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 material variances, we need to know how transactions relating to materials are recorded in cost accounting.

Of the transactions relating to materials, the ones involving purchases and returns of materials are financial accounting transactions which are also considered in cost accounting and the ones relating to consumption of materials 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. Materials Purchased for Cash or Credit
2. Direct Material consumption
3. Indirect Material consumption for Factory
4. Abnormal Loss of Materials

There are other transactions like material returns to stores and material returns to the vendors etc. We are limiting the discussion to only those transactions which would aid our understanding of this topic.

Ledger Accounts affected by the Transactions

1. Material/Stores Ledger Control a/c ~ MLC/SLC

   Used to record the receipt and disposal i.e. the in and out of the material stock

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 transactions whose information is derived from financial accounts

Journal Entries

Journal

Particulars		Amount (Dr)	Amount (Cr)
SLC a/c To GLA a/c	Dr	–	–
[For the value of materials purchased for cash or credit]
WIP a/c To SLC a/c	Dr	–	–
[For the value of materials consumed as direct materials]
FOHC a/c To SLC a/c	Dr	–	–
[For the value of materials consumed as indirect materials in factory]
CPL a/c To SLC a/c	Dr	–	–
[For the value of loss on materials on account of abnormal reasons.]

Ledger Posting

Stores 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	– – –

Work in Progress a/c

DrCr
Particulars	Amount	Particulars	Amount
To SLC a/c	–

Factory Overhead Control a/c

DrCr
Particulars	Amount	Particulars	Amount
To SLC a/c	–

Costing Profit and Loss a/c

DrCr
Particulars	Amount	Particulars	Amount
To SLC a/c	–

General Ledger Adjustment a/c

DrCr
Particulars	Amount	Particulars	Amount
		By SLC a/c	–

All the variances i.e. Material - Price, Mix, Yield variances are accounted for. Note that Usage/Quantity Variance is the sum of Mix and Yield Variance and Cost Variance is the sum of Price and Usage/Quantity Variance.

Ledger Accounts Used

The ledger accounts that are used for recording transactions relating to material variances are

• Material Price Variance a/c
• Material Mix Variance a/c
• Material Yield Variance a/c
• Material Usage/Quantity Variance a/c
• Material 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.

• Price Variance

  1. Where the price variance in relation to the materials purchased (and not just the materials used) during a period, is treated as the material price variance, it is identified at the time of recording material purchases.

     The materials taken into stores are valued at standard price and the variance thereon is transferred to the variance account where in price variance is recorded. In such a case, the stocks in the Stores Ledger Control a/c would always reflect the standard prices.

     This may also be done by recording material purchases at the purchase price and then transferring the variance from the Stores Ledger Control a/c to the variance account where Material Price Variance is recorded.

  2. Where just the price variance in relation to the materials used and not the materials purchased during a period is treated as the material price variance, it is identified at the time of issuing materials to the production process.

     The materials issued to production as direct and indirect materials are issued at standard prices and the variance thereon is transferred to the relevant variance account.

     In such a case, the stocks in the Stores Ledger Control a/c would not reflect the standard prices. Their value is dependent on the method followed for pricing the issue of stocks (FIFO, LIFO or AVERAGE).

  Where standard costing systems are in use, the first method is generally adopted.

• Mix Variance

  The mix variance arises only when there are two or more materials involved in the production process.
  1. Where all the constituent materials are issued for production at the same time, the mix variance is identified at the time of issue of materials to the production processes.
  2. Where all the constituent materials are issued for production at different times, it would not be possible to assess the actual mix ratio (i.e. the ratio in which all the materials are actually issued/used). In such a case, the mix variance would be identified at the time of transfer of completed production to the finished goods stock

• Yield Variance

  The yield variance is related to output achieved and thus can be identified after completion of the production process i.e. at the time of transfer of completed production to the finished goods stock

• Quantity/Usage Variance

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

  MQV/MUV

  =

  MMV + MYV/MSUV

  We may deliberately avoid identifying the mix and yield variances in which case we use the formula for calculating the usage/Quantity variance.

  Mix and Yield variances are not considered when there is only one kind of material used in the production process (in which case all the usage variance is nothing but yield variance.)

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

  Where Usage/Quantity 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.

  MCV	=	MPV + MQV/MUV
  Or	=	MPV + MQV/MUV + MMV + MYV/MSUV

  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

• Price Variance

  Standard Price = 20/kg

  Actual Price = 25/kg;

  Actual Quantity Purchased = 2,000 kgs

  The prices of the materials have increased and the new price is 24/kg. After reviewing the variances it was decided that this increase is inevitable and has to be accepted.

  Material Price Variance AQ (SP − AP)

  • Before revision of standard

    MPV	=	2,000 kgs (20/kg − 25/kg)
    	=	− 10,000

  • After revision of standard

    MPV	=	2,000 kgs (24/kg − 25/kg)
    	=	− 2,000
    	=	Abnormal Variance

  Normal Variance

  =	Old − New
  =	(− 10,000) − (− 2,000)
  =	− 8,000

  Of the initial variance identified − 10,000, − 8,000 is to be regarded as normal and the rest − 2,000 is abnormal.

• Mix Variance

  There is a revision in the ratio in which the materials are to be mixed.
  • Before revision of standard

    MMV = + 1,800

  • After revision of standard

    MMV	=	+ 600
    	=	Abnormal Variance

  Normal Variance

  =	Old − New
  =	(+ 1,800) − (+ 600)
  =	+ 1,200

  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, + 1,200 of the variance is normal and + 600 is abnormal.

• Yield Variance

  There is a change in the method of production, whereby each kg of material yielded 12 units compared to the original standard wherein the yield would be only 10 units per kg.
  • Before revision of standard

    MYV/MSUV = + 2,000

  • After revision of standard

    MYV/MSUV	=	− 600
    	=	Abnormal Variance

  Normal Variance

  =	Old − New
  =	(+ 2,000) − (− 600)
  =	+ 2,600

  Thus, + 2,600 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 materials are debited to the Stores Ledger Control a/c when they are acquired. The value of materials used for production are transferred to the work-in-progress a/c forming part of work in progress. The value of materials 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 value of materials in 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 value of materials relating to the period for which the variance has been identified. This total value of materials is the sum of the value of material included in stock of materials, 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 value of material included in

• Closing stock of Raw Materials in Stores Ledger Control a/c
• 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 material variances would be as follows

• Price Variance

  Total price variance is present as a balance in the Material Price Variance a/c.
  • Normal part of the variance is apportioned between SLC a/c, WIP a/c, FGLC a/c and CGS a/c and
  • Abnormal part is transferred/adjusted to MCV a/c.

• Mix Variance

  Total Mix variance is present as a balance in the Material Mix Variance a/c and
  • Normal part of the variance is apportioned between WIP a/c, FGLC a/c and CGS a/c.
  • Abnormal part is transferred/adjusted to MUV a/c.

• Yield/Sub-Usage Variance

  Total Yield/Sub-Usage variance is present as a balance in the Material Yield/Sub-Usage Variance a/c and
  • Normal part of the variance is apportioned between WIP a/c, FGLC a/c and CGS a/c.
  • Abnormal part is transferred/adjusted to MUV a/c

• Usage/Quantity Variance a/c

  This is a consolidation account. It represents the total abnormal part of mix and yield variances. Since the total balance represents abnormal variance, it is adjusted/transferred to MCV a/c.

  Where the Mix and Yield variances are not identified separately we identify the Usage/Quantity Variance directly. In such cases, the MUV a/c is not a consolidation account.

  Where MUV a/c is not a consolidation account

  Where MUV a/c is not a consolidation account, the total Usage/Quantity variance is present as a balance in the Material Usage/Quantity 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 "MCV a/c"

• Cost Variance a/c

  This is a consolidation account. It represents the total abnormal part of price and usage variances. Since the total balance represents abnormal variance, it is adjusted/transferred to Costing P&L a/c.

  Where the Price and Usage/Quantity variances are not identified separately we identify the Cost Variance directly. In such cases, the MCV a/c is not a consolidation account.

  Where MCV a/c is not a consolidation account

  Where MCV a/c is not a consolidation account, the total Cost variance is present as a balance in the Material Cost Variance a/c and
  • Normal part of the variance is apportioned between SLC a/c, WIP a/c, FGLC a/c and CGS a/c.
  • Abnormal part is transferred/adjusted to Costing P/L 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 the normal part of the Price and Cost variances influences all the four accounts i.e. the SLC a/c, WIP a/c, FGLC a/c, COS a/c.
3. Adjustment of the normal part of Mix, Yield and Quantity/Usage variance does not influence the SLC a/c. It influences only the three accounts i.e. the WIP a/c, FGLC a/c, COS a/c.
4. Where Usage/Quantity Variance a/c and Cost Variance a/c are consolidation accounts and the variance transferred to them from other accounts is only abnormal, they do not have normal variance to be transferred/treated.