Learning Outcomes
- Compute the direct materials efficiency variance
The Direct Materials Efficiency Variance isolates quantity issues from cost issues. Just as the Direct Materials Cost Variance reflects a deviation from the standard unit cost of raw materials, the efficiency variance reports when more or less than the standard amount of material is used to produce a product or complete a process. This materials usage variance is calculated by subtracting the standard quantity (SQ) per unit from the actual (AQ) and then multiplying that difference by the Standard Cost (SC):
Direct Materials Efficiency Variance = (AQ – SQ) x SC
Alternatively, the Direct Materials Efficiency Variance could be calculated by multiplying Actual Quantity of raw materials (AQ) by the Standard Cost (SC), which would give the total cost of materials without regard to the price variance. Subtracting from that the product of the Standard Quantity of raw materials (AQ) and the Standard Cost (SC) would give the total expected cost of materials if the conversion process used those materials exactly as expected.
(AQ x SC) – (SQ x SC)
From the accounting records, we know that the company purchased and used in production 6,800 BF of lumber to make 1,620 bodies. Based on a standard of four BF per body, we expected raw materials usage to be 6,480 (1,620 bodies x 4 BF per blank).
We can already see that we have an unfavorable variance. Let’s do the calculation:
(AQ – SQ) x SC
(6,800-6,480) x $6.00 = $1,920.00
Alternatively:
(AQ * SC) – (SQ * SC) = (6,800 * $6.00) – (6,480 * $6.00) = $40,800 – $38,800= $1,920.00
Even though the answer is a positive number, the variance is unfavorable because more materials were used than the standard quantity allowed to complete the job. If the standard quantity allowed had exceeded the quantity actually used, the materials usage variance would have been favorable.
Accountants determine whether a variance is favorable or unfavorable by reliance on reason or logic. If more materials were used than the standard quantity, or if a price greater than the standard price was paid, the variance is unfavorable. If the reverse is true, the variance is favorable.
Let’s look at the two variances together:
| Description | Amount | Favorable or Unfavorable |
|---|---|---|
| Direct Materials Cost Variance | $(2,720.00) | |
| Direct Materials Efficiency Variance | 1,920.00 | |
| Single Line $ (800.00)Double line | Favorable |
And relate them back to the budget v. actual report:
| Actual | Budget | |
|---|---|---|
| Sales revenue | $ 178,200.00 | $ 178,200.00 |
| Subcategory, Variable manufacturing costs | Single Line | Single Line |
| Direct materials | 38,080.00 | 38,880.00 |
| Direct Labor | 46,500.00 | 43,740.00 |
| Allocated overhead | 1,395.00 | 1,944.00 |
| Subcategory, Fixed manufacturing costs | ||
| Allocated overhead | 13,485.00 | 13,365.00 |
| Cost of Goods Manufactured and sold | Single Line 99,460.00 | Single Line 97,929.00 |
| Gross Profit | Single Line$ 78,740.00Double line | Single Line$ 80,271.00Double line |
We can double-check our work by reconciling the two variances to the overall variance in the budget:
(actual quantity x actual cost) – (standard quantity x standard cost)
| AQ | AP | SQ | SC | TOTAL VAR | Favorable or Unfavorable |
|---|---|---|---|---|---|
| 6,800.00 | $ 5.60 | $ 38,080.00 | Actual total cost of materials | ||
| 6,480.00 | 6.00 | 38,880.00 | Budgeted total cost of materials | ||
| Variance | Single Line (800.00)Double line | Favorable |
Again, in reporting to our internal users, we would omit the parenthesis that we use in accounting to show a negative amount, since that may confuse non-financial managers who are relying on the report. We would show the variances as follows:
| Description | Amount | Favorable or Unfavorable | |
|---|---|---|---|
| Direct Materials Cost Variance | $2,720.00 | Favorable | |
| Direct Materials Efficiency Variance | 1,920.00 | Unfavorable | |
| Overall Direct Materials Variance | Single Line $ 800.00Double line | Favorable |
This shows that we saved money by buying cheaper, but lost money because of material waste. It could be that the cheaper lumber has more knots, therefore forcing workers to throw more of the raw materials in the scrap heap. The responsible managers (e.g. purchasing and production) will have to get together to do more observations and research. It may also be that our expectations are unrealistic, and we need to change our budget parameters.
Before we go on to explore direct labor variances, check your understanding of the direct materials efficiency variance.
