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4.7. Journal Entries of 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.

The following diagram shows the impact within the general ledger accounts.

4.8. Factory Overhead Variances

Remember that manufacturing costs consist of direct material, direct labor, and factory overhead. You have just seen how variances are computed for direct material and direct labor. Similar variance analysis should be performed to evaluate spending and utilization for factory overhead. But, overhead variances are a bit more challenging to calculate and evaluate. As a result the techniques for factory overhead evaluation vary considerably from company to company (and textbook to textbook). If you progress to advanced managerial accounting courses, you will likely learn about a variety of alternative techniques. For now, let's focus on one comprehensive approach.

4.9. Variable Versus Fixed Overhead

To begin, recall that overhead has both variable and fixed components (unlike direct labor and direct material that are exclusively variable in nature). The variable components may consist of items like indirect material, indirect labor, and factory supplies. Fixed factory overhead might include rent, depreciation, insurance, maintenance, and so forth. Because variable and fixed costs behave in a completely different fashion, it stands to reason that proper evaluation of variances between expected and actual overhead costs must take into account the intrinsic cost behavior. As a result, variance analysis for overhead is split between variances related to variable overhead and variances related to fixed overhead.

4.10. 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

 
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