 Hello and welcome to the session. This is Professor Farhad and the session we're gonna look at direct labor and direct material variance and Look at the price and usage as well as the rate and efficiency variance We will not be looking at the overhead variance neither variable nor fixed. I will have that for another recording Hello and welcome to the session This is Professor Farhad and the session would look at direct labor and direct material variances and to be more specific Price and usage rate and efficiency variance in another session I would look at the overhead direct overhead variance as well as fixed overhead variance This lecture as well as my other lectures are posted on my website as well as the PowerPoint slides will be posted there So before we start the session, we need to be familiar with something called standard cost So we need to be familiar with what is a Standard cost and how does it work? Well, hopefully you are familiar with the food recipe a food recipe basically tells you this is how much you need of material to make a Cupcake, this is how much flour and how much yeast so on so forth As long as you mix it together you follow the recipe you should have the cupcake or if you're making a pizza You need the dough the sauce the cheese as long as you a flour as long as you mix it together Correctly, and you bake it as instructed you will get the pizza And in theory if you follow it and practice it should work But you know for a fact if you have a recipe and you follow the recipe exactly Often times it doesn't come out exactly in the shape or taste that you want and guess what in the manufacturing world and the real world Engineers companies management they put together what's called a cost sheet and what is a cost sheet? The cost sheet is what should go into the product what type of material? How much time we should spend on that product to have that product finish? So a standard cost or a cost sheet is a form providing the standard quantities How much we should use in quantities of each input required to produce a unit of output and the standard price? So in the quantities we have material and We have direct labor and for the material we need to pay money for that and for the labor We need to pay money for the labor so the standard cost sheet tells you how much you should invest Or how much you should put into your production? So each unit comes out the same as the other unit We know for a fact in theory This is how it works in reality that may not be true and to be to be like even more realistic We're a little bit more interesting what I'm gonna try to do in this example start with an example that we are all familiar with Let's assume you are starting to deliver a you're starting a business delivering Pizza and a salad so that's what you do. You make pizza and a salad and you deliver that to working people Okay, that's that's what you want to do and here are the ingredient for your pizza and your salad Okay, and these are the instruction. Well, obviously you need labor to do so so you cannot do this by yourself Okay, so this is what you're gonna be making pizza and salad and delivering pizza and salad to people So here's what's gonna happen. So based on this information. I'm gonna kind of make up some numbers Okay, and tell you what what are your standard? So your direct material standard. So what I did I added I added up I Yeah, I added up all the weight For the ingredient and just just make it I'm just making things up. So you need one pound of Material of direct material and I add up all the prices here are all the prices for that pound and you need for that You need to pay four dollars and eighty eight cent for the material Which is direct material per one pizza is four dollars and eighty eight cent Also for that. This is for the direct material for the direct labor You need one hour Okay, and you can hire someone at ten dollar per hour So it's gonna cost you ten dollars So all in all you have direct labor and direct materials of fourteen dollars and eighty eight cent now keep in mind You're gonna be producing high quality pizza and high quality salad that people are willing to pay for it And you're gonna deliver it for that matter. Okay, that's your business So now let's see let's work some work some numbers and see what's gonna happen Let's assume you purchased you purchased and used for that matter and used so let me just make sure and used 500 pounds for the month of June 500 pounds of Material for the month of June you paid Five dollar per pound so to buy the material you paid five dollar per pound And you thought you were gonna pay for eighty eight based on this based on this This thing that you find online the price was a little bit higher for some of the ingredient You had me happen to pay five dollars. That's fine and notice you use that you use that all up And let's also Let's assume also you produced 400 pizzas and Salads so you produce 400 pizzas and salad or gonna assume those are the same unit pizzas and salad You're producing pizza and salad is one year. You produce 400 meals more or less. All right. Now we need to know What happened in terms of variances? Did you exactly follow the recipe? What happened? So I'm gonna show you how you will need to solve this problem Okay, and basically if you if you follow this if you follow this you should be good to go So here's what's gonna happen. I'm gonna show you a three column method first What you do is you have a column called actual? Okay, and under the actual you're gonna take your actual quantity times the actual price and It's your actual quantity how much you actually use times the actual price This is column one and I'm gonna have column three Obviously there's column two in between and column three you're gonna be using the standard And I'm gonna call this actual quantity AP and actual actual quantity aq and actual price AP You're gonna be using standard quantity sq times the standard price SP Okay in the third column and The column in the middle Here's what's gonna happen So when you do variances here what we're gonna do For each item we're gonna keep one constant and change the other so what's gonna happen in the middle We're gonna go with actual quantity Which is this item here actual quantity times This item here Standard price actual quantity times the standard price So if you set up your formulas like this and you're I'm gonna explain this a little bit further what I did Okay, so let's try to punch in some numbers and see what we did So for the first column further, let's compare column one and column two. Let's compare One and two once again notice the actual quantity is the same or what you did as you change the price So any any change between those two column has to do with the price because all what you did is you change the price The quantity is the same. All right, so let's see. What was the actual quantity that you used you used? 500 pounds of material and what was the actual price? How much did you pay? You paid $5. Therefore your actual price Your actual column will have two thousand five hundred. What was the actual quantity that you used? $500 how much you should have paid you should have paid $4 and 88 cent. So if we take 500 times times 500 times clear 500 times point 488 that's gonna give us 2440 what does that mean? Well, it means the difference between those two and we already know it's unfavorable Why because we thought we're gonna pay 488, but we paid five dollars. So two thousand five hundred minus two thousand four hundred and forty We have a sixty dollars Unfavorable price variance simply, but we paid a little bit more than what we should have a little bit more sixty dollar more It's not a big deal Let's move on and compare column two to column three column two already prepared column two two thousand four hundred and forty Let's look at column three column three is the standard quantity. I produced 400 pizzas well For my standard quantity I Should have 400 pizzas and and 400 pizzas right and one pound per pizza. So I'm gonna be using 400 and my standard price my standard price should have been four dollars and 88 cent Well, what's 400 times? 400 times four point eight eight that's One thousand nine hundred and fifty two Wow So, all right, let's see now. We're gonna compare one thousand nine hundred and fifty two to two thousand four hundred and forty and find the difference Let's find the difference first 2440 minus one nine hundred one thousand nine hundred and fifty two and that's four hundred and eighty eight dollars Is this favorable or unfavorable? And I hope you know it's unfavorable Because to make to make 400 pizzas we need 400 pounds, but we actually used this 500 pounds So back basically our employee in the process. They basically lost 100 down Maybe they were making the pizza. It wasn't good. They throw it away. They were making the salad that didn't come out Right. They throw the material away. So there's a lot of wastage. That's what we're saying here. Okay, so this is the Usage usage It has to do with quantity so this is quantity this is the quantity variance and this is the price variance So on both end we are not good. So the price it wasn't that bad $60, but the usage we need to train those employees those employees They're either not trained not supervised some something's wrong We gave them 500 pounds of material based on our recipe. They should be able to make 500 pizzas they only made 400 pizzas and I'm assuming here that all That the all the material was used if all the material was not used then it would have been a little bit different Let's assume we only used Well, let's finish this that's finishes example before we make any assumptions So what is the total variance the total variance the gather is 488 plus 60 and it's 548 dollars unfavorable. We're doing something wrong. Okay, especially with the usage variance Now, let's assume just let's let's assume for the sake of the example that we only used remember we purchase 500 Let's assume. We only used 450 pounds Then the the middle column what we need to do here The middle column the middle column what we do when we do the usage variance will take 400 we would have took if we used only 450 pound we would have used 450 times 4.88 when we're making the comparison between 2 and 3 Okay, so the comparison between 1 and 2 will stay the same because what we purchased is what we purchased But the usage if let's assume we only used 450 in this example I said I bought 500 and I used 500. Okay, but if I said I only used 450 When you compare 2 and 3 you would use the usage what you actually use for the usage comparison. So that's just okay Good, so that's that So we did really bad on this now for the labor we need to do the same thing the same analysis for the labor See how bad or how good the labor variance is well the material was no good Let's look at the labor the labor we use the same exact concept We use actual quantity times actual price standard quantity times the standard price Okay, so we use the same concept and I'm gonna abbreviate here We're gonna be using for column one actual quantity times actual price column three standard quantity times standard price and in between actual quantity times standard price actual quantity times standard price Now what are we gonna be what assumption are we gonna be making here? I'm gonna assume That we spend the employees that we hire spend 350 hours to make those pizzas Times one because we need one hour per pizza and we pay them $8. Wow 350 times 8 2800 so remember when I first started this problem. I said I'm gonna hire someone at $10. So guess what I Had a lot of people come in and said I can do this for you I can do this for you have a lot of I have a lot of supplies So you know what said let me lower my price. I offer them $8 and they took it They took the $8. That's fine. What was my standard quantity? My standard quantity was if I needed to produce 400 pizzas 400 pizzas times one hour per pizza That's gonna give me 400 times $10 I should have paid $10 I Am go I was I was supposed to pay for 400 pizzas $4,000 Okay, this is the standard quantity. This is the actual so this is the actual and this is the standard Now let's take the actual 350 times the standard equal to 3500 we're gonna do the same exact comparison again We're gonna look at column one and column to serve one We have column one right here column two and column three And we're gonna compare column one and column two and this is gonna give us the braid variance great variance if we look at look at the difference 3500 minus 2800 I saved $700 this is favorable variance and let me let me let me take let's look at it from a different perspective I saved $2 per hour and they worked for me 350 hours. Therefore. I saved $700 So on the labor I got cheaper labor this could explain this could explain why my material usage was bad Okay, because maybe I paid for a cheap labor and I'm paying I paid the price now For the efficiency how efficient were they I'm gonna have to compare two and three. So this is the rate The rate variance and the other variance. It's the efficiency variance again, not usage. We call it efficiency Efficiency Efficiency so the difference between four thousand and four thousand and three thousand five hundred is five hundred That's also favorable. That's also favorable. Okay, that's also favorable There is five hundred dollar favorable because I spend less time than I should have Well, that's also favorable. So together we have one thousand two hundred Favorable variance when it comes to labor. Wow, they work fast. These people were trying to impress me So they work fast that could also explain because they work fast. They could also explain The problem with the usage they did work fast. They did work fast, but they wasted a lot of money So what should I do under those circumstances? Well, I'm gonna ask them to keep working fast I just we need I need to cut down on the material usage make them more efficient for next month. So this is how I This is how I Analyze my variance is also I paid sixty dollar more. That's my fault. You know, I'm the owner I'm the one who made the purchases. So maybe I need to find something cheaper. Okay Now this is basically how you could you how you can use this now? I'm gonna go ahead and work another example just have kind of Just for for illustration purposes. So let's assume we have the following standard. We have we are making frames and And direct material we need four pounds and The cost the input cost for us is 55 cent. So it's gonna cost us material per frame to 22 We need to put the frame together point zero five of an hour real quick. We're gonna have to pay someone $20 so $20 time point zero five. It's gonna cost us $1 and direct labor So this is what we're gonna be producing this frame right here So let's take a look at what we have here and what we can do And again what you should do here, you should go with column one column two and column three So, you know, so see if you could see if you can see if you can solve this problem So what happened is this the standard cost the standard cost for us for the sake of this example the standard cost was four pound at 55 cent per pound 220 Okay, we happen to produce 80,000 pounds. Let's do this real quick So let me just go through column one column two and column three for this example column one Column one actual quantity. Well, let's let's since we have column three readily available So we produce 80,000 frame and it should it should cost us it should cost us 80,000 frame we use four pound per frame four pound per frame And 80,000 frames times four pounds That's three how many how many pounds is this times four equal to three hundred and twenty thousand times point five five That's equal to let me just do this real quick Three hundred and twenty two thousand pound times point five five That's one hundred and seventy six thousand So standard quantity times standard price should have been 322,000 times 55 pennies, which it should be 176,000 What we actually use is 300 actual pound use 328. So let's just put the formula again actual quantity times actual price actual quantity is 328,000 times Point six times point six So this is going to be 196,800 dollars. So this is the column one the actual And in the middle what's going to happen is in the middle We're going to have actual quantity, which is 328,000 pound times the standard price, which is 55 pennies And that's equal to 180,400 dollars now all we have to do is compare column one to column two Okay, which is what do we call this we call this the price variance the price variance We already know we paid a little bit more. We know we know we already paid a little bit more. What's the difference between? What's the difference between column one and column two 196,800 minus 180,400 16,400 16,400 and that's unfavorable and we already know this. Okay, we already know this And let me just show you this real quick. This is actual quantity times Standard price if you take those two formulas what you can do you can factor out the actual quantity you can factor out The actual quantity so actual quantity times the difference in the price Standard price minus actual price. Okay, which is point zero five Point zero five times the actual quantity 328,000. So this is basically a short cut to this. Okay, so if you take 328,000 pound times point zero five will give you 16,400. This is the price the usage variance Let's see if we use more or less. Let's first find the difference between the two 180,400 minus 176,000 That's 4,400 that's 4,400 we were supposed to use 320,000 pound. We actually used 328 that's unfavorable Okay, because remember remember that the 55 pennies is constant in this in this so So we we change the other one notice here if we take actual quantity times standard price minus standard quantity times standard price we can factor out the standard price Standard price if we factor out the standard price it's actual quantity minus the standard quantity Okay, so we find the difference in the quantity times the standard price. It's going to give us 4,400 also unfavorable. So let's take a look at the solution This is basically what we are talking about here actual quantity times actual price standard quantity times the standard price An actual quantity times the standard price in the middle the difference is unfavorable and unfavorable for both the price difference is unfavorable and the efficiency or the usage Is unfavorable unfavorable Now let's take a look at the labor the labor cost The labor cost is 0.05 per frame times 20. It's going to cost us $1 per frame We produced 80,000 frame it should cost us that's easy $80,000 Actual our work 4,400 Average cost we paid on average $18. Okay, let's do this This is column one the actual actual quantity times actual labor price actual quantity Which is 4,400 hours we spend times we paid actually $18. This is the column one column three The standard quantity we should have you we should have spent 4,000 hour because we produce 4,000 frame And we should have paid $20 per labor time, which is 4,000 times 20 is Is 80,000 so this is column three now what we have to do is is Find the difference between column one in column two and it's going to give me the price variance and the difference between column two And column three. It's going to give me the efficiency variance. So I'm going to have to take actual quantity Times standard labor price actual quantity 4,400 times the standard price Times the standard price, which is $20 That gave me 8,088,000. So if I compare 88,000 to 79,200 I have a favorable variance of two of 8,800 And I should notice I'm it's going to be favorable. Why because I saved two dollar I saved two dollar per Per hour I saved two dollar per hour because I thought I was going to pay 20 I paid 18 Okay, I saved two dollar per hour Okay times They work for me 4,400 hours. Therefore. I saved that much Now once again, let me show you the formula that I showed you earlier. Maybe here. It's clear notice If I take those two formulas Okay, if I take this formula and this formula what I can do I can factor out notice the The actual quantity is a common between the two if I take the actual quantity times The the standard price minus the actual price 20 minus 18 gives me two and the actual quantity was 4,400 4,400 I have a variance of 8,800 and it's favorable. Okay Now let's compare column two to column three I already have column two column three standard quantity times the standard price and I find the difference and it's 8,000 Is it favorable or is it unfavorable? Well, I was supposed to use 4,000 hours to produce those 80,000 frame I I actually incur 4,800 it means the The the variance is unfavorable by 8,000 Once again, let me show you how how another way to look at this formula We have this formula minus this formula If we have this formula minus this formula, what's what's common between the two is standard price So if I take the standard price factor it out times the difference between because we're subtracting those two So I took the actual quantity minus standard quantity and the difference between them is 400 And the standard price is 20. That's going to give me 8,000 that's unfavorable. That's unfavorable Overall, what does that mean? What does that mean? It means when it comes to To the to the labor I got a cheaper labor $2 cheaper, but they were not efficient Again, I I hired I hired cheap labor. So overall my labor is inefficient. I'm sorry. My I saved $800 on my labor But for my usage big mistake big mistake that labor wasn't good. Okay, because my Material my material variance was really bad. So overall My if I take overall variance 20,800 minus which is negative and I saved 800 on the labor I'm still down $20,000 on this project not good at all. But this is this is how you break down the direct material and a direct labor variance Which is a topic you will see in your managerial accounting as well cost accounting as well as on the CPA exam As well on the CMA Exam if you have any questions any comments by all means email me or see me in class If you're studying for your CPA study hard, it's worth it