Material Variances :: Cost Accounting Treatment

Recording, Posting » Transactions involving Materials

Transactions involving materials and their accounting treatment in Costing Accounting Records Assumption :: A separate set of cost ledgers are being maintained for recording the transactions relevant to costing. Transactions Materials Purchased for Cash or Credit Direct Material consumption Indirect Material consumption for Factory Abnormal Loss of Materials There are other transactions like material returns to stores and material returns to the vendors etc. We are limiting the discussion to only those transactions which would aid our understanding of this topic. Ledger Accounts affected by the Transactions SLC » Stores Ledger Control a/c     [Used to record the in and out of the material stock] WIP » Work In Progress a/c     [Used to record cost upto works costs i.e. (direct costs and factory overheads)] FOHC » Factory Overhead Control a/c     [Used to record the factory overheads] CP&L » Costing Profit and Loss a/c     [Used to record the gross profit and the profits and gains of abnormal nature] GLA » General Ledger Adjustment a/c     [Used to record the transactions whose information is derived from financial accounts] Journal Entries Journal in the books of M/s __ for the period from ____ to _____ Date V/R No. Particulars L/F Debit Amount (in Rs) Credit Amount (in Rs) 01. – SLC a/c       To GLA a/c Dr – – xxx xxx [For the value of materials purchased for cash or credit] 02. – WIP a/c       To SLC a/c Dr – – xxx xxx [For the value of materials consumed as direct materials] 03. – FOHC a/c       To SLC a/c Dr – – xxx xxx [For the value of materials consumed as indirect materials in factory] 04. – CPL a/c       To SLC a/c Dr – – xxx xxx [For the value of loss on materials on account of abnormal reasons.] Ledger Posting Dr Stores Ledger Control a/c Cr Date Particulars J/F Amount (in Rs) Date Particulars J/F Amount (in Rs) 01.   To GLA a/c   –   xxxxx   02. 03. 04. By WIP a/c By FOHC a/c By C P/L a/c   – – – xxx xxx xxx

Variances Accounted For

All the variances i.e. Material - Price, Mix, Yield variances are accounted for. Note that Usage/Quantity Variance is the sum of Mix and Yield Variance and Cost Variance is the sum of Price and Usage/Quantity Variance. Ledger Accounts Used The ledger accounts that are used for recording transactions relating to material variances are Material Price Variance a/c Material Mix Variance a/c Material Yield Variance a/c Material Usage/Quantity Variance a/c Material Cost Variance a/c When (at what point?) are the variances Identified? There are different situations involved in the process of identifying the variances depending on the nature of the product and the method adopted by the organisation. Price Variance Where during a period, the price variance in relation to the materials purchased (and not just the materials used) is treated as the material price variance, it is identified at the time of recording the value of goods purchased. The materials taken into stores are valued at standard price and the variance thereon is transferred to the relevant variance account. In such a case, the stocks in the "Stores Ledger Control a/c" would always reflect the standard prices. Where during a period, just the price variance in relation to the materials used (and not the materials purchased) is treated as the material price variance, it is identified at the time of issuing materials to the production process. The materials issued to production as direct and indirect materials are issued at standard prices and the variance thereon is transferred to the relevant variance account. In such a case, the stocks in the "Stores Ledger Control a/c" would not reflect the standard prices. Their value is dependent on the method followed for pricing the issue of stocks (FIFO, LIFO or AVERAGE). Where standard costing systems are in use, the first method is generally adopted. Mix Variance The mix variance arises only when there are two or more materials involved in the production process. Where all the constituent materials in total are issued for production at the same time, the mix variance is identified at the time of issue of materials to the production processes. Where all the constituent materials are issued for production at different times, it would not be possible to assess the actual mix ratio (i.e. the ratio in which all the materials are actually issued/used). In such a case, the mix variance would be identified at the time of transfer of completed production to the finished goods stock Yield Variance The yield variance can be identified after completion of the production process i.e. at the time of transfer of completed production to the finished goods stock Usage/Quantity Variance Where we identify the mix and yield variances, Usage Variance would be nothing but the sum of mix and yield variances. Where we do not identify mix and yield variances separately Usage/Quantity Variance is identified after completion of production process i.e. at the time of transfer of completed production to finished goods stock. We may deliberately avoid identifying the mix and yield variances in which case we use the formula for calculating the usage/Quantity variance. Mix and Yield variances are not thought of when there is only one kind of material used in the production process (in which case all the usage variance is nothing but yield variance.) Cost Variance Where we identify the price and usage variances, Cost Variance would be nothing but the sum of price and usage variances. Where we do not identify price, usage/quantity Variances separately, cost variance is identified after completion of production process i.e. at the time of transfer of completed production to finished goods stock. We use the formula for calculating the Cost variance in such cases.

Variance :: Normal/Abnormal

The variance is considered to be normal when the deviation of the actual from the standard is found to be on account of acceptable/normal reasons. Such a situation can be compared to a situation where there is a need for a revision in standards. It indicates the variance that should be accepted and absorbed into cost. Any variance or a part of the variance which is avoidable and would not have occurred under normal circumstances is abnormal variance. For example, Price Variance Standard Price = Rs. 20/kg; Actual Price = Rs. 25/kg; Actual Quantity Purchased = 2,000 kgs. The prices of the materials have increased and the new price is Rs. 24/kg. After reviewing the variances it was decided that this increase is inevitable and has to be accepted. Material Price Variance AQ (SP − AP) Before revision of standard = 2,000 kgs (Rs. 20/kg − Rs. 25/kg) ⇒ MPV = − Rs. 5,000. After revision of standard = 2,000 kgs (Rs. 24/kg − Rs. 25/kg) ⇒ MPV = − Rs. 1,000. Of the initial variance identified (− Rs. 5,000), − Rs. 1,000 is abnormal and the rest − Rs. 4,000 is to be regarded as normal. Mix Variance There is a revision in the ratio in which the materials are to be mixed. Material Mix Variance before revising the standard is + Rs. 1,800. After revising the standards the mix variance turns out to be + Rs. 600. The variance measured using the new standards would be the real variance which should not have been there and is thus abnormal. Anything other than that is acceptable and is normal. Thus, + Rs. 1,200 of the variance is normal and + Rs. 600 is abnormal. Yield Variance There is a change in the method of production, whereby each kg of material yielded 12 units compared to the original standard wherein the yield would be only 10 units per kg. Material Yield Variance measured taking the original standard into consideration is + Rs. 2,000. But when measured with the revised standard, the yield variance turns out to be − Rs. 600. Thus, + Rs. 2,600 of the variance is normal and − Rs. 600 is abnormal.

Treatment of Normal and Abnormal Parts of the Variances

In adjusting the normal part of the variance appropriately we need to identify that part of the normal variance which influences the value of Materials included in Closing stock of Raw Materials » Is adjusted to "Stores Ledger Control a/c" Closing Work in Progress » Is adjusted to "Work-In-Progress a/c" Closing Finished Goods » Is adjusted to "Finished Goods Ledger Control a/c" Cost of Goods Sold » Is adjusted to "Cost of Sales a/c" No adjustment is made with regard to the abnormal part of the variance and it is eliminated from accounting completely Accounting Treatment The treatment/adjustment of normal and abnormal parts of the variance with respect to each ledger account is as follows: Price Variance The total price variance appears as a debit balance in the "Material Price Variance a/c" and The normal part of the variance is apportioned between SLC a/c, WIP a/c, FGLC a/c and CGS a/c; and The abnormal part is transferred/adjusted to "MCV a/c" Mix Variance The total Mix variance appears as a debit balance in the "Material Mix Variance a/c" and The normal part of the variance is apportioned between WIP a/c, FGLC a/c and CGS a/c. The abnormal part is transferred/adjusted to "MUV a/c" YieldSub-Usage Variance The total Yield/Sub-Usage variance appears as a debit balance in the "Material Yield/Sub-Usage Variance a/c" and The normal part of the variance is apportioned between WIP a/c, FGLC a/c and CGS a/c. The abnormal part is transferred/adjusted to "MUV a/c" Usage/Quantity Variance a/c This is a consolidation account. It represents the total abnormal part of mix and yield variances. Since the total balance represents abnormal variance, it is adjusted/transferred to "MCV a/c". Where the Mix and Yield variances are not identified separately we identify the Usage/Quantity Variance directly. In such cases, the "MCV a/c" is not a consolidation account. In such a case, the total Usage/Quantity variance appears as a debit balance in the "Material Usage/Quantity Variance a/c" and The normal part of the variance is apportioned between WIP a/c, FGLC a/c and CGS a/c. The abnormal part is transferred/adjusted to "MUV/MQV a/c" Cost Variance a/c This is a consolidation account. It represents the total abnormal part of price and usage variances. Since the total balance represents abnormal variance, it is adjusted/transferred to "Costing P&L a/c." Where the Price and Usage/Quantity variances are not identified separately we identify the Cost Variance directly. In such cases, the "MCV a/c" is not a consolidation account. In such a case, the total Cost variance appears as a debit balance in the "Material Cost Variance a/c" and The normal part of the variance is apportioned between SLC a/c, WIP a/c, FGLC a/c and CGS a/c. The abnormal part is transferred/adjusted to "Costing P/L a/c" Note Adjustment of normal variance may result in the relevant account being either debited or credited depending on the nature of the variance being adjusted. Adjustment of the normal part of the Price and Cost variances influences all the four accounts i.e. the SLC a/c, WIP a/c, FGLC a/c, COS a/c. Adjustment of the normal part of Mix, Yield and Quantity/Usage variance does not influence the SLC a/c. It influences only the three accounts i.e. the WIP a/c, FGLC a/c, COS a/c. Where "Usage/Quantity Variance a/c" and "Cost Variance a/c" are consolidation accounts and the variance transferred to them from other accounts is only abnormal, they do not have normal variance to be transferred/treated.

Author Credit : The Edifier

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