80 12.4: Direct Materials Variance Analysis
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Last updated
- Dec 28, 2020
Learning Objectives
- Calculate and analyze direct materials variances.
Question: In the dialogue at the beginning of the chapter, the president of Jerry’s Ice Cream was concerned about significant cost overruns for direct materials. We cannot simply explain these costs by saying that “we paid too much for materials” or “too many materials were used in production.” Variances must be calculated to identify the exact cause of the cost overrun. What variances are used to analyze the difference between actual direct material costs and standard direct material costs?
- Answer
Direct Materials Price Variance Calculation
Question: The materials price variance answers the question, did we spend more or less on direct materials than expected? If the variance is unfavorable, we spent more than expected. If the variance is favorable, we spent less than expected. How is the materials price variance calculated?
Direct Materials Quantity Variance Calculation
Question: The materials quantity variance answers the question, did we use more or fewer direct materials in production than expected? If the variance is unfavorable, we used more than expected. If the variance is favorable, we used fewer than expected. How is the materials quantity variance calculated?
Possible Causes of Direct Materials Variances
Question: The managerial accountant at Jerry’s Ice Cream will likely investigate the cause of the unfavorable materials price variance of $88,000. This will lead to discussions with the purchasing department. What might have caused the $88,000 unfavorable materials price variance?
Question: Jerry’s Ice Cream might also choose to investigate the $21,000 favorable materials quantity variance. Although this could be viewed as good news for the company, management may want to know why this favorable variance occurred. What might have caused the $21,000 favorable materials quantity variance?
Business in action 12.2 – The Effect of Rising Materials Costs on Auto Suppliers
In the first six months of 2004, steel prices increased 76 percent, from $350 a ton to $617 a ton. For auto suppliers that use hundreds of tons of steel each year, this had the unexpected effect of increasing expenses and reducing profits. For example, a major producer of automotive wheels had to reduce its annual earnings forecast by $10,000,000 to $15,000,000 as a result of the increase in steel prices.
Most auto part suppliers operate with very small margins. GR Spring and Stamping, Inc., a supplier of stampings to automotive companies, was generating pretax profit margins of about 3 percent prior to the increase in steel prices. Profit margins have been cut in half since steel prices began rising.
These thin margins are the reason auto suppliers examine direct materials variances so carefully. Any unexpected increase in steel prices will likely cause significant unfavorable materials price variances, which will lead to lower profits. Auto part suppliers that rely on steel will continue to scrutinize materials price variances and materials quantity variances to control costs, particularly in a period of rising steel prices.
Source: Brett Clanton, “Steel Costs Slam Auto Suppliers,” The Detroit News, June 29, 2004, http://www.detnews.com.
Clarification of Favorable Versus Unfavorable
Question: Why are variances labeled favorable or unfavorable?
Key Takeaway
Review problem 12.3
Carol’s Cookies expected to use 1.5 pounds of direct materials to produce 1 unit (batch) of product at a cost of $2 per pound. Actual results are in for last year, which indicates 390,000 batches of cookies were sold. The company purchased 640,000 pounds of materials at $1.80 per pound and used 624,000 pounds in production.
- Calculate the materials price and quantity variances using the format shown in Figure 12.4.
- Use the alternative approach to calculating the materials price and quantity variances, and compare the result to the result in part 1. (Hint: the variances should match.)
- Suggest several possible reasons for the materials price and quantity variances.
Definitions
- The difference between actual costs for materials purchased and budgeted costs based on the standards.
- The difference between the actual quantity of materials used in production and budgeted materials that should have been used in production based on the standards.
- A variance that has a positive impact on operating profit.
- A variance that has a negative impact on operating profit.
