We next illustrate journal entries for Webb Company using standard costing. Our focus is on direct materials and direct manufacturing labor. All the numbers in the following journal entries are found in Exhibit 7-3.
NOTE: In each of the following entries, unfavorable variances are always debits (they decrease operating income), and favorable variances are always credits (they increase operating income).
Isolate the direct materials price variance at the time the materials are purchased by increasing (debiting) the Direct Materials Control account by the standard price for materials. This is the earliest time possible to isolate this variance.
The table depicts how to isolate the direct materials price variance. The details of the table are as follows:
1. Direct materials control: 22,200 square yards times 30 dollars per square yard equals 666,000
2. Direct materials price variance: 22,200 square yards times 2 dollars per square yard equals 44,400
3. Accounts payable control: 22,200 square yards times 28 dollars per square yard equals 621,600
This records the direct materials purchased.
Isolate the direct materials efficiency variance at the time the direct materials are used by increasing (debiting) the Work-in-Process Control account. Use the standard quantities allowed for the actual output units manufactured times their standard purchase prices.
The table depicts how to isolate the direct materials efficiency variance. The details of the table are as follows:
1. Work-in-process control: 10,000 jackets times 2 yards per jacket times 30 dollars per square yard equals 600,000
2. Direct materials efficiency variance: 2,200 square yards times 30 dollars per square yard equals 66,000
3. Direct materials control: 22,200 square yards times 30 dollars per square yard equals 666,000
3. Accounts payable control: 22,200 square yards times 28 dollars per square yard equals 621,600
This records the direct materials used.
Isolate the direct manufacturing labor price variance and efficiency variance at the time labor is used by increasing (debiting) the Work-in-Process Control by the standard hours and standard wage rates allowed for the actual units manufactured. Note that the Wages Payable Control account measures the actual amounts payable to workers based on the actual hours they worked and their actual wage rate.
The table depicts the actual amounts payable to workers. The details of the table are as follows:
1. Work-in-process control: 10,000 jackets times 0.80 hour per jacket times 20 dollars per hour equals 160,000
2. Direct manufacturing labor price variance: 9,000 hours times 2 dollars per hour equals 18,000
3. Direct manufacturing labor efficiency variance: 1,000 hours times 20 dollars per hour equals 20,000
4. Wages payable control: 9,000 hours times 22 per hour equals 198,000
This records the liability for Webb’s direct manufacturing labor costs.
Standard costing and variance analysis focus managerial attention on areas not operating as expected. The journal entries point to another advantage of standard costing systems: They simplify product costing. As each unit is manufactured, costs are assigned to it using the standard cost of direct materials, the standard cost of direct manufacturing labor, and, as you will see in a later chapter (Chapter 8), the standard manufacturing overhead cost.
From the perspective of control, variances are isolated at the earliest possible time. For example, the direct materials price variance is calculated at the time materials are purchased. Managers take corrective actions—such as negotiating cost reductions from current suppliers or obtaining price quotes from new suppliers—soon after purchases are made and the unfavorable variance is known. If managers only learn about the variances after materials are used in production, it would delay these actions.
Suppose variance amounts are immaterial at the end of the fiscal year. For simplicity, assume that the balances in the different direct-cost variance accounts as of April 2020 are also the balances at the end of 2020. Webb would record the following journal entry to write off the direct-cost variance accounts to the Cost of Goods Sold account.
The table depicts writing off the direct-cost variance accounts to the cost of goods sold account. The details of the table are as follows:
1. Cost of goods sold: 59,600
2. Direct materials price variance: 44,400
3. Direct materials efficiency variance: 66,000
4. Direct manufacturing labor price variance: 18,000
5. Direct manufacturing labor efficiency variance: 20,000
Alternatively, assume Webb has inventories at the end of the fiscal year and that the variances are material. The variance accounts will be prorated among the cost of goods sold and various inventory accounts using the methods described in Chapter 4. For example, the Direct Materials Price Variance will be prorated among Materials Control, Work-in-Process Control, Finished Goods Control, and Cost of Goods Sold on the basis of the standard costs of direct materials in each account’s ending balance. Direct Materials Efficiency Variance is prorated among Work-in-Process Control, Finished Goods Control, and Cost of Goods Sold on the basis of the direct material costs in each account’s ending balance (after proration of the direct materials price variance).
As discussed in Chapter 4, many accountants, industrial engineers, and managers argue that to the extent variances measure inefficiency during the year, they should be written off against income for that period instead of being prorated among inventories and the cost of goods sold. They believe it is better to apply a combination of the write-off and proration methods for each individual variance so that, unlike full proration, the firm does not end up carrying the costs of inefficiency as part of its inventoriable costs. Consider the efficiency variance: The portion of the variance due to avoidable inefficiencies should be written off to cost of goods sold. In contrast, the portion that is unavoidable should be prorated. Likewise, if a portion of the direct materials price variance is unavoidable because it is entirely caused by general market conditions, it too should be prorated.