 Hello and welcome to the session. This is Professor Farhad in which we would look at direct material variance and direct labor variance. Specifically, we're going to be looking at price and usage. So when it comes to direct material variance, we're going to break it down into price and usage. When it comes to labor variance, we're going to do the same thing, but rather than price, we're going to call the labor is rate and the usage efficiency. Simply put, we are trying to find out whether we spent more money or whether we used more or less resources, whether that resources is material or whether that resources is time. So the point is studying variances. When we say variances or various analysis, you are varying from something. That's important to remember. You are varying from standard cost. So what is a standard cost? Standard cost is how much it will cost you to produce a unit, to finish a unit. Now who sets standard cost? Well, usually in a manufacturing company, it's the industrial engineers. It's the people that created the product, designed the product or the people that work with the product. They know how much quantity do we need. They know how much it should cost us. So standard cost is what do we think something should cost us. So it's the standard quantities of input required to produce an output. So how much quantity do we use? Now the quantity could be material, the quantity could be time. Also for the quantity, the material and the time, we need to pay a price. Also, we should know what the price is going to be. How much are we going to pay our labor? How much are we going to purchase this material for? So all this information is put down in something called the standard cost. And when we vary, when we differ, when we deviate from this standard cost, what's going to happen is we're going to have variances. And this is what we need to study. Specifically in this session, we're going to be studying the direct material variances and the direct labor. Now we also have to study the, guess what, variable overhead variances and fixed overhead variances, which we'll see in the next session. Simply put, think of producing a pizza. So let's make the example simple, but the example could be projected or amplified for any other unit, anything that you are producing. So when you are producing a pizza, you need the material. Well, of course you do need material. You need flour, you need tomato sauce, you need maybe ketchup. If you're using ketchup in it, you need sugar, you need cheese, mozzarella cheese, so on and so forth. So for the purpose of this pizza, it's a veggie pizza, this is the material that we need. So what's going to happen if that's what you're doing, if you are producing pizzas, you are going to have a standard cost. And you're going to say, I need one pound of material for each one pizza. So to produce this pizza, I need one pound of this material. So I'm going to measure the input in pounds, one pound of material to produce one pizza. It's going to cost me, it should cost me $4.88 per pound of material to buy all of this, put it all together into one pound. The direct labor standard is $10. I'm going to have to hire someone and it's going to take them one hour to produce this pizza, one hour, and it's going to cost me, I can hire someone for $8 an hour. I did purchase and used 500 pounds of material for the month of June. I paid $5 per pound. Well, hold on a second, you just said it should cost you $4.88. Well, that's what I thought. But with inflation, now it's costing me $5 or there is some shortage of one of the, you know, mozzarella cheese, it costs me a little bit more. It doesn't matter. So what you pay and what you thought you're going to pay differ and this is what we need to study. So this is how much you actually paid, actual. So the $5 is the actual, sometimes they don't give you the actual price. Sometimes they tell you, you paid, you know, $15,000 and you purchased, I don't know, 15,000 pounds just for the sake of this illustration. So you paid $1 per pound. They don't give you this price per unit. So just make sure you are aware of this. You produced 400 pizzas with this material. Actual labor rate was eight. Actually, you thought it's going to, you thought you will need $10 to pay your labor. Somehow, when you started to advertise this pizza position, a lot of people showed up at the door and you thought, you know what, I don't have to pay 10. I have plenty of supply. You lower your price. You actually paid eight. The actual hours for producing those 500 pizza were 350. Again, this is the actual hour. Now what we're going to do, we're going to take this data and compute direct labor variances, compute direct material variances to learn about our process. Why do we need to do this? To take corrective actions, to better manage the company, to better control cost. Now, before we compute direct material variance and direct labor variance, most likely you are a student or a CPA candidate looking for some help. Well, if that's the case, that's great. Go to farhatlectures.com where you will find additional resources such as lectures, multiple choice, true, false. If you have not connected with me on LinkedIn, please do so. Take a look at my LinkedIn recommendation, like this recording, share it with other, connect with me on Instagram, Facebook, Twitter, and Reddit. Now, first, we're going to look at the direct material variance. Simply put, how much did we use of material, more or less? And also, we're going to look at usage and price. So did we use more or less and did we pay more or less? Like, kind of, we already know some of the answers because the way the information is given to us. But nevertheless, the formula will be the same. Okay, so I'm going to be using what we called the three column, three column method. And in the three column method, I'm going to have one column for my actual cost, one column for my standard cost, or sometime this is called flexible cost. Well, you need to understand what goes into each column and how do we perform the computation? Starting with the actual, it's easy. How much did you actually paid? And how much did you actually purchase? Well, I actually purchased my actual quantity is 500 pounds. My actual price is $5. Actual quantity times actual price will give me 2500. I like when I prepare my three column, I would like to go from column one to column three. And column three, I'm going to use my standard. What should have, how many units that I produce? I produce 400 units. It's, it's $1 per direct, a one pound per direct material. So I need, I produce 400 pizzas. Therefore, I use 400 pounds. And the standard price per pound is 488. Well, 488 times 400 pounds is the standard quantity and times the standard price. It's 1,950. Now in the middle column, in column two, I'm going to use my actual quantity times the standard price. Now sometime I may not use the actual, actual quantity purchase, which I'll show you in the next slide. But for now, since I purchase and use them all, therefore actual quantity is 500. The standard price is 488. So column number two is actual quantity times the standard price, 2,444. Now I'm ready to compute my variances using this three, three column method. If I take the difference between column one and column two, that's going to be my price variance. How do I know this is my price variance? Take a look at what's inside the formulas here, actual quantity, actual price, actual quantity, standard price. Well, if we are looking at those two, we can factor the actual quantity out. So because there's actual quantity, actual quantity, what's left is standard price minus actual price. So minus actual price. So what I'm looking for, I'm looking to find out the difference in price. And I know I paid 12 pennies more, and I purchased 500 unit, 500 pounds. Therefore, if I take 500 pounds times I paid 12 cent more, I overpaid by $60. Therefore, my price variance is unfavorable you for $60, unfavorable for $60. So you could use that three column, or you can say find the difference in actual price and the standard price, how much I actually paid, how much I should have paid multiplied by the actual quantity, and I will find out whether I overpaid or underpaid. I overpaid. The difference between column two and column three, it's going to give me the usage variance. If I compute this difference, it's going to give me a difference of 488, and it's going to tell me your difference is unfavorable. Well, does that make sense? Well, let's see what we have here. Let's look at column two and column three. This is the formula for column two. This is the formula for column three. What is common between the two formulas? Well, let's say standard price. So if I factor the standard price out, it's the standard price times the actual quantity minus the standard quantity. Well, what should have been my standard quantity? Well, I produced, what happened is I produced 400 pizzas. Actually, yes, I produced 400 pizzas, but I used 500 pounds. Remember, I purchased and used 500 pounds, but I purchased and used 500 pounds, and for those, I should have produced 500 pizzas. I only produced 100. Therefore, the difference is 100 times the standard price. What's the standard price? The standard price is 488. Therefore, my variance is 488, and it's unfavorable because I did not, I used, basically, there was a wastage of 100 pound. 100 pound, I used them, but I did not produce anything. If I used them all, I should have produced 500 pizzas. Well, because that that should have been my standard. Therefore, I have an unfavorable standard. I unfavorable variance of 488. Now, what's my total direct material variance? They're both unfavorable, unfavorable plus unfavorable equal to 548 unfavorable direct material variance. This is the total. This is the total. This is the price, and this is the usage, and you break it down. Now, again, you could use the three column or you can use the formula, whatever you are comfortable with. Now, when you use the formula, you have to understand how the formula is used. There is no plus and minuses. You have to understand whether you use more or less. If you use more, you have an unfavorable. If you use less quantity, you have favorable. If you paid more, it's unfavorable. If you actually paid more, it's unfavorable. If you actually paid less, it's favorable. So there is no plus and minuses because many students ask me, should I, you know, subtract standard price minus actual price or actual price minus standard price? Understand what you are doing. It doesn't matter which one you get. Just understand what you are doing. Now, let's assume you purchased 500 pounds, but you only used 450 pounds. How would you compute the variances? Because this could be a problem, a problem in a sense given in a problem. Here's what's going to happen. For column one and column two, you would use the same computation. Why? Because column one and column two deals with the price. And for the price, it doesn't matter whether you use them or not, because we're looking at the price. But so the price variance, the same one, you take the difference between column two and column three. Here you have to be careful. Here, actual quantity, you have to change the 500 to 450, perform your computation and find the unfavorable variance. So rather than using 500 because you only used 450, you would use the 450. So it will be a difference. It will make a difference for the usage, not the price, because obviously you did not use everything. You only used 450 of the 500 pound. Therefore, you cannot say, well, there's 50 pound of wastage. You did not use them yet. Let's take a look at direct labor variance. We're going to look at the efficiency as well as the rate. Again, we're going to use the three column method actual, flexible or standard and column two. So let's take a look at the actual, actual. We actually work 350 hours. We actually paid our employee $8. So the first column, the interest $2,800. The third column, it should have, it should have, we should have put 400 hours because one hour per pizza. And we should have paid $10 per hour. Therefore, the standard should be 4,000. This is column three. Now again, bring actual quantity times standard price in the middle. And that's standard price times actual quantity will give us 3,500. Now again, the same exact concept, the difference between one and two is the rate, is the rate variance. And the difference is, well, I call it price or rate, which has to do with the price, price of the labor. If you notice I saved, there's a favorable of 350. Can we explain this? Yes, let's take a look at the formula just kind of to explain this actual quantity times actual price standard quantity times the actual price. What can we do? We can factor actual quantity because actual quantity is in both actual price or actual rate minus the standard rate or the standard price. We paid $2 less and we used 350 hours. Well, guess what? We have a favorable variance of $700. And this is where we come up with the 700. Now let's do the same thing for column two and column three. If we find the difference, we see that also it's a favorable variance of 500. Why? Now we have to do with the quantity. It should have, it, we should have invested or used 400 hours to make those pizzas. How many hours did we use? Not 3500. This is 350. 350 hours. Therefore, we saved kind of, we saved, let's put saved in quote, but we were fast that we produced those in 50 hours less. 50 hours last time is a standard cost of standard price of $10. We have a favorable variance of 500. Well, together we have a favorable variance for the rate, favorable variances for the efficiency. Total labor favorable variance is 1200. That's favorable. So what can we say? We can say that the employee work fast because it took them less time to produce those pizzas. Well, we wasted material. Remember in the, on the prior slide when we did the material variance, let's go back to the material variance. If you remember for the material variance, it was unfavorable 488 because we used 100 pounds of material that we kind of, we did not produce anything with it. It was wastage. Well, it could be because the employee worked fast. So what they did, they work fast. They spend less time. Okay, we saved $500 on time. We wasted $488 on usage. Why am I saying this? This is the information that's important to manager. We need to know what's going on. Working fast, it's good for management, but if you are wasting material, let's stop this. Let's maybe keep working fast, but train you to not to waste material. So that's the point here. That's the moral of the story. Also, we used cheap labor. Maybe because we use cheap labor, we paid only $8. The employee were not competent enough. That's why they had a lot of usage. They work fast. We don't know, but that's what we need to know. We need to train them. We need to figure out what's going on because this is a feedback loophole. We need to know it's going to tell us something about our operation. And this is what it told us. The employee that we hired, maybe it should not take us one hour to complete the pizza because we budgeted $1. One hour. Maybe one hour is too long. Maybe we need to change our standard. That's one thing. That could be a reason. Maybe they're not working fast. It should take less time to produce a pizza. We are over. We over budgeted the time to produce one pizza. That could be the case too. Again, this is how managerial or cost accounting is used to run the company, to help you make decisions. What should you do now? Go to far-hat lectures, work MCQs through false exercises that's going to help you do better in this topic, whether you are an accounting student or a CPA candidate. It doesn't matter. Invest in yourself, study hard, good luck, and stay safe.