Problem for Self-Study

O’Shea Company manufactures ceramic vases. It uses its standard costing system when developing its flexible-budget amounts. In September 2020, O’Shea produced 2,000 finished units. The following information relates to its two direct manufacturing cost categories: direct materials and direct manufacturing labor.

Direct materials used were 4,400 kilograms (kg). The standard direct materials input allowed for one output unit is 2 kilograms at $15 per kilogram. O’Shea purchased 5,000 kilograms of materials at $16.50 per kilogram, a total of $82,500. (This Problem for Self-Study illustrates how to calculate direct materials variances when the quantity of materials purchased in a period differs from the quantity of materials used in that period.)

Actual direct manufacturing labor-hours were 3,250, at a total cost of $66,300. Standard manufacturing labor time allowed is 1.5 hours per output unit, and the standard direct manufacturing labor cost is $20 per hour.

Required

  1. Calculate the direct materials price variance and efficiency variance and the direct manufacturing labor price variance and efficiency variance. Base the direct materials price variance on a flexible budget for actual quantity purchased, but base the direct materials efficiency variance on a flexible budget for actual quantity used.
  2. Prepare journal entries for a standard costing system that isolates variances at the earliest possible time.

Solution

  1. 1. Exhibit 7-6 shows how the columnar presentation of variances introduced in Exhibit 7-3 can be adjusted for the difference in timing between purchase and use of materials. Note, in particular, the two sets of computations in column 2 for direct materials—the $75,000 for direct materials purchased and the $66,000 for direct materials used. The direct materials price variance is calculated on purchases so that managers responsible for the purchase can immediately identify and isolate reasons for the variance and initiate any desired corrective action. The efficiency variance is the responsibility of the production manager, so this variance is identified only at the time materials are used.

Exhibit 7-6

Columnar Presentation of Variance Analysis for O’Shea Company: Direct Materials and Direct Manufacturing Labor for September 2020a

A table shows the level 3 variance analysis for O’Shea Company.
a F = favorable effect on operating income; U = unfavorable effect on operating income.

Details of direct material and direct manufacturing labor are as follows:

  • Direct material

    • 1. Actual Costs Incurred (The actual inputs quantity times the actual price): dollar 82,500 (which is 5,000 kg times dollar 16.50 per kg)

    • 2. Actual input quantity times budgeted price

      • dollar 75,000 (which is 5,000 kg times dollar 15.00 per kg)

      • dollar 66,000 (which is 4,400 kg times dollar 15.00 per kg)

    • 3. Flexible budget (it is the budgeted input quantity allowed for actual output times the budgeted price): dollar 60,000 (which is 2,000 units times 2 kg per unit times dollar 15 per kg)

    • Price variance: dollar 7,500 that has unfavorable effect on operating income, is the difference between dollar 82,500 and dollar 75,000

    • Efficiency variance: dollar 6,000 that has unfavorable effect on operating income, is the difference between dollar 66,000 and dollar 60,000

  • Direct manufacturing labor

    • Actual Costs Incurred (The actual inputs quantity times the actual price): dollar 66,300 (which is 3,250 hours times dollar 20.40 per hour)

    • 2. Actual input quantity times budgeted price: dollar 65,000 (which is 3,250 hours times dollar 20 per hour)

    • 3. Flexible budget (it is the budgeted input quantity allowed for actual output times the budgeted price): dollar 60,000 (which is 2,000 units times 1.50 hour per unit times dollar 20 per hour)

    • Price variance: dollar 1,300 that has unfavorable effect on operating income is the difference between above 1 and 2.

    • Efficiency variance: dollar 5,000 that has unfavorable effect on operating income is the difference between above 2 and 3.

  1. 2.

<p>A table shows a journal entry for O’Shea Company</p>

The table depicts journal entries for a standard costing system that isolates variances at the earliest possible times. The details of the table are as follows:

1. Materials control, 5,000 kilograms times 15 dollars per kilogram: 75,000

2. Direct materials price variance, 5,000 kilograms times 1.50 dollars per kilogram: 7,500

3. Accounts payable control, 5,000 kilograms times 16.50 dollars per kilogram: 82,500

4. Work-in-process control, 2,000 units times 2 kilograms per unit times 15 dollars per kilogram: 60,000

5. Direct materials efficiency variance, 400 kilograms times 15 dollars per kilogram: 6,000

6. Materials control, 4,400 kilograms times 15 dollars per kilogram: 66,000

7. Work-in-Process Control, 2,000 units times 1.5 hours per unit times 20 dollars per hour: 60,000

8. Direct manufacturing labor price variance, 3,250 hours times 0.40 dollars per hour: 1,300

9. Direct manufacturing labor efficiency variance, 250 hours times 20 dollars per hour: 5,000

10. Wages payable control, 3,250 hours times 20.40 dollars per hour: 66,300

NOTE: All the variances are debits because they are unfavorable and therefore reduce operating income.