The journal entry to record the direct labor rate and efficiency variance is made simultaneously. The general form of this journal entry follows. (It assumes a favorable direct labor rate variance and an unfavorable direct labor efficiency variance.
Notice that only standard hours and standard rates are used to assign direct labor costs to Work in Process. Actual prices and quantities are not used. This emphasizes the principle that all inventories are carried at standard. The journal entry for Helado’s use of direct labor during the first week of May follows. Since both variances are unfavorable, the variance accounts are debited
Investigating Direct Materials and Labor Variances
Rarely will actual performance exactly meet the established standards, nor does management expect it to do so. Random variations around the standard are expected. Because of this, management should have in mind an acceptable range of performance. When variances are within this range, they are assumed to be caused by random factors. When a variance falls outside this range, the deviation is likely to be caused by nonrandom factors, either factors that managers can control or factors they cannot control. In the noncontrollable case, managers need to revise the standard. For the controllable case, an investigation should be undertaken only if the anticipated benefits are greater than the expected costs. In making this assessment, a manager must consider whether a variance will recur. If so, the process may be permanently out of control, meaning that periodic savings may be achieved if corrective action is taken. For example, consider Helado’s unfavorable materials usage variance. Assume that investigation reveals that the unfavorable direct variance was the result of rejecting a 1,200-quart batch because of poor consistency and flavor. Some settings in the mixing process had been mistakenly altered, resulting in a faulty mix of ingredients. The setting was corrected, and no further problems were noticed.
Because it is difficult to assess the costs and benefits of variance analysis on a caseby- case basis, many firms adopt the general guideline of investigating variances only if they fall outside an acceptable range. The acceptable range is the standard, plus or minus an allowable deviation. The top and bottom measures of the allowable range are called the control limits. The upper control limit is the standard plus the allowable deviation, and the lower control limit is the standard minus the allowable deviation. Current practice sets the control limits subjectively: based on past experience, intuition, and judgment, management determines the allowable deviation from standard.
The control limits are usually expressed both as a percentage of the standard and as an absolute dollar amount. For example, the allowable deviation may be expressed as the lesser of 10 percent of the standard amount or $10,000. In other words, management will not accept a deviation of more than $10,000 even if that deviation is less than 10 percent of the standard. Alternatively, even if the dollar amount is less than $10,000, aninvestigation is required if the deviation is more than 10 percent of the standard amount. Formal statistical procedures can also be used to set the control limits. In this way, less subjectivity is involved and a manager can assess the likelihood of the variance being caused by random factors. The use of such formal procedures has gained little acceptance.
Responsibility for the Direct Materials Variances
The responsibility for controlling the direct materials price variance is usually the purchasing agent’s. Admittedly, the price of direct materials is largely beyond his or her control; however, the price variance can be influenced by such factors as quality, quantity discounts, distance of the source from the plant, and so on. These factors are often under the control of the agent. The production manager is generally responsible for direct materials usage. Minimizing scrap, waste, and rework are all ways in which the manager can ensure that the standard is met. However, at times, the cause of the variance is attributable to others outside the production area. For example, the purchase of lower-quality direct materials may produce bad output. In this case, responsibility would be assigned to purchasing rather than production.
Responsibility for the Direct Labor Variances
Direct labor rates are largely determined by such external forces as labor markets and union contracts. When direct labor rate variances occur, they often do so because an av- erage wage rate is used for the rate standard or because more skilled and more highly paid laborers are used for less skilled tasks. Wage rates for a particular direct labor activity often differ among workers because of differing levels of seniority. Rather than selectingdirect labor rate standards reflecting those different levels, an average wage rate is often chosen. As the seniority mix changes, the average rate changes. This will give rise to a direct labor rate variance; it also calls for a new standard to reflect the new seniority mix. Controllability is not assignable for this cause of a direct labor rate variance. However, the use of direct labor is controllable by the production manager.
Read disposition of direct materials and direct labor variances
The use
of more skilled workers to perform less skilled tasks (or vice versa) is a decision that a production manager consciously makes. For this reason, responsibility for the direct labor rate variance is generally assigned to the individuals who decide how direct labor will be used. The same is true of the direct labor efficiency variance. However, as is true of all variances, once the cause is discovered, responsibility may be assigned elsewhere. For example, frequentbreakdowns of machinery may cause interruptions and nonproductive use of direct labor. But the responsibility for these breakdowns may be faulty maintenance. If so, th maintenance manager should be charged with the unfavorable direct labor efficiency variance.
Rarely will actual performance exactly meet the established standards, nor does management expect it to do so. Random variations around the standard are expected. Because of this, management should have in mind an acceptable range of performance. When variances are within this range, they are assumed to be caused by random factors. When a variance falls outside this range, the deviation is likely to be caused by nonrandom factors, either factors that managers can control or factors they cannot control. In the noncontrollable case, managers need to revise the standard. For the controllable case, an investigation should be undertaken only if the anticipated benefits are greater than the expected costs. In making this assessment, a manager must consider whether a variance will recur. If so, the process may be permanently out of control, meaning that periodic savings may be achieved if corrective action is taken. For example, consider Helado’s unfavorable materials usage variance. Assume that investigation reveals that the unfavorable direct variance was the result of rejecting a 1,200-quart batch because of poor consistency and flavor. Some settings in the mixing process had been mistakenly altered, resulting in a faulty mix of ingredients. The setting was corrected, and no further problems were noticed.
Because it is difficult to assess the costs and benefits of variance analysis on a caseby- case basis, many firms adopt the general guideline of investigating variances only if they fall outside an acceptable range. The acceptable range is the standard, plus or minus an allowable deviation. The top and bottom measures of the allowable range are called the control limits. The upper control limit is the standard plus the allowable deviation, and the lower control limit is the standard minus the allowable deviation. Current practice sets the control limits subjectively: based on past experience, intuition, and judgment, management determines the allowable deviation from standard.
The control limits are usually expressed both as a percentage of the standard and as an absolute dollar amount. For example, the allowable deviation may be expressed as the lesser of 10 percent of the standard amount or $10,000. In other words, management will not accept a deviation of more than $10,000 even if that deviation is less than 10 percent of the standard. Alternatively, even if the dollar amount is less than $10,000, aninvestigation is required if the deviation is more than 10 percent of the standard amount. Formal statistical procedures can also be used to set the control limits. In this way, less subjectivity is involved and a manager can assess the likelihood of the variance being caused by random factors. The use of such formal procedures has gained little acceptance.
Responsibility for the Direct Materials Variances
The responsibility for controlling the direct materials price variance is usually the purchasing agent’s. Admittedly, the price of direct materials is largely beyond his or her control; however, the price variance can be influenced by such factors as quality, quantity discounts, distance of the source from the plant, and so on. These factors are often under the control of the agent. The production manager is generally responsible for direct materials usage. Minimizing scrap, waste, and rework are all ways in which the manager can ensure that the standard is met. However, at times, the cause of the variance is attributable to others outside the production area. For example, the purchase of lower-quality direct materials may produce bad output. In this case, responsibility would be assigned to purchasing rather than production.
Responsibility for the Direct Labor Variances
Direct labor rates are largely determined by such external forces as labor markets and union contracts. When direct labor rate variances occur, they often do so because an av- erage wage rate is used for the rate standard or because more skilled and more highly paid laborers are used for less skilled tasks. Wage rates for a particular direct labor activity often differ among workers because of differing levels of seniority. Rather than selectingdirect labor rate standards reflecting those different levels, an average wage rate is often chosen. As the seniority mix changes, the average rate changes. This will give rise to a direct labor rate variance; it also calls for a new standard to reflect the new seniority mix. Controllability is not assignable for this cause of a direct labor rate variance. However, the use of direct labor is controllable by the production manager.
Read disposition of direct materials and direct labor variances
The use
of more skilled workers to perform less skilled tasks (or vice versa) is a decision that a production manager consciously makes. For this reason, responsibility for the direct labor rate variance is generally assigned to the individuals who decide how direct labor will be used. The same is true of the direct labor efficiency variance. However, as is true of all variances, once the cause is discovered, responsibility may be assigned elsewhere. For example, frequentbreakdowns of machinery may cause interruptions and nonproductive use of direct labor. But the responsibility for these breakdowns may be faulty maintenance. If so, th maintenance manager should be charged with the unfavorable direct labor efficiency variance.
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