Accounting for Variances

Accounting for variances between actual and standard costs is basically the same under all standard-costing systems. The procedures are described in Chapters 7 and 8. Suppose that in Example 1, SVC had an unfavorable direct materials price variance of $42,000. Then the journal entry would be as follows:

Direct materials costs are often a large proportion of total manufacturing costs, sometimes as much as 60%. Consequently, many companies measure the direct materials efficiency variance in total by physically comparing what remains in direct materials inventory against what should remain based on the output of finished goods for the accounting period. In our example, suppose that such a comparison showed an unfavorable materials efficiency variance of $30,000. The journal entry would be as follows:

The underallocated or overallocated conversion costs are split into various overhead variances (spending variance, efficiency variance, and production-volume variance), as explained in Chapter 8. Each variance is closed to the Cost of Goods Sold account, if it is immaterial in amount.

This example uses the SVC data to illustrate a backflush costing that differs more from sequential tracking than the backflush costing in Example 1. This example and Example 1 have the same first trigger point, purchase of direct materials and incurring of conversion costs. But the second trigger point in Example 2 is the sale, not the completion, of finished goods. Note that there is no journal entry for Production resulting in work in process (Stage B) and Completion of good finished units of product (Stage C) because this method is used when there are ­minimal work-in-process and finished-goods inventories (units started are quickly converted into finished goods that are immediately sold).

In this example, there is only one inventory account: direct materials, whether the materials are in storerooms, in process, or in finished goods.

Exhibit 21-8, Panel A, summarizes the journal entries for Example 2 with two trigger points: Purchase of direct materials and incurring of conversion costs and Sale of finished goods (and recognizing under- or overallocated costs). As in Example 1, for each stage, the backflush costing entries for SVC are shown on the left. The comparable entries under sequential tracking are shown on the right.

The entries for direct materials purchased and conversion costs incurred (Stage A) are the same as in Example 1, except that the inventory account is called Inventory Control. As in Example 1, no entry is made to record the production of work-in-process inventory (Stage B) because the work-in-process inventory is minimal. When finished goods are completed (Stage C), no entry is recorded because the completed units are expected to be sold quickly and the finished-goods inventory is expected to be minimal. As finished goods are sold (Stage D), the cost of goods sold is calculated as $\text{99,000}\hspace{0.17em}\text{units\hspace{0.17em}sold}\times \mathrm{\$}31\hspace{0.17em}\text{per\hspace{0.17em}unit}=\$\text{3,069,000},$ which is composed of direct materials costs $(\text{99,000}\hspace{0.17em}\text{units}\times \mathrm{\$}19\hspace{0.17em}\text{per\hspace{0.17em}unit}=\mathrm{\$}\text{1,881,000})$ and conversion costs allocated $(\text{99,000}\hspace{0.17em}\text{units}\hspace{0.17em}\times \hspace{0.17em}\mathrm{\$}12\hspace{0.17em}\text{per\hspace{0.17em}unit}=\mathrm{\$}\text{1,188,000}).$ This is the same Cost of Goods Sold calculated under sequential tracking as described in Example 1.

Under this method of backflush costing, conversion costs are not inventoried because no entries are recorded when finished goods are produced in Stage C. That is, compared with sequential tracking, Example 2 does not assign $\mathrm{\$}\text{12,000}\hspace{0.17em}(\mathrm{\$}12\hspace{0.17em}\text{per\hspace{0.17em}unit}\times \text{1,000}\hspace{0.17em}\text{units})$ of conversion costs to finished-goods inventory produced but not sold. Of the $1,260,000 in conversion costs, $1,188,000 is allocated at standard cost to the units sold. The remaining $72,000 $(\mathrm{\$}\text{1,260,000}\hspace{0.17em}-\hspace{0.17em}\mathrm{\$}\text{1,188,000})$ of conversion costs is underallocated compared to $60,000 under sequential tracking. Entry (D2) presents the journal entry if SVC, like many companies, writes off these underallocated costs monthly as additions to the Cost of Goods Sold account.

The April 30 ending balance of the Inventory Control account is $69,000 $(\mathrm{\$}\text{1,950,000}-\mathrm{\$}\text{1,881,000}).$ This balance represents the $50,000 direct materials still on $\text{hand}+\mathrm{\$}\text{19,000}$ direct materials embodied in the 1,000 finished units manufactured but not sold during the period. Finished-goods inventory under sequential tracking is: direct materials, $\mathrm{\$}\text{19,000}+\text{conversion}$ costs, $12,000 for a total of $31,000. Exhibit 21-8, Panel B, provides a general-ledger overview of Example 2. The approach described in Example 2 closely approximates the costs computed using sequential tracking when a company holds minimal work-in-process and finished-goods inventories.

Toyota’s cost accounting system at its Kentucky plant is similar to this example. Two advantages of this system are (1) it removes the incentive for managers to produce for inventory because conversion costs are recorded as period costs instead of inventoriable costs and (2) it focuses managers on sales.

This example has two trigger points. In contrast to Example 2, the first trigger point in Example 3 is delayed until Stage C, SVC’s completion of good finished units of product. Note that there are no journal entries for Purchase of direct materials and incurring of conversion costs (Stage A) and Production resulting in work in process (Stage B) because this method is used when there are minimal direct materials and work-in-process inventories (direct materials purchased are quickly placed into production and then quickly converted into finished goods).

Exhibit 21-9, Panel A, summarizes the journal entries for Example 3 with two ­trigger points: Completion of good finished units of product and Sale of finished goods (and recognizing under- or overallocated costs). As in Examples 1 and 2, for each stage, the backflush costing entries for SVC are shown on the left. The comparable entries under sequential tracking are shown on the right.

No entry is made for direct materials purchases of $1,950,000 (Stage A) because the acquisition of direct materials is not a trigger point in this form of backflush costing. As in Examples 1 and 2, actual conversion costs are recorded as incurred and no entry is made to record production resulting in work-in-process inventory (Stage B). The cost of 100,000 good finished units completed (Stage C) is recorded at standard cost of $\mathrm{\$}31\mathrm{\hspace{0.17em}}(\mathrm{\$}19\hspace{0.17em}\text{direct materials}+\mathrm{\$}12\hspace{0.17em}\text{conversion costs})$ per unit as in Example 1 except that Accounts Payable Control is credited (instead of Materials and In-Process Inventory Control) because no entry had been made when direct materials were purchased in Stage A. Note that at the end of April, $50,000 of direct materials purchased have not yet been placed into production $(\mathrm{\$}\text{1,950,000}-\mathrm{\$}\text{1,900,000}=\mathrm{\$}\text{50,000}),$ nor have the cost of those direct materials been entered into the inventory-costing system. The Example 3 version of backflush costing is suitable for a JIT production system in which both direct materials inventory and work-in-process inventory are minimal. As finished goods are sold (Stage D), the cost of goods sold is calculated as $\text{99,000}\hspace{0.17em}\text{units sold}\times \mathrm{\$}31\hspace{0.17em}\text{per unit}=\$\text{3,069,000}.$ This is the same Cost of Goods sold calculated under sequential tracking. The Finished Goods Control account has a balance of $31,000 under both this form of backflush costing and sequential tracking. The journal entry to dispose of the difference between the actual conversion costs incurred and standard conversion costs allocated is the same under backflush costing and sequential tracking. The only difference between this form of backflush costing and sequential tracking is that direct materials inventory of $50,000 (and the corresponding Accounts Payable Control) is not recorded, which is no problem if direct materials inventories are minimal. Exhibit 21-9, Panel B, provides a general-ledger overview of Example 3.

Extending Example 3, backflush costing systems could use the sale of finished goods as the only trigger point. This version of backflush costing is most suitable for a JIT production system with minimal direct materials, work-in-process, and finished-goods inventories. That’s because this backflush costing system maintains no inventory accounts.