 Hello, and welcome to the session in which we would look at variances. However, we're going to be using journal entries. In the prior session, we looked at the standard cost system, and we learn about variances, which is the difference between the actual cost and standard cost. And we could have favorable variances when the actual cost is less than the standard cost, or we might have what's called unfavorable variances when the actual costs are greater than the standard cost. And to account for these variances, companies may use separate ledgers such as material price variance, labor efficiency variance. So we have many variances and we learn about those in the prior session. In this session, we're going to be learning about how companies journalize those variances. So companies, they use credit for favorable variance to indicate a reduction in cost or an increase in profit. So think of it as a contra expense when you have a favorable variance. Remember, favorable variance, it means it's you did not spend as much as you expected. It's favorable, or you earn more revenue. That's that's fine too. We could have also unfavorable variances from a journal entry perspective. Unfavorable variances, think of them as expenses. They take a debit. Now, the best way to illustrate this is to actually look at an example. Before we proceed any further, I have a public announcement about my company, farhatlectures.com. Farhat accounting lectures is a supplemental educational tool that's going to help you with your CPA exam preparation, as well as your accounting courses. My CPA material is aligned with your CPA review course such as Becker, Roger, Wiley, Gleam, Miles. My accounting courses are aligned with your accounting courses, broken down by chapter and topics. My resources consist of lectures, multiple choice questions, true false questions, as well as exercises. Go ahead, start your free trial today, no obligation, no credit card required. So starting with the price variance, let's assume Aram company purchased 3,000 pounds of iron ore at $27 per pound. Now the standard cost list, the cost per pound at $25. Now we are going to go ahead and journalize this entry and we have a variance here. So the first thing is we are computing a price variance. Can you tell me whether this price variance favorable or unfavorable? I hope you know this price variance is unfavorable. Why? Because we paid $27 for something we think we should pay for at $25. At least from our standard cost sheet, we budgeted from standard cost system perspective $25. Well how do we process this journal entry? Well let's start with the easy part. What's the easy part? I purchased 3,000 pounds and I paid $27 per pound. Let's start there. Whether I paid cash or I purchased this on credit, I'm responsible for $81,000 which is 3,000 pounds times $27. And I would like you to always start with this journal entry which is involved cash or accounts payable. Now I purchased inventory or raw material inventory or direct material inventory. You need to purchase the direct material inventory at the standard cost. What is my standard cost? My standard cost is I should have purchased the 3,000 pound at $25 and that would have gave me 75,000 therefore I debit direct material inventory 75,000 at the standard cost but I actually paid 81,000. Well the difference between the two is my variance and we already know it's unfavorable variance because I paid extra $2 per pound and I purchased how many pounds? 3,000 pounds therefore I have an unfavorable variance of $6,000. So I have a direct price or direct material price variance which is a debit because it's unfavorable variance of $6,000. Now obviously if it was favorable variance it would have been rather than a debit it would have been a credit. So this is an example of a price variance. Now also we could have a usage variance during the month that's a sum item company used the 3,000 pound of material to produce 400 units of XYZ. So XYZ is whatever we are producing. Now the quantity the standard quantity to produce one unit is seven pounds. So based on our standard if we needed to produce those 400 units 400 units we should have used times seven we should have used 2,800 pounds. Now how many pounds did we use? We used 3,000 pounds. So we already know from this from this angle that we also have an unfavorable but here usage it means we used more than when we should have well and how much more it's specifically 200 pounds more and also we paid more if you notice also we paid $2 more. So how do we process this journal entry? Well now since we are using and we are producing we're going to debit work and process. How much do we debit work and process? We're going to debit work and process the standard input. What's the standard input? The standard input should have been 400 units times seven pound times $25. So that should have been the standard input which is $70,000. So we're going to debit work and process $70,000 based on the standard input. Now what did we take out of direct material? Well we took out 3,000 pounds because we used actually we actually used 3,000 pounds and we're going to take it out at standard cost of $25. Therefore we credit direct material inventory to get the material out 3,000 pound at standard cost of 75. Notice here there's a difference between 70 and 75,000. Again the difference is unfavorable. Why is it unfavorable? Because I used an additional 200 pounds at a standard cost of $25. That's going to give me an unfavorable variance of 5,000. Again we have an unfavorable variance. An unfavorable variance will be reflected as a debit. Think of it as an extra cost. Think of it as an expense. Cost expenses are recorded with a debit. So this is an example of a usage for a for the material. Let's take a look at labor variances. Also labor variances we could have price or cost for the labor and the efficiency of the labor. Whether the labor people did a good job finishing the job on time or they spent more time. Let's assume Adam company spent 3,400 hours and 149,600 to complete the production of the 700 unit of XYZ company. Now right from this information I would if I take 149,600 divided by 3,400 hours I see that I paid $44 per hour for the employees. Why? Because this is how much I paid. This is how many hours they worked and they produce 700 units. So my actual hourly rate my actual is 44. Now the standard calls for five direct labor hours for each unit error rate of $40. Well the first thing I can tell you is this. If I was planning to spend $40 per hour I already see that I spent $44. So from a price perspective you know I paid more for the labor. I paid $4 more. We'll get to that but at least hopefully you can see this up front. Also if I produced 700 unit and the standard call for five direct labor hour I should have spent 3,500 hours. Guess what? I spent 3,400 hours. So what I have here for the efficiency I have a favorable efficiency of 100 hours. So I just want you to see this before we dive into the journal entry. Now the first thing I would start with is how much I paid or how much am I going to be accruing. It's 149,600. I credit a cruel payroll 149,600. Then I'm going to debit work and process because this is going to go work in process at the standard. What is the standard? The standard should have been 700 hours sorry 700 unit times five hours per unit. We should have spent 3,500 hours times the standard rate $40. It should have been 140,000. Therefore I'm going to debit work and process inventory for the labor cost the standard one 140. Notice it should have cost 140. It cost 149,600. What do we have? We have variances. Now what variances do we have? We already know that we paid $4 extra per direct labor hour and how many hours did we incur? 3,400. So from a direct labor rate variance it was unfavorable. The difference is $4 times 3,400. This was unfavorable variance of 13,600. Now we also know from not from a usage from an efficiency perspective we saved labor saved 100 hours. Well at a standard cost of $440 we come up we saved $4,000 on efficiency. So we have a direct labor efficiency variance. We did a good job. We saved 100 hours at $40 that's $4,000. Always make sure your journal entry will balance this. For example here it's going to be 153,153,600 and this is going to be 153,600 as well. It's always good to make sure your journal entries are balancing. What should you do now? Go to far hat lectures to look at additional resources that's going to help you understand this concept better. I know we learn about variances but these are the journal entries for variances. You need to know how to record those journal entries. 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