[ObsceneTickmark]

Hi everyone. Just a quick conceptual question regarding the direct materials usage variance. I understand the math and the steps to calculate the variance, however I don’t understand the theory behind it. With the DM Price variance, we are calculating a difference in real dollars (Change in actual purchase price from standard * actual units purchased). In my example the price changed from a standard of $10 to actual of $8. However with DM Usage, I don’t understand why standard costs are even considered.

I see how a change in actual quantity used vs. standard usage for that level of production can create a variance, but why multiply that unit difference against standard cost? Assuming there was a price variance, that standard cost never happened in the real world. Wouldn’t multiplying the change in qty used with ACTUAL unit price give a dollar amount that is more relevant?

What am I missing? Thanks!

[Anonymous]

The underlying concepts:

1). DM quantity variance happens at a different time than DM price variance.

The two DM variances are separate events. DM price variance occur when the purchasing manager makes the purchase. DM quantity usage variance occurs when the item is actually used in production, which is the responsibility of the production manager. So the purchase could have been made months before it's actually used in the production.

(2). Under the standard costing system, inventory is recorded on the book at STANDARD cost.

So at the time of purchase we would record the direct material inventory using the standard price per unit. The only time we will ever use the actual price for the standard costing system is to credit the CASH. you would have the following journal entry:

DR: Direct Material (always STANDARD price/unit)

CR: Cash (recorded (Actual price/unit)

The difference is your DM price variance

Then, let's say four months down the line, the material is put into the production, the material is removed from it's account and put into WIP. Since the direct material was originally recorded on the book at Standard price per unit at the time of purchase, we will also remove it at standard price per unit as well.

DR: WIP (standard quantity @ standard price)

CR: Direct Material (actual quantity @ standard price)

The difference is your DM usage variance.

So by the time the direct material reaches the WIP account, both the quantity and the price are recorded at Standard. AKA, Standard costing.

[Author]

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