Standard Costing

Under a standard costing system, production and inventories are reported at the standard cost—including the standard quantity of direct materials that should have been used to make the products. If the manufacturer actually uses more direct materials than the standard quantity of materials for the products actually manufactured, the company will have an unfavorable direct materials usage variance. If the quantity of direct materials actually used is less than the standard quantity for the products produced, the company will have a favorable usage variance. The amount of a favorable and unfavorable variance is recorded in a general ledger account Direct Materials Usage Variance. (Alternative account titles include Direct Materials Quantity Variance or Direct Materials Efficiency Variance.) Let's demonstrate this variance with the following information.

January 2009

In order to calculate the direct materials usage or quantity variance, we start with the number of acceptable units of products that have been manufactured—also known as the good output. At DenimWorks this is the number of good aprons physically produced. If DenimWorks produces 100 large aprons and 60 small aprons during January, the production and the finished goods inventory will begin with the cost of the direct materials that should have been used to make those aprons. Any difference will be a variance.

Standard costs are sometimes referred to as the "should be costs." DenimWorks should be using 278 yards of denim to make 100 large aprons and 60 small aprons as shown in the following table.

	Large Aprons	Small Aprons	Total
Actual aprons manufactured	100	60
Standard yards of denim per apron manufactured	2.0 yd.	1.3 yd.
Total standard yards of denim for the actual good aprons manufactured—the number of yards of denim that should have been used to make the good output	200	78 yd.	278 yd.

We determine the total standard cost of the denim that should have been used to make the 160 aprons by multiplying the standard quantity of denim (278 yards) by the standard cost of a yard of denim ($3 per yard):

	Large Aprons	Small Aprons	Total
Total standard yards of denim for the actual good (aprons) manufactured	200 yd.	78 yd.	278 yd.
Standard cost per yard	$3	$3	$3
Standard cost of denim in the good output—the aprons actually produced in January	$600	$234	$834

An inventory account (such as F.G. Inventory or Work in Process) is debited for $834; this is the standard cost of the direct materials component in the aprons manufactured in January 2009.

The Direct Materials Inventory account is reduced by the standard cost of the denim actually removed from the direct materials inventory. Let's assume that the actual quantity of denim removed from the direct materials inventory and used to make the aprons in January was 290 yards. Because Direct Materials Inventory reports the standard cost of the actual materials on hand, we reduce the account balance by $870 (290 yards used $3 standard cost per yard). After removing 290 yards of materials, the balance in the Direct Materials Inventory account is $2,130 (710 yards x $3 standard cost per yard).

The Direct Materials Usage Variance is: [the standard quantity of material that should have been used to make the good output minus the actual quantity of material used] X the standard cost per yard.

In our example, DenimWorks should have used 278 yards of material to make 100 large aprons and 60 small aprons. Because the company actually used 290 yards of denim, we say that DenimWorks did not operate efficiently—an extra 12 yards of denim was used (278 vs. 290 = 12). When we multiply the 12 yards by the standard cost of $3 per yard, the result is an unfavorable direct materials usage variance of $36.

Let's put the above information into a format commonly used for computing variances:

Direct Materials Usage/Quantity/Efficiency Variance Analysis

		2. Credit Direct Materials Inventory for the actual yards of denim used x the standard cost per yard of denim	3. Direct Material Usage Variance (Std Yd - Act Yd) x Std Cost	1. Debit Inventory-FG for the standard yards of denim that should have been used to make the good output x the standard cost per yard of denim
		Act Yd x Std Cost	Difference	Std Yd x Std Cost
		290 act yd x $3	(12 yd) x $3	278 std yd x $3
		$870		$834
			$36 Unfavorable

The journal entry for the direct materials portion of the January production is:

Date	Account Name		Debit	Credit
Jan. 31, 2009	Inventory-FG		834
	Direct Materials Usage Variance		36
		Direct Materials Inventory		870

February 2009

Let's assume that in February 2009 DenimWorks produces 200 large aprons and 100 small aprons and that 520 yards of denim are actually used. From this information we can compute the following:

	Large Aprons	Small Aprons	Total
Actual aprons manufactured	200	100	300
Standard yards of denim per apron manufactured	2.0 yd.	1.3 yd.
Total standard yards of denim for the actual aprons manufactured	400 yd.	130 yd.	530 yd.
Standard cost per yard	$3	$3	$3
Standard cost of denim in the good output	$1,200	$390	$1,590

Let's put the above information into our format:

Direct Materials Usage (or Quantity) Variance Analysis

		2. Credit Direct Materials Inventory for the actual yards of denim used x the standard cost per yard of denim	3. Direct Material Usage Variance (Std Yd - Act Yd) x Std Cost	1. Debit Inventory-FG for the standard yards of denim that should have been used to make the good output x the standard cost per yard of denim
		Act Yd x Std Cost	Difference	Std Yd x Std Cost
		520 act yd x $3	10 yd x $3	530 std yd x $3
		$1,560		$1,590
			$30 Favorable

The journal entry for the direct materials portion of the February production is:

Date	Account Name		Debit	Credit
Feb. 28, 2009	Inventory-FG		1,590
		Direct Materials Usage Variance		30
		Direct Materials Inventory		1,560

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