiency and rate variances

Once again, debits reflect unfavorable variances, and vice versa. Such variance amounts are generally reported as decreases (unfavorable) or increases (favorable) in income, with the standard cost going to the Work in Process Inventory account. The following diagram shows the impact within the general ledger accounts.

Before looking closer at these variances, it is first necessary to recall that overhead is usually applied based on a predetermined rate, such as $X per direct labor hour (you may find it helpful to review this concept from Part 3 of the Managerial and Cost Accounting book. This means that the amount debited to work in process is driven by the overhead application approach. This will become clearer with the following illustration.

8.12. An Illustration of Variable Overhead Variances

Let's return to the illustration for Blue Rail. Variable factory overhead for August consisted primarily of indirect materials (welding rods, grinding disks, paint, etc.), indirect labor (inspector time, shop foreman, etc.), and other items. Extensive budgeting and analysis had been performed, and it was estimated that variable factory overhead should be applied at $10 per direct labor hour. During August, $105,000 was actually spent on variable factory overhead items. The standard cost for August's production was as follows:

8.10. Variances Relating to Variable Factory Overhead

The cost behavior for variable factory overhead is not unlike direct material and direct labor, and the variance analysis is quite similar. The goal will be to account for the total "actual" variable overhead by applying: (1) the "standard" amount to work in process, and (2) the "difference" to appropriate variance accounts. This accounting objective is no different than observed for direct material and direct labor!

On the left-hand side of the following graphic, 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 "under applied overhead" since not all that is spent is applied to production). The right-hand side is the opposite scenario (favorable/over applied overhead). Beneath the graphics are T-accounts intending to illustrate the cost flow. As monies are spent on overhead (wages, utilization of indirect materials, etc.), the cost (xxx) 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 (as on the left scale), the balance (zz) is transferred to variance accounts representing the unfavorable outcome. When less is spent than applied (as on the right scale), the balance (zz) represents the favorable overall variances.

Variances Relating to Variable Factory Overhead

8.11. Exploring Variable Overhead Variances

A good manager will want to explore the nature of variances relating to variable overhead. It is not sufficient to simply conclude that more or less was spent than intended. As with direct material and direct labor, it is possible that the prices paid for underlying components deviated from expectations (a variable overhead spending variance). On the other hand, it is possible that the company's productive efficiency drove the variances (a variable overhead efficiency variance). Thus, the Total Variable Overhead Variance can be divided into a Variable Overhead Spending Variance and a Variable Overhead Efficiency Variance.

Before looking closer at these variances, it is first necessary to recall that overhead is usually applied based on a predetermined rate, such as $X per direct labor hour (you may find it helpful to review this concept from Part 3 of the Managerial and Cost Accounting book. This means that the amount debited to work in process is driven by the overhead application approach. This will become clearer with the following illustration.

 
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