When preparing the financial statements, a debit balance in the Materials Usage Variance account (which means an unfavorable variance) will have to be added to the standard cost of the products. If the standard costs associated with the variance are in the goods that have been sold, the debit balance in the variance account will be added to the Cost of Goods Sold, an income statement expense. (This is reasonable, because the standard cost is too low compared to the actual cost of the materials.) If the output associated with the variances is entirely in finished goods inventory, then the debit balance in the variance account will be added to the finished goods inventory amount reported on the balance sheet. Again, this is necessary because the standard cost of the finished goods inventory is too low. If the products are in work in process, finished goods inventory, and cost of goods sold, you would assign the variance to all three categories based on the proportions associated with the variance amounts. Accountants refer to this as prorating the variances. If the variance amount is insignificant, accountants will simply assign these small variances to the cost of goods sold. This is reasonable if most of the goods that were produced have been sold. Generally, inventories are small in relation to the quantities produced.
Credit balances in the variance accounts represent favorable variances and will reduce the standard costs that are reported as debit balances in inventory on the balance sheet or as cost of goods sold expense on the income statement. The favorable variances will be prorated as discussed above or simply credited to cost of goods sold when the variances are not significant or material in amount.
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