Most companies dispose of variances at the end of the year by either closing them to Cost of Goods Sold or prorating them among Work in Process, Cost of Goods Sold, and Finished Goods. If the variances are immaterial, then the most expedient disposition is simply to assign them to Cost of Goods Sold. To illustrate, assume that the variances we have computed for the first week in May are the year-end variances (for Helado Company). Assuming the variances are immaterial, the following entry would be made to dispose of them:
If the variances are judged to be material, then the proration option is usually exercised. This option is driven by GAAP requirements that inventories and cost of goods sold be reported at actual costs. Yet, if variances are measures of inefficiency, it seems difficult to justify carrying costs of inefficiency as assets. It seems more logical to write off the costs of inefficiency as a cost of the period. With this conceptual qualification,we will illustrate one method of proration, using Helado’s May variances as year-end variances. We will assume that direct materials and direct labor are added uniformly throughout the process; thus, the direct materials and direct labor variances can be assigned in proportion to the total prime costs in each of the three inventory accounts.
Other proration variations are possible. For example, direct materials variances could be assigned in proportion to the total direct materials cost in each account, and the direct labor variances could be assigned in proportion to the total direct labor costs. Some even argue that finer assignments of the variances may be needed. The direct materials price variance, for example, could be assigned to the MUV account, the materials inventory account, work in process, finished goods, and the cost of goods sold account (with the other variances assigned only to the usual three inventory accounts). Assume that the standard prime costs (before allocation of the direct materials and direct labor variances) are as follows (these are assumed values):Read four variance method two variable overhead variances
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