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The sooner that the accounting system reports a variance, the sooner that management can direct its attention to the difference from the planned amounts.If we assume that a company uses the perpetual inventory system and that it carries all of its inventory accounts at standard cost (including Direct Materials Inventory or Stores), then the standard cost of a finished product is the sum of the standard costs of the inputs: Usually there will be two variances computed for each input: Since the calculation of variances can be difficult, we developed several business forms (for PRO members) to help you get started and to understand what the variances tell us. We just released our 29-page Managerial & Cost Accounting Insights.Let's assume that your Uncle Pete runs a retail outlet that sells denim aprons in two sizes.Pete suggests that you get into the manufacturing side of the business, so on January 1, 2017 you start up an apron production company called Denim Works.A credit to the variance account indicates that the actual cost is less than the standard cost.After this transaction is recorded, the Direct Materials Price Variance account shows an overall credit balance of 0.Rather than assigning the actual costs of direct material, direct labor, and manufacturing overhead to a product, many manufacturers assign the expected or standard cost.This means that a manufacturer's inventories and cost of goods sold will begin with amounts reflecting the standard costs, not the actual costs, of a product.
Any difference between the standard cost of the material and the actual cost of the material received is recorded as a purchase price variance.
In general journal format the entry looks like this: The 0 credit to the price variance account communicates immediately (when the denim arrives) that the company is experiencing actual costs that are more favorable than the planned, standard cost.
In February, Denim Works orders 3,000 yards of denim at .05 per yard.
We'll also use the account Direct Materials Inventory.
(Other account titles often used for direct materials are Raw Materials Inventory or Stores.) Direct materials refers to just that—raw materials that are directly traceable into a product.
When we make your journal entries for completed aprons (shown below), we'll use an account called Inventory-FG which means Finished Goods Inventory.