In Cost Accounting, there are two methods available for recording transactions involving costs. These transactions relating to cost accounting involve some transactions that are already accounted for in financial accounting and other transactions which are exclusive to cost accounting.

Cost Ledger Accounting

Under this method, separate records/books called cost ledgers are maintained for cost accounting. These are independent of financial accounting and all the transactions relevant to cost accounting are recorded in them.

Information that is relevant to financial accounting is pulled from the financial accounting records and recorded again under a methodology similar to self balancing ledgers in financial accounting using a controlling account by name General Ledger Adjustment a/c. Financial accounting records are not influenced in any way by the transactions in the cost ledgers.

Cost Ledgers are self balancing i.e. a trial balance with a list of ledger account balances can be prepared independently for this book and in the absence of any errors the trial balance would agree.

Integrated Accounting

Under this method, cost accounting and financial accounting are clubbed together, thus the name integrated accounting. Transactions exclusive to cost accounting are also recorded in the same set of books as the transactions relating to financial accounting.

Since there is only one set of books, if at all a trial balance is prepared, it would contain all the ledger accounts (balances) we come across in cost accounting as well as financial accounting.

To understand accounting for labor/labour variances, we need to know how transactions relating to labor/labour are recorded in cost accounting.

Of the transactions relating to labor/labour, the ones involving expense paid or payable are financial accounting transactions which are also considered in cost accounting and the ones relating to utilisation of labor/labour are exclusive to cost accounting.

Assumption

To give us a better understanding, we are assuming that a separate set of cost ledgers are being maintained for recording the transactions relevant to costing i.e accounting for costs is being done under the Cost Ledger Accounting method.

Transactions

1. Wages paid or payable
2. Direct Labour/Labor utilised
3. Indirect Labour/Labor utilised for Factory
4. Abnormal Idle Time (Loss of Labour/Labor)

Ledger Accounts affected by the Transactions

1. Wage Ledger Control a/c ~ WLC

   Used to record the incurrence and allocation of the labour/labor costs.

2. Work In Progress a/c ~ WIP

   Used to record cost up to works costs i.e. direct costs and factory overheads.

3. Factory Overhead Control a/c ~ FOHC

   Used to record factory overheads

4. Costing Profit and Loss a/c ~ C P&L

   Used to record gross profit and the losses and gains of abnormal nature

5. General Ledger Adjustment a/c ~ GLA

   Used to record the transactions whose information is derived from financial accounts

Journal Entries

Journal

Particulars		Amount (Dr)	Amount (Cr)
WLC a/c To GLA a/c	Dr	–	–
[For the wages incurred (paid and outstanding)]
WIP a/c To WLC a/c	Dr	–	–
[For the amount of wages utilised as direct expenses]
FOHC a/c To WLC a/c	Dr	–	–
[For the amount of wages treated as Factory overheads]
CP&L a/c To WLC a/c	Dr	–	–
[For the amount of wages relating to abnormal loss time]

Ledger Posting

Wage Ledger Control a/c

DrCr
Particulars	Amount	Particulars	Amount
To GLA a/c	–	By WIP a/c By FOHC a/c By C P/L a/c	– – –

All the variances i.e. Labour/Labor - Rate of Pay, Mix/Gang-Composition, Idle Time and Yield/Sub-Efficiency variances are accounted for. Note that Usage/Gross-Efficiency Variance is the sum of Efficiency and Idle Time variances, Efficiency Variance the sum of Mix/Gang-Composition and Yield/Sub-Efficiency Variances and Cost Variance the sum of Rate of Pay and Usage/Gross-Efficiency Variances.

Ledger Accounts Used

The ledger accounts that are used for recording transactions relating to labour/labor variances are

• Labour/Labor Rate of Pay Variance a/c
• Labour/Labor Idle Time Variance a/c
• Labour/Labor Gross Efficiency/Usage Variance a/c
• Labour/Labor Net Efficiency/Usage Variance a/c
• Labour/Labor Mix/Gang-Composition Variance a/c
• Labour/Labor Yield Variance a/c
• Labour/Labor Cost Variance a/c

There are different possibilities in identifying variances depending on the nature of the product and the method adopted by the organisation.

• Rate of Pay Variance

  The variance in relation to the rate at which wages are paid or payable is identified at the time of recording the wages incurred/due in the cost ledgers.

• Idle Time Variance

  The wage cost for the total time spent by labourers/laborers is classified as direct labour/labor or indirect labour/labor depending on how the labourers/laborers are used and is transferred to the relevant account.

  The variance relating to the idle time included within the time that has not been so classified can be identified when the idle time has been identified.

  The variance relating to the idle time from the direct or indirect labour/labor transferred to the relevant accounts may be identified at any time subsequent to transfer.

• Mix/Gang-Composition Variance

  The mix variance arises only when there are two or more labour/labor types involved in the production process.
  1. Where all the constituent labour/labor types in total are allocated for production at the same time, the mix/gang-composition variance is identified at the time of classification and transfer of wages to the production processes.
  2. Where the constituent labour/labor types are decided at the time of actually employing the labour/labor to the production process, this variance is identified after completion of production process i.e. at the time of transfer of completed production to finished goods stock.

• Yield/Sub-Efficiency

  The yield/sub-efficiency variance can be identified after completion of the production process i.e. at the time of transfer of completed production to the finished goods stock.

• Efficiency Variance

  Efficiency variance may be derived as a sum of its constituent variances or by using a direct formula.

  LEV	=	LMV/LGCV + LYV/LEV
  Or	=	0 + LYV/LEV

  We may deliberately avoid identifying the mix/gang-composition and yield/sub-efficiency variances and use the formula for calculating the Efficiency variance directly.

  Mix/gang-composition and yield/sub-efficiency variances are not thought of when there is only one labour/labor type used in the production process, in which case all the efficiency variance is nothing but yield/sub-efficiency variance.

  Where Efficiency Variance is derived as the sum of its constituent parts, it is identified on identifying its constituent variances.

  Where Efficiency Variance is calculated directly it is identified on completion of the production process i.e. at the time of transfer of completed production to finished goods stock.

• Usage/Gross-Efficiency Variance

  Usage/Gross-Efficiency variance may be derived as a sum of its constituent variances or by using a direct formula.

  LUV/LGEV	=	LITV + LEV
  Or	=	LITV + LMV/LGCV + LYV/LEV

  Where Usage/Gross-Efficiency Variance is derived as the sum of its constituent parts, it is identified on identifying its constituent variances.

  Where Usage/Gross-Efficiency Variance is calculated directly it is identified on completion of the production process i.e. at the time of transfer of completed production to finished goods stock.

• Cost Variance

  Cost variance may be derived as a sum of its constituent variances or by using a direct formula.

  LCV	=	LRPV + LUV/LGEV
  Or	=	LRPV + LITV + LEV
  Or	=	LRPV + LITV + LMV/LGCV + LYV/LSEV

  Where Cost Variance is derived as the sum of its constituent parts, it is identified on identifying its constituent variances.

  Where Cost Variance is calculated directly it is identified on completion of the production process i.e. at the time of transfer of completed production to finished goods stock.

Normal Variance

The variance is considered to be normal when the deviation of the actual from the standard is found to be on account of acceptable/normal reasons. Such a situation can be compared to a situation where there is a need for a revision in standards. It indicates the variance that should be accepted and absorbed into cost.

Abnormal Variance

Any variance or a part of the variance which is avoidable and would not have occurred under normal circumstances is abnormal variance.

Examples

• Rate of Pay Variance

  Standard Price = 8/hr

  Actual Price = 10.50/hr;

  Actual Time Worked = 1,000 hrs

  There was a revision of minimum wages as per the agreement between the management and the labour/labor unions and the new wage rate accepted upon is 10/hr. Since the variance on account of revision in wage rates is on account of revision in agreements with the labourers/laborers, it is acceptable.

  Labour/Labor Rate of Pay Variance AT (SR − AR)

  • Before revision of standard

    LRPV	=	1,000 hrs (8/hr − 10.50/hr)
    	=	− 2,500

  • After revision of standard

    LRPV	=	1,000 hrs ( 10/hr − 10.50/hr)
    	=	− 500

  Of the initial variance identified − 2,500, − 500 is to be regarded as normal and the rest − 2,000 is to be regarded as abnormal.

• Mix/Gang-Composition Variance

  There is a revision in the ratio in which times of the labour/labor types are to be mixed on account of shortage of semi-skilled labourers/laborers.
  • Before revision of standard

    LMV/GCV = + 2,400

  • After revision of standard

    LMV/GCV	=	+ 800
    	=	Abnormal Variance

  Normal Variance	=	Old − New
  	=	(+ 2,400) − (+ 800)
  	=	+ 1,600

  The variance measured using the new standards would be the real variance which should not have been there and is thus abnormal. Anything other than that is acceptable and is normal. Thus, + 1,600 of the variance is normal and + 800 is abnormal.

• Yield Variance

  There is a change in the method of production, whereby each hour of production time yielded 12 units compared to the original standard which indicates a yield of 15 units per hour.
  • Before revision of standard

    LYV/LSEV = − 1,000

  • After revision of standard

    LYV/LSEV	=	+ 600
    	=	Abnormal Variance

  Normal Variance	=	Old − New
  	=	(− 1,000) − (+ 600)
  	=	− 1,600

  Thus, − 1,600 of the variance is normal and + 600 is abnormal.

The normal part of the variance indicates the value that should be adjusted to cost. A positive value indicates additional cost that should have been taken into consideration. A negative value indicates that higher cost has been absorbed already and has to be reduced to make the cost normal.

The value of labour/labor is debited to Wage Ledger Control a/c when they are incurred. The cost of labour/labor used for production is transferred to work-in-progress a/c forming part of work in progress. The labour/labor cost included in the work in progress whose production is completed gets transferred to the Finished Goods a/c as a part of the value of finished goods. The labour/labor cost included in the value of finished goods gets transferred to Cost of Goods sold a/c as a part of the value of goods sold.

The normal part of the variance has to be adjusted over the total labour/labor cost relating to the period for which the variance has been identified. This total labour/labor cost is the sum of labour/labor costs included in stock of work in progress, stock of finished goods and the stock of goods sold.

The total normal variance has to be apportioned among the labour/labor costs included in

• Closing Work in Progress in Work-In-Progress a/c
• Closing Finished Goods in Finished Goods Ledger Control a/c
• Cost of Goods Sold in Cost of Sales a/c

The abnormal part of the variance is transferred to the costing profit and loss a/c thereby eliminating it from normal cost.

Accounting Treatment

The treatment/adjustment of normal and abnormal parts of various labour/labor variances is as follows:

• Rate of Pay Variance

  The total Rate of Pay variance is present as a balance in the Labour/Labor Rate of Pay Variance a/c.
  • Normal part of the variance is apportioned between WIP a/c, FGLC a/c and CGS a/c.
  • Abnormal part is transferred/adjusted to LCV a/c.

• Mix/Gang-Composition Variance

  The total Mix/Gang-Composition variance is present as a balance in the Labour/Labor Mix/Gang-Composition Variance a/c.
  • Normal part of the variance is apportioned between WIP a/c, FGLC a/c and CGS a/c.
  • Abnormal part is transferred/adjusted to LEV a/c.

• Yield/Sub-Efficiency Variance

  The total Yield/Sub-Efficiency variance is present as a balance in the Labour/Labor Yield/Sub-Efficiency Variance a/c.
  • Normal part of the variance is apportioned between WIP a/c, FGLC a/c and CGS a/c.
  • Abnormal part is transferred/adjusted to LUV/LGEV a/c.

• Efficiency Variance

  This is a consolidation account. It represents the total abnormal part of Mix/Gang-Composition and Yield/Sub-Efficiency variances. Since the total balance represents abnormal variance, it is adjusted/transferred to LUV/LGEV a/c.

  Where the Mix/Gang-Composition and Yield/Sub-Efficiency variances are not identified separately we identify the Efficiency Variance directly. In such cases, the LEV a/c is not a consolidation account.

  Where LEV a/c is not a consolidation account

  Where LEV a/c is not a consolidation account, the total Efficiency variance is present as a balance in the Labour/Labor Efficiency Variance a/c.
  • The normal part of the variance is apportioned between WIP a/c, FGLC a/c and CGS a/c.
  • The abnormal part is transferred/adjusted to LUV/LGEV a/c

• Idle Time Variance

  The total Idle time variance appears as a debit balance in the Labour/Labor Idle Time Variance a/c.

  It being completely abnormal, is transferred/adjusted to LUV/LGEV a/c.

• Usage/Gross-Efficiency Variance

  This is a consolidation account. It represents the total abnormal part of Efficiency and Idle Time variances. Since the total balance represents abnormal variance, it is adjusted/transferred to LCV a/c.

  Where the Efficiency and Idle Time variances are not identified separately we identify the Usage/Gross-Efficiency Variance directly. In such cases, the LUV/LGEV a/c is not a consolidation account.

  Where LUV/LGEV a/c is not a consolidation account

  Where LUV/LGEV a/c is not a consolidation account, the total Usage/Gross-Efficiency variance is present as a balance in the Labour/Labor Usage/Gross-Efficiency Variance a/c.
  • The normal part of the variance is apportioned between WIP a/c, FGLC a/c and CGS a/c.
  • The abnormal part is transferred/adjusted to LCV a/c

• Cost Variance

  This is a consolidation account. It represents the total abnormal part of Rate of Pay and Usage/Gross-Efficiency variances. Since the total balance represents abnormal variance, it is adjusted/transferred to Costing Profit and Loss a/c.

  Where the Rate of Pay and Usage/Gross-Efficiency variances are not identified separately we identify the Cost Variance directly. In such cases, the LCV a/c is not a consolidation account.

  Where LCV a/c is not a consolidation account

  Where LCV a/c is not a consolidation account, the total Cost variance is present as a balance in the Labour/Labor Cost Variance a/c.
  • The normal part of the variance is apportioned between WIP a/c, FGLC a/c and CGS a/c.
  • The abnormal part is transferred/adjusted to Costing Profit and Loss a/c

Note

1. Adjustment of normal variance may result in the relevant account being either debited or credited depending on the nature of the variance being adjusted.
2. Adjustment of normal part of the Rate of Pay, Mix/Gang-Composition, Yield/Sub-Efficiency variances influences the WIP a/c, FGLC a/c, COS a/c.
3. Idle Time Variance does not have a normal part to be adjusted
4. Where Efficiency Variance a/c, Usage/Gross-Efficiency Variance a/c and Cost Variance a/c are consolidation accounts, the variance transferred to them from other accounts is only abnormal, they do not have normal variance to be transferred/treated.