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Overabsorbed is usually USED in the context of a manufacturer's PRODUCTION overhead costs. Since manufacturing overhead costs are not directly traceable to products, they need to be allocated, assigned, or applied to the products through an overhead rate. We also state that the products absorb the overhead costs through the overhead rate.

The overhead rate is normally a predetermined rate—meaning that it was calculated prior to the start of the accounting year by using 1) the expected amount of overhead costs, and 2) the expected volume of production. Because of these two estimates, it is unlikely that the amount of overhead allocated, applied, assigned, or absorbed will be equal to the ACTUAL overhead costs incurred.

If the actual products manufactured are assigned or absorb more overhead through the overhead rate than the actual amount of overhead costs incurred, the products have overabsorbed the overhead costs.

At the end of the accounting year, the amount of the overapplied, overassigned, or overabsorbed overhead is often credited to the cost of goods sold. The reasons are 1) the overabsorbed amount is not SIGNIFICANT, and 2) most of the products ABSORBING too much overhead costs have been sold. If the overabsorbed amount is significant, then the amount overabsorbed must be prorated or allocated as a reduction to the cost of the inventories and to the cost of goods sold based on where the overabsorbed overhead costs are residing at the end of the accounting year.

Overabsorbed is usually used in the context of a manufacturer's production overhead costs. Since manufacturing overhead costs are not directly traceable to products, they need to be allocated, assigned, or applied to the products through an overhead rate. We also state that the products absorb the overhead costs through the overhead rate.

The overhead rate is normally a predetermined rate—meaning that it was calculated prior to the start of the accounting year by using 1) the expected amount of overhead costs, and 2) the expected volume of production. Because of these two estimates, it is unlikely that the amount of overhead allocated, applied, assigned, or absorbed will be equal to the actual overhead costs incurred.

If the actual products manufactured are assigned or absorb more overhead through the overhead rate than the actual amount of overhead costs incurred, the products have overabsorbed the overhead costs.

At the end of the accounting year, the amount of the overapplied, overassigned, or overabsorbed overhead is often credited to the cost of goods sold. The reasons are 1) the overabsorbed amount is not significant, and 2) most of the products absorbing too much overhead costs have been sold. If the overabsorbed amount is significant, then the amount overabsorbed must be prorated or allocated as a reduction to the cost of the inventories and to the cost of goods sold based on where the overabsorbed overhead costs are residing at the end of the accounting year.

I don't believe there is a NORMAL balance. If a company pays exactly the STANDARD cost of its direct materials, there will be no balance in the account Direct Materials Price Variance. If a company uses exactly the standard quantity of direct material for its output, there will be no balance in the account Direct Materials Usage Variance.

If the actual price per unit of direct materials is more than the standard cost per unit, the difference will be entered as a debit into the account Direct Materials Price Variance. If the actual price per unit of direct materials is less than the standard cost per unit, the difference will be entered as a credit into the price variance account.

The account Direct Materials Usage Variance will have a debit entered when the actual quantity of direct material USED is greater than the standard quantity for the good output. If the actual quantity of direct material is less than the standard quantity of direct material for the good output, a credit is entered into the usage variance account.

If the standards are realistic, a MANUFACTURER would be pleased with a zero balance in its variance accounts. A credit balance in a variance account signifies that things were better than standard. A debit in a variance account INDICATES that things were worse than the standard.

I don't believe there is a normal balance. If a company pays exactly the standard cost of its direct materials, there will be no balance in the account Direct Materials Price Variance. If a company uses exactly the standard quantity of direct material for its output, there will be no balance in the account Direct Materials Usage Variance.

If the actual price per unit of direct materials is more than the standard cost per unit, the difference will be entered as a debit into the account Direct Materials Price Variance. If the actual price per unit of direct materials is less than the standard cost per unit, the difference will be entered as a credit into the price variance account.

The account Direct Materials Usage Variance will have a debit entered when the actual quantity of direct material used is greater than the standard quantity for the good output. If the actual quantity of direct material is less than the standard quantity of direct material for the good output, a credit is entered into the usage variance account.

If the standards are realistic, a manufacturer would be pleased with a zero balance in its variance accounts. A credit balance in a variance account signifies that things were better than standard. A debit in a variance account indicates that things were worse than the standard.

SINCE the financial statements must reflect the COST principle, both the standard costs and the variances must be included in the financial statements.

For example, if a DIRECT material has a standard cost of $400 but the company PAID $422, the financial statement must report $422 (the standard cost of $400 plus the price VARIANCE of $22).

How the variances are reported on the financial statements is discussed in the last part of our Explanation of Standard Costing.

Since the financial statements must reflect the cost principle, both the standard costs and the variances must be included in the financial statements.

For example, if a direct material has a standard cost of $400 but the company paid $422, the financial statement must report $422 (the standard cost of $400 plus the price variance of $22).

How the variances are reported on the financial statements is discussed in the last part of our Explanation of Standard Costing.

There can be a connection between the direct materials variances and the direct labor variances. In FACT, there can be a relationship between many of the variances.

LET's assume that a lower costing material is purchased in order to achieve a favorable materials PRICE variance. If the materials have some negative attributes, it is possible that an unfavorable materials usage variance could RESULT. If the materials' attributes cause additional labor hours, then an unfavorable direct labor efficiency variance will result. If the materials required more experienced labor, it is possible that a labor rate variance will also occur.

The above example can also extend to the overhead variances. If more electricity and SUPPLIES had to be used because of the materials' attributes, there will be an unfavorable variable overhead efficiency variance. If the volume of output is curtailed by the materials' attributes, there could possibly be a fixed overhead volume variance.

There can be a connection between the direct materials variances and the direct labor variances. In fact, there can be a relationship between many of the variances.

Let's assume that a lower costing material is purchased in order to achieve a favorable materials price variance. If the materials have some negative attributes, it is possible that an unfavorable materials usage variance could result. If the materials' attributes cause additional labor hours, then an unfavorable direct labor efficiency variance will result. If the materials required more experienced labor, it is possible that a labor rate variance will also occur.

The above example can also extend to the overhead variances. If more electricity and supplies had to be used because of the materials' attributes, there will be an unfavorable variable overhead efficiency variance. If the volume of output is curtailed by the materials' attributes, there could possibly be a fixed overhead volume variance.

In a standard costing system, some favorable variances are not indicators of EFFICIENCY in operations. For example, the materials price variance, the labor rate variance, the manufacturing overhead spending and budget variances, and the PRODUCTION volume variance are generally not RELATED to the efficiency of the operations.

On the other hand, the materials usage variance, the labor efficiency variance, and the variable manufacturing efficiency variance are indicators of operating efficiency. However, it is possible that some of these variances could result from standards that were not realistic. For example, if it realistically takes 2.4 hours to produce a UNIT of output, but the standard is SET for 2.5 hours, there should be a favorable variance of 0.1 hour. This 0.1 hour variance results from the unrealistic standard, rather than operational efficiency.

In a standard costing system, some favorable variances are not indicators of efficiency in operations. For example, the materials price variance, the labor rate variance, the manufacturing overhead spending and budget variances, and the production volume variance are generally not related to the efficiency of the operations.

On the other hand, the materials usage variance, the labor efficiency variance, and the variable manufacturing efficiency variance are indicators of operating efficiency. However, it is possible that some of these variances could result from standards that were not realistic. For example, if it realistically takes 2.4 hours to produce a unit of output, but the standard is set for 2.5 hours, there should be a favorable variance of 0.1 hour. This 0.1 hour variance results from the unrealistic standard, rather than operational efficiency.

The departmentalizing of manufacturing overhead costs allows for better planning and CONTROL if the head of each department is held RESPONSIBLE for the costs and productivity of his or her department.

The departmentalizing of manufacturing overhead costs also allows for the computation and application of SEVERAL departmental overhead cost rates instead of having a single, plant-wide overhead rate. This is important when there are a variety of products and some require many operations in a department with high overhead rates, while other products require very few operations in the high cost department. There may also be products which require many hours of processing, but they occur in LOW cost departments. For instance, the assembly and packing departments of a manufacturer are likely to have very low overhead cost rates. On the other hand, the fabricating and MILLING departments will likely have much higher overhead cost rates.

The departmentalizing of manufacturing overhead costs allows for better planning and control if the head of each department is held responsible for the costs and productivity of his or her department.

The departmentalizing of manufacturing overhead costs also allows for the computation and application of several departmental overhead cost rates instead of having a single, plant-wide overhead rate. This is important when there are a variety of products and some require many operations in a department with high overhead rates, while other products require very few operations in the high cost department. There may also be products which require many hours of processing, but they occur in low cost departments. For instance, the assembly and packing departments of a manufacturer are likely to have very low overhead cost rates. On the other hand, the fabricating and milling departments will likely have much higher overhead cost rates.

I assume that the burden rate in inventory refers to a manufacturer's indirect manufacturing costs, which are also referred to as factory overhead, indirect production costs, and burden. In the U.S., a manufactured product's cost consists of direct materials, direct labor, and manufacturing overhead. Since manufacturing overhead is an indirect cost, it is usually assigned or allocated through an overhead rate or burden rate. Two examples of an overhead or burden rate are 1) a percentage of direct labor, and 2) an hourly cost rate assigned on the basis of MACHINE HOURS.

A product's manufacturing cost, consisting of direct materials, direct labor and manufacturing overhead, is used to report the cost of goods SOLD and also the cost of UNITS in inventory. THEREFORE, if you look at the detail of a product's inventory cost, you may see the manufacturing overhead being assigned or applied to the unit through a burden rate.

I assume that the burden rate in inventory refers to a manufacturer's indirect manufacturing costs, which are also referred to as factory overhead, indirect production costs, and burden. In the U.S., a manufactured product's cost consists of direct materials, direct labor, and manufacturing overhead. Since manufacturing overhead is an indirect cost, it is usually assigned or allocated through an overhead rate or burden rate. Two examples of an overhead or burden rate are 1) a percentage of direct labor, and 2) an hourly cost rate assigned on the basis of machine hours.

A product's manufacturing cost, consisting of direct materials, direct labor and manufacturing overhead, is used to report the cost of goods sold and also the cost of units in inventory. Therefore, if you look at the detail of a product's inventory cost, you may see the manufacturing overhead being assigned or applied to the unit through a burden rate.

BOM is the acronym for bill of materials. A BOM is a listing of the QUANTITIES of each of the materials used in manufacturing a PRODUCT.

Industrial manufacturers are likely to have an enormous number of BOMs. Each of the BOMs will be a very detailed list of all of the quantities of every material used in the various steps of manufacturing each part or product.

To visualize a BOM, think of a bakery that produces only pies. Each pie's BOM will list the INGREDIENTS in the pie's recipe. Each BOM will list the number of pounds (or other unit of measure) of the specific fruit, the QUANTITY of a specific sugar (or other sweetener), the quantity and type of cinnamon, the quantity of nutmeg, the type of crust. There will also be a BOM for the pie crust. The pie crust BOM will SPECIFY the quantity and type of flour, the quantity and type of butter (or oil), the quantity of salt, etc.

BOM is the acronym for bill of materials. A BOM is a listing of the quantities of each of the materials used in manufacturing a product.

Industrial manufacturers are likely to have an enormous number of BOMs. Each of the BOMs will be a very detailed list of all of the quantities of every material used in the various steps of manufacturing each part or product.

To visualize a BOM, think of a bakery that produces only pies. Each pie's BOM will list the ingredients in the pie's recipe. Each BOM will list the number of pounds (or other unit of measure) of the specific fruit, the quantity of a specific sugar (or other sweetener), the quantity and type of cinnamon, the quantity of nutmeg, the type of crust. There will also be a BOM for the pie crust. The pie crust BOM will specify the quantity and type of flour, the quantity and type of butter (or oil), the quantity of salt, etc.

An unfavorable VOLUME variance indicates that the amount of fixed manufacturing overhead COSTS applied (or assigned) to the manufacturer's output was less than the budgeted or planned amount of fixed manufacturing overhead costs for the same TIME PERIOD. The unfavorable volume variance indicates that the period's output was less than the planned output.

The volume variance is also referred to as the production volume variance, the capacity variance, or the idle capacity variance.

An unfavorable volume variance indicates that the amount of fixed manufacturing overhead costs applied (or assigned) to the manufacturer's output was less than the budgeted or planned amount of fixed manufacturing overhead costs for the same time period. The unfavorable volume variance indicates that the period's output was less than the planned output.

The volume variance is also referred to as the production volume variance, the capacity variance, or the idle capacity variance.

An unfavorable fixed OVERHEAD budget variance results when the actual amount spent on fixed manufacturing overhead costs exceeds the budgeted amount. The fixed overhead budget variance is also known as the fixed overhead spending variance.

Fixed overhead costs are the indirect manufacturing costs that are not expected to change when the volume of activity changes. Some EXAMPLES of fixed manufacturing overhead include the depreciation, property TAX and INSURANCE of the factory buildings and equipment, and the salaries of the manufacturing supervisors and managers.

SINCE the fixed manufacturing overhead costs should remain the same within reasonable ranges of activity, the amount of the fixed overhead budget variance should be relatively small.

An unfavorable fixed overhead budget variance results when the actual amount spent on fixed manufacturing overhead costs exceeds the budgeted amount. The fixed overhead budget variance is also known as the fixed overhead spending variance.

Fixed overhead costs are the indirect manufacturing costs that are not expected to change when the volume of activity changes. Some examples of fixed manufacturing overhead include the depreciation, property tax and insurance of the factory buildings and equipment, and the salaries of the manufacturing supervisors and managers.

Since the fixed manufacturing overhead costs should remain the same within reasonable ranges of activity, the amount of the fixed overhead budget variance should be relatively small.

In cost accounting, manufacturing OVERHEAD costs are often assigned to products by using a predetermined overhead rate. The predetermined rate is likely based on an annual manufacturing overhead BUDGET divided by some activity such as the expected number of machine hours. Instead of saying that the manufacturing overhead is assigned, we MIGHT say it is allocated, applied or apportioned to the products manufactured during the period. We COULD also say that the products have absorbed the overhead.

If the amount of overhead assigned to the products manufactured is greater than the amount of overhead actually incurred, the products have overabsorbed the overhead costs. If the amount of overhead assigned to the products is less than the amount of overhead actually incurred, the products have underabsorbed the overhead costs.

The cause of the overabsorption or underabsorption will be some combination of 1) the quantity of products manufactured, and 2) the actual overhead costs incurred.

In cost accounting, manufacturing overhead costs are often assigned to products by using a predetermined overhead rate. The predetermined rate is likely based on an annual manufacturing overhead budget divided by some activity such as the expected number of machine hours. Instead of saying that the manufacturing overhead is assigned, we might say it is allocated, applied or apportioned to the products manufactured during the period. We could also say that the products have absorbed the overhead.

If the amount of overhead assigned to the products manufactured is greater than the amount of overhead actually incurred, the products have overabsorbed the overhead costs. If the amount of overhead assigned to the products is less than the amount of overhead actually incurred, the products have underabsorbed the overhead costs.

The cause of the overabsorption or underabsorption will be some combination of 1) the quantity of products manufactured, and 2) the actual overhead costs incurred.

The material usage variance in a standard costing system results from using more or less than the standard quantity of direct materials specified for the actual goods produced. If the actual quantity of the input direct materials is more than the standard quantity allowed for the good OUTPUT, the variance is unfavorable and the Material Usage Variance account will have a debit balance . If the actual quantity of the input direct materials is less than the standard quantity allowed for the good output, the variance is favorable and a credit will be entered in the Materials Usage Variance account.

When preparing the financial statements, a debit balance in the Materials Usage Variance account (which MEANS an unfavorable variance) will have to be added to the standard cost of the products. If the standard costs associated with the variance are in the goods that have been SOLD, the debit balance in the variance account will be added to the Cost of Goods Sold, an income statement expense. (This is reasonable, because the standard cost is too low compared to the actual cost of the materials.) If the output associated with the variances is entirely in finished goods inventory, then the debit balance in the variance account will be added to the finished goods inventory amount reported on the balance sheet. Again, this is necessary because the standard cost of the finished goods inventory is too low. If the products are in WORK in process, finished goods inventory, and cost of goods sold, you WOULD assign the variance to all three categories based on the proportions associated with the variance amounts. Accountants refer to this as prorating the variances. If the variance amount is insignificant, accountants will simply assign these small variances to the cost of goods sold. This is reasonable if most of the goods that were produced have been sold. Generally, inventories are small in relation to the quantities produced.

Credit balances in the variance accounts represent favorable variances and will reduce the standard costs that are reported as debit balances in inventory on the balance sheet or as cost of goods sold expense on the income statement. The favorable variances will be prorated as discussed above or simply credited to cost of goods sold when the variances are not significant or material in amount.

The material usage variance in a standard costing system results from using more or less than the standard quantity of direct materials specified for the actual goods produced. If the actual quantity of the input direct materials is more than the standard quantity allowed for the good output, the variance is unfavorable and the Material Usage Variance account will have a debit balance . If the actual quantity of the input direct materials is less than the standard quantity allowed for the good output, the variance is favorable and a credit will be entered in the Materials Usage Variance account.

When preparing the financial statements, a debit balance in the Materials Usage Variance account (which means an unfavorable variance) will have to be added to the standard cost of the products. If the standard costs associated with the variance are in the goods that have been sold, the debit balance in the variance account will be added to the Cost of Goods Sold, an income statement expense. (This is reasonable, because the standard cost is too low compared to the actual cost of the materials.) If the output associated with the variances is entirely in finished goods inventory, then the debit balance in the variance account will be added to the finished goods inventory amount reported on the balance sheet. Again, this is necessary because the standard cost of the finished goods inventory is too low. If the products are in work in process, finished goods inventory, and cost of goods sold, you would assign the variance to all three categories based on the proportions associated with the variance amounts. Accountants refer to this as prorating the variances. If the variance amount is insignificant, accountants will simply assign these small variances to the cost of goods sold. This is reasonable if most of the goods that were produced have been sold. Generally, inventories are small in relation to the quantities produced.

Credit balances in the variance accounts represent favorable variances and will reduce the standard costs that are reported as debit balances in inventory on the balance sheet or as cost of goods sold expense on the income statement. The favorable variances will be prorated as discussed above or simply credited to cost of goods sold when the variances are not significant or material in amount.

Standard costing is an accounting technique that some manufacturers use to identify the differences or variances between 1) the actual COSTS of the goods that were produced, and 2) the costs that should have occurred for those goods. The costs that should have occurred for the actual good output are known as standard costs.

Standard costing is likely integrated with a manufacturer's budgets (profit plan, master budget) for an accounting YEAR and involve the product costs: direct materials, direct labor, and manufacturing overhead. With standard costing, the accounts for inventories and the cost of goods sold contain the standard costs of the inputs that should have been used to make the actual good output.

If the company had incurred more than the standard costs for the direct materials, direct labor, and manufacturing overhead, the company will not meet its projected net income. In other words, the variances will direct management's attention to the production inefficiencies or higher input costs. In turn, management can take ACTION to correct the problems or seek higher selling PRICES.

Since the external financial statements must reflect the historical cost principle, the standard costs in the inventories and the cost of goods sold will need to be adjusted for the variances. Since most of the goods manufactured will have been sold, most of the variances will be reported on the income statement as part of the cost of goods sold.

Standard costing is an accounting technique that some manufacturers use to identify the differences or variances between 1) the actual costs of the goods that were produced, and 2) the costs that should have occurred for those goods. The costs that should have occurred for the actual good output are known as standard costs.

Standard costing is likely integrated with a manufacturer's budgets (profit plan, master budget) for an accounting year and involve the product costs: direct materials, direct labor, and manufacturing overhead. With standard costing, the accounts for inventories and the cost of goods sold contain the standard costs of the inputs that should have been used to make the actual good output.

If the company had incurred more than the standard costs for the direct materials, direct labor, and manufacturing overhead, the company will not meet its projected net income. In other words, the variances will direct management's attention to the production inefficiencies or higher input costs. In turn, management can take action to correct the problems or seek higher selling prices.

Since the external financial statements must reflect the historical cost principle, the standard costs in the inventories and the cost of goods sold will need to be adjusted for the variances. Since most of the goods manufactured will have been sold, most of the variances will be reported on the income statement as part of the cost of goods sold.

STANDARD COSTING was DEVELOPED to assist a MANUFACTURER plan and control its operations. Generally accepted accounting principles or GAAP require that a manufacturer's financial statements comply with the cost principle. This means that the inventories, the cost of goods sold, and the resulting net income must reflect the manufacturer's actual costs.

Standard costing will meet the GAAP requirements if the variances between the standard costs and the actual costs are properly prorated to the inventories and to the cost of goods sold prior to ISSUING the financial statements.

Standard costing was developed to assist a manufacturer plan and control its operations. Generally accepted accounting principles or GAAP require that a manufacturer's financial statements comply with the cost principle. This means that the inventories, the cost of goods sold, and the resulting net income must reflect the manufacturer's actual costs.

Standard costing will meet the GAAP requirements if the variances between the standard costs and the actual costs are properly prorated to the inventories and to the cost of goods sold prior to issuing the financial statements.

One reason for a manufacturer to use standard costs is to plan carefully what its costs will be for the upcoming budgeting year and to then compare the actual costs with those planned costs. If the actual costs are similar to the standard costs (the planned costs; what the costs should be) the company is on TRACK to reach the cost part of its profit plan. If the actual costs DEVIATE from the standard costs, management is alerted by the variances that are reported for materials, labor and manufacturing overhead. Hence standard costs allow a manufacturer to practice management by exception. That is, if the actual costs are what they should be, management action is not REQUIRED. If the actual costs are more than the standard costs, management must take action or it will not ACHIEVE the planned profit.

The standard cost variances direct management's ATTENTION to the area where the problems are occurring. If the problems cannot be solved easily, management may need to explore alternate materials or processes, attempt to increase selling prices, etc. Again, without reacting to the variances the company's planned profit for the year will not be met.

One reason for a manufacturer to use standard costs is to plan carefully what its costs will be for the upcoming budgeting year and to then compare the actual costs with those planned costs. If the actual costs are similar to the standard costs (the planned costs; what the costs should be) the company is on track to reach the cost part of its profit plan. If the actual costs deviate from the standard costs, management is alerted by the variances that are reported for materials, labor and manufacturing overhead. Hence standard costs allow a manufacturer to practice management by exception. That is, if the actual costs are what they should be, management action is not required. If the actual costs are more than the standard costs, management must take action or it will not achieve the planned profit.

The standard cost variances direct management's attention to the area where the problems are occurring. If the problems cannot be solved easily, management may need to explore alternate materials or processes, attempt to increase selling prices, etc. Again, without reacting to the variances the company's planned profit for the year will not be met.

The production volume variance is associated with a standard COSTING system used by some manufacturers. This variance indicates the difference between 1) the company's budgeted amount of fixed manufacturing overhead costs, and 2) the amount of the fixed manufacturing overhead costs that were assigned to (or absorbed by) the company's production OUTPUT.

To illustrate the production volume variance, let's assume that a MANUFACTURER had budgeted $300,000 of fixed manufacturing overhead (supervisors' compensation, depreciation, etc.) for the upcoming year. During that period it expected to have 30,000 machines hours of good output. Based on this plan the manufacturer established a fixed manufacturing overhead rate of $10 per standard machine hour. If the company actually produces 29,000 standard machine hours of good output, the products will be assigned (or will have absorbed) $290,000 of the fixed manufacturing overhead. This will cause an unfavorable production volume variance of $10,000 ($300,000 budgeted vs. $290,000 assigned; or 1,000 too few standard machine hours of good output X $10 per standard machine hour).

If our example had stated that the manufacturer actually produced 32,000 standard machine hours of good output, the products would have been assigned $320,000 of fixed manufacturing overhead costs COMPARED to the budgeted amount of $300,000. This SCENARIO would result in a favorable production volume variance of $20,000 ($300,000 budgeted vs. $320,000 assigned; or 2,000 additional standard machine hours of good output X $10 per standard machine hour).

The production volume variance is associated with a standard costing system used by some manufacturers. This variance indicates the difference between 1) the company's budgeted amount of fixed manufacturing overhead costs, and 2) the amount of the fixed manufacturing overhead costs that were assigned to (or absorbed by) the company's production output.

To illustrate the production volume variance, let's assume that a manufacturer had budgeted $300,000 of fixed manufacturing overhead (supervisors' compensation, depreciation, etc.) for the upcoming year. During that period it expected to have 30,000 machines hours of good output. Based on this plan the manufacturer established a fixed manufacturing overhead rate of $10 per standard machine hour. If the company actually produces 29,000 standard machine hours of good output, the products will be assigned (or will have absorbed) $290,000 of the fixed manufacturing overhead. This will cause an unfavorable production volume variance of $10,000 ($300,000 budgeted vs. $290,000 assigned; or 1,000 too few standard machine hours of good output X $10 per standard machine hour).

If our example had stated that the manufacturer actually produced 32,000 standard machine hours of good output, the products would have been assigned $320,000 of fixed manufacturing overhead costs compared to the budgeted amount of $300,000. This scenario would result in a favorable production volume variance of $20,000 ($300,000 budgeted vs. $320,000 assigned; or 2,000 additional standard machine hours of good output X $10 per standard machine hour).

The materials usage variance, which is also referred to as the materials QUANTITY variance, is associated with a standard costing system. The materials usage variance results when a company USES more or less than the standard quantity of materials (input) that should have been used for the products actually manufactured (the good output).

The materials usage variance is unfavorable when the actual quantity of materials used exceeded the standard quantity of materials. The materials usage variance is FAVORABLE when the actual quantity of materials used was less than the standard quantity. In the U.S. the materials usage variance is expressed in dollars, which is calculated by multiplying the favorable or unfavorable quantity (such as pounds) TIMES the standard cost per pound.

To illustrate, let's assume that a company has a standard of 5 pounds of materials to produce one unit of output. The company also established that the standard cost per pound of the materials is $3 per pound. If the company produced 100 units of output, the company should have used 500 pounds of input (100 units of good output X 5 pounds of input per unit of output). If the company actually used 530 pounds of input, the materials usage variance will be $90 unfavorable (30 pounds of ADDITIONAL input X the standard cost per pound of $3). The $90 unfavorable materials usage variance can be explained by the following: $1,590 (530 actual pounds used X $3 standard cost) vs. the standard of $1,500 (100 units of output X 5 standard pounds = 500 standard pounds x $3 standard cost).

The materials usage variance, which is also referred to as the materials quantity variance, is associated with a standard costing system. The materials usage variance results when a company uses more or less than the standard quantity of materials (input) that should have been used for the products actually manufactured (the good output).

The materials usage variance is unfavorable when the actual quantity of materials used exceeded the standard quantity of materials. The materials usage variance is favorable when the actual quantity of materials used was less than the standard quantity. In the U.S. the materials usage variance is expressed in dollars, which is calculated by multiplying the favorable or unfavorable quantity (such as pounds) times the standard cost per pound.

To illustrate, let's assume that a company has a standard of 5 pounds of materials to produce one unit of output. The company also established that the standard cost per pound of the materials is $3 per pound. If the company produced 100 units of output, the company should have used 500 pounds of input (100 units of good output X 5 pounds of input per unit of output). If the company actually used 530 pounds of input, the materials usage variance will be $90 unfavorable (30 pounds of additional input X the standard cost per pound of $3). The $90 unfavorable materials usage variance can be explained by the following: $1,590 (530 actual pounds used X $3 standard cost) vs. the standard of $1,500 (100 units of output X 5 standard pounds = 500 standard pounds x $3 standard cost).

This variance tells us how efficient the direct labor was in making the actual output that was produced by the direct labor.

The direct labor efficiency variance COMPARES the standard HOURS that it should have taken to make the actual output Vs. the actual hours it TOOK and multiplies the difference in hours by the standard cost per direct labor hour.

Here's an example with amounts. Let's assume the standard for direct labor is 3 hours per UNIT of output and the standard cost for an hour of direct labor is $10. Let's say the output for the period is 6,000 units and the actual direct labor hours were 18,400 hours and the labor earned $10.30 per hour. The standard direct labor cost for the actual output should have been 18,000 hours (6,000 units of output times 3 standard hours) at $10 per hour for a total of $180,000. The actual direct labor cost was $189,520 (18,400 hours at $10.30 per hour). This means a TOTAL (efficiency and rate) variance of $9,520. Some of that variance is due to the rate being $0.30 too much and some of that variance is due to the direct labor using too many hours—not being efficient.

The direct labor efficiency variance focuses on the direct labor hours: 6,000 units of output should have taken 3 hours each for a total of 18,000 direct labor hours. The actual direct labor hours were 18,400 hours. This means there was an unfavorable direct labor efficiency variance of 400 hours times the standard rate of $10 for a total of $4,000.

The direct labor rate variance is the $0.30 unfavorable variance in the hourly rate ($10.30 actual rate Vs. $10.00 standard rate) times the 18,400 actual hours for an unfavorable direct labor rate variance of $5,520.

The combination of the unfavorable direct labor efficiency variance of $4,000 + the unfavorable direct labor rate variance of $5,520 is the total unfavorable direct labor variance of $9,520.

This variance tells us how efficient the direct labor was in making the actual output that was produced by the direct labor.

The direct labor efficiency variance compares the standard hours that it should have taken to make the actual output Vs. the actual hours it took and multiplies the difference in hours by the standard cost per direct labor hour.

Here's an example with amounts. Let's assume the standard for direct labor is 3 hours per unit of output and the standard cost for an hour of direct labor is $10. Let's say the output for the period is 6,000 units and the actual direct labor hours were 18,400 hours and the labor earned $10.30 per hour. The standard direct labor cost for the actual output should have been 18,000 hours (6,000 units of output times 3 standard hours) at $10 per hour for a total of $180,000. The actual direct labor cost was $189,520 (18,400 hours at $10.30 per hour). This means a TOTAL (efficiency and rate) variance of $9,520. Some of that variance is due to the rate being $0.30 too much and some of that variance is due to the direct labor using too many hours—not being efficient.

The direct labor efficiency variance focuses on the direct labor hours: 6,000 units of output should have taken 3 hours each for a total of 18,000 direct labor hours. The actual direct labor hours were 18,400 hours. This means there was an unfavorable direct labor efficiency variance of 400 hours times the standard rate of $10 for a total of $4,000.

The direct labor rate variance is the $0.30 unfavorable variance in the hourly rate ($10.30 actual rate Vs. $10.00 standard rate) times the 18,400 actual hours for an unfavorable direct labor rate variance of $5,520.

The combination of the unfavorable direct labor efficiency variance of $4,000 + the unfavorable direct labor rate variance of $5,520 is the total unfavorable direct labor variance of $9,520.

I assume that the purchase price variance was recorded at the time that the RAW materials were purchased. If that price variance is significant, it should be reclassified to the following: raw materials inventory, work-in-process inventory, finished goods inventory, and cost of goods sold. The reclassification is also KNOWN as prorating the variance or allocating the variance.

The reclassification of the purchase price variance should be based on the location of the raw materials which had created the price variance. If those raw materials were RECENTLY purchased and are entirely in the raw materials inventory, then all of the price variance should be assigned to the raw materials inventory. If the price variance occurred throughout the year, the variance should be assigned to the raw materials inventory, work-in-process inventory, finished goods inventory, and cost of goods sold based on the quantity of the raw materials in each of these CATEGORIES.

If the AMOUNT of the purchase price variance is very small and/or the inventory turnover rates are very high, the entire amount of the price variance might be reclassified entirely to the cost of goods sold.

I assume that the purchase price variance was recorded at the time that the raw materials were purchased. If that price variance is significant, it should be reclassified to the following: raw materials inventory, work-in-process inventory, finished goods inventory, and cost of goods sold. The reclassification is also known as prorating the variance or allocating the variance.

The reclassification of the purchase price variance should be based on the location of the raw materials which had created the price variance. If those raw materials were recently purchased and are entirely in the raw materials inventory, then all of the price variance should be assigned to the raw materials inventory. If the price variance occurred throughout the year, the variance should be assigned to the raw materials inventory, work-in-process inventory, finished goods inventory, and cost of goods sold based on the quantity of the raw materials in each of these categories.

If the amount of the purchase price variance is very small and/or the inventory turnover rates are very high, the entire amount of the price variance might be reclassified entirely to the cost of goods sold.

This phrase is used in cost accounting and involves the assigning, applying, or allocating of fixed manufacturing overhead costs to the UNITS produced by a manufacturer.

Three examples of fixed manufacturing overhead costs include 1) depreciation of the manufacturing equipment, 2) the property tax on the factory building, and 3) the salaries of the factory supervisors. Each of these costs comes in large dollar amounts (they do not occur at a rate of say $1.00 PER unit) and none is directly traceable to the products manufactured. The dollar AMOUNT of each of these costs will probably not change if the company produces 10% more units or 10% fewer units.

Because the fixed manufacturing overhead costs are indirect product costs (not directly traceable to the products) the ACCOUNTANT allocates (or assigns or applies) these costs to the products on some basis—perhaps on the basis of machine hours or through activity-based costing. While the accountant assigns or allocates these costs, the products are said to be absorbing these fixed manufacturing costs. (Absorption costing, which is required for external financial statements, means that each product's cost includes direct materials, direct labor, variable manufacturing overhead, and fixed manufacturing overhead.)

Fixed manufacturing overhead cost is usually applied to the products (and is absorbed by the products) through the use of a PREDETERMINED annual overhead rate that is based on some planned volume of production. If the actual product volume is less than the planned volume (and the costs are as planned) the fixed manufacturing overhead will be underabsorbed. When the actual volume exceeds the planned volume and the costs are as planned, the fixed manufacturing overhead will be overabsorbed.

This phrase is used in cost accounting and involves the assigning, applying, or allocating of fixed manufacturing overhead costs to the units produced by a manufacturer.

Three examples of fixed manufacturing overhead costs include 1) depreciation of the manufacturing equipment, 2) the property tax on the factory building, and 3) the salaries of the factory supervisors. Each of these costs comes in large dollar amounts (they do not occur at a rate of say $1.00 per unit) and none is directly traceable to the products manufactured. The dollar amount of each of these costs will probably not change if the company produces 10% more units or 10% fewer units.

Because the fixed manufacturing overhead costs are indirect product costs (not directly traceable to the products) the accountant allocates (or assigns or applies) these costs to the products on some basis—perhaps on the basis of machine hours or through activity-based costing. While the accountant assigns or allocates these costs, the products are said to be absorbing these fixed manufacturing costs. (Absorption costing, which is required for external financial statements, means that each product's cost includes direct materials, direct labor, variable manufacturing overhead, and fixed manufacturing overhead.)

Fixed manufacturing overhead cost is usually applied to the products (and is absorbed by the products) through the use of a predetermined annual overhead rate that is based on some planned volume of production. If the actual product volume is less than the planned volume (and the costs are as planned) the fixed manufacturing overhead will be underabsorbed. When the actual volume exceeds the planned volume and the costs are as planned, the fixed manufacturing overhead will be overabsorbed.

A favorable budget VARIANCE indicates that an actual result is better for the company (or other organization) than the amount that was budgeted.

Here are three examples of favorable budget variances:

1. Actual revenues are more than the budgeted or planned revenues.
2. Actual expenses are less than the budget or plan.
3. Actual MANUFACTURING costs are less than the amount budgeted for the period.

Occasionally, a favorable budget variance for revenues will be ANALYZED to determine whether it was the result of higher than planned selling prices, greater QUANTITIES, or a more favorable mix of items sold.

A favorable budget variance indicates that an actual result is better for the company (or other organization) than the amount that was budgeted.

Here are three examples of favorable budget variances:

Occasionally, a favorable budget variance for revenues will be analyzed to determine whether it was the result of higher than planned selling prices, greater quantities, or a more favorable mix of items sold.

A standard cost has been described as a predetermined cost, an estimated future cost, an expected cost, a budgeted UNIT cost, a forecast cost, or a "should be" cost. Standard costs are often a part of a manufacturer's annual profit plan and operating budgets. Standard costs will be established for the following year's direct materials, direct labor, and manufacturing overhead. If standard costs are used, there will be:

• a standard cost for each unit of INPUT (e.g., $20 per hour of direct labor)
• a standard quantity of each input for each unit of output (e.g., 2 hours of labor for each product)
• a standard cost for each unit of output (e.g., $20 X 2 hours = $40 of direct labor per product)

Under a standard cost system, the standard costs of the manufacturing activities will be recorded in the inventories and the cost of goods sold accounts. Since the company MUST pay its VENDORS and production workers the actual costs incurred, there are likely to be some differences. The difference between the standard costs and the actual manufacturing costs is referred to as a cost variance and will be recorded in separate variance accounts. Any balance in a variance account indicates that the company is deviating from the amounts in its profit plan.

While standard costs can be a useful management tool for a manufacturer, its external financial statements must comply with the cost principle and the MATCHING principle. Therefore, significant variances must be reviewed and properly reported as part of the cost of goods sold and/or inventories.

A standard cost has been described as a predetermined cost, an estimated future cost, an expected cost, a budgeted unit cost, a forecast cost, or a "should be" cost. Standard costs are often a part of a manufacturer's annual profit plan and operating budgets. Standard costs will be established for the following year's direct materials, direct labor, and manufacturing overhead. If standard costs are used, there will be:

Under a standard cost system, the standard costs of the manufacturing activities will be recorded in the inventories and the cost of goods sold accounts. Since the company must pay its vendors and production workers the actual costs incurred, there are likely to be some differences. The difference between the standard costs and the actual manufacturing costs is referred to as a cost variance and will be recorded in separate variance accounts. Any balance in a variance account indicates that the company is deviating from the amounts in its profit plan.

While standard costs can be a useful management tool for a manufacturer, its external financial statements must comply with the cost principle and the matching principle. Therefore, significant variances must be reviewed and properly reported as part of the cost of goods sold and/or inventories.

Some people use cost and price interchangeably. Others use the term cost to mean one component of a PRODUCT's selling price. Even the same person might use the terms differently.

For example, in standard costing the price VARIANCE of the raw MATERIALS refers to the difference between the standard cost and the actual cost of the materials.

In other SITUATIONS we define a product's selling price as: product costs + expenses + profit.

As these two examples indicate, there can be different MEANINGS for the terms cost and price.

Some people use cost and price interchangeably. Others use the term cost to mean one component of a product's selling price. Even the same person might use the terms differently.

For example, in standard costing the price variance of the raw materials refers to the difference between the standard cost and the actual cost of the materials.

In other situations we define a product's selling price as: product costs + expenses + profit.

As these two examples indicate, there can be different meanings for the terms cost and price.

Direct materials are the traceable matter used in manufacturing a product. The direct materials for a MANUFACTURER of dessert products will include flour, sugar, eggs, milk, vegetable oil, spices, and other ingredients in the recipes. In manufacturing, the direct materials are listed in each product's bill of materials. (Indirect materials such as oil for greasing the baking pans, etc. will likely be viewed as part of the manufacturing supplies and will be ALLOCATED to products along with other manufacturing overhead.)

The direct materials contained in manufactured products are also defined as:

• a product cost (along with the costs of the direct labor and manufacturing overhead)
• an inventoriable cost (along with the costs of direct labor and manufacturing overhead)
• a prime cost (along with the cost of direct labor) The costs of direct materials should be reported in the FINANCIAL statements according to their location or position:
• if not yet PUT into production, report as raw materials inventory on the balance sheet
• if put into production but the goods are not completed, report as part of the cost of work-in-process inventory on the balance sheet
• if put into production and the goods are completed but not yet sold, report as part of the cost of the finished goods inventory on the balance sheet
• if put into production and the goods have been completed and sold, report as part of the cost of goods sold on the income statement

Direct materials are the traceable matter used in manufacturing a product. The direct materials for a manufacturer of dessert products will include flour, sugar, eggs, milk, vegetable oil, spices, and other ingredients in the recipes. In manufacturing, the direct materials are listed in each product's bill of materials. (Indirect materials such as oil for greasing the baking pans, etc. will likely be viewed as part of the manufacturing supplies and will be allocated to products along with other manufacturing overhead.)

The direct materials contained in manufactured products are also defined as:

DIRECT labor refers to the employees and temporary help who work directly on a manufacturer's products. (People working in the production area, but not directly on the products, are referred to as indirect labor.)

The direct labor cost is 1) the cost of the wages and fringe benefits of the direct labor employees and 2) the cost of the temporary help who work directly on the manufacturer's products.

The direct labor cost is also defined as:

• a product cost (along with the costs of the direct materials and manufacturing overhead)
• an inventoriable cost (along with the costs of the direct materials and manufacturing overhead)
• a PRIME cost (along with direct materials)
• a conversion cost (along with manufacturing overhead)

Direct labor refers to the employees and temporary help who work directly on a manufacturer's products. (People working in the production area, but not directly on the products, are referred to as indirect labor.)

The direct labor cost is 1) the cost of the wages and fringe benefits of the direct labor employees and 2) the cost of the temporary help who work directly on the manufacturer's products.

The direct labor cost is also defined as:

A budget usually refers to a department's or a company's projected revenues, COSTS, or expenses. A standard usually refers to a projected amount per UNIT of product, per unit of INPUT (such as direct materials, factory overhead), or per unit of output.

For example, a manufacturer will have budgets for its manufacturing or factory overhead departments. Let's assume that the budgeted manufacturing overhead for the UPCOMING year is expected to be $1,000,000 in order to produce the expected 100,000 identical units of product. The standard cost of manufacturing overhead per unit of product is $10 ($1,000,000 divided by 100,000 units). When the products are not identical, the $1,000,000 of manufacturing overhead MIGHT be divided by the expected number of machine hours required to manufacture the units of product. Assuming it will take 50,000 machine hours, the standard cost of the manufacturing overhead will be $20 per machine hour ($1,000,000 divided by 50,000 machine hours).

A budget usually refers to a department's or a company's projected revenues, costs, or expenses. A standard usually refers to a projected amount per unit of product, per unit of input (such as direct materials, factory overhead), or per unit of output.

For example, a manufacturer will have budgets for its manufacturing or factory overhead departments. Let's assume that the budgeted manufacturing overhead for the upcoming year is expected to be $1,000,000 in order to produce the expected 100,000 identical units of product. The standard cost of manufacturing overhead per unit of product is $10 ($1,000,000 divided by 100,000 units). When the products are not identical, the $1,000,000 of manufacturing overhead might be divided by the expected number of machine hours required to manufacture the units of product. Assuming it will take 50,000 machine hours, the standard cost of the manufacturing overhead will be $20 per machine hour ($1,000,000 divided by 50,000 machine hours).

Generally a cost variance is the difference between a cost's actual amount and its budgeted or planned amount. For example, if a company had actual REPAIRS expense of $950 for MAY but the budgeted amount was $800, the company had a cost variance of $150. Since the actual cost was more than the budgeted amount, the cost variance is said to be unfavorable. When an actual cost is less than the budgeted amount, the cost variance is said to be favorable.

Cost variances are a KEY part of the standard costing system used by many manufacturers. In such a system the cost variances explain the difference between 1) the standard, predetermined and expected costs of the good output, and 2) the actual MANUFACTURING costs incurred. These cost variances send an early signal to MANAGEMENT that the company is experiencing actual costs that are different from the company's plan. Standard costing systems will report a minimum of two cost variances for each of the following manufacturing costs: direct materials, direct labor and manufacturing overhead.

Generally a cost variance is the difference between a cost's actual amount and its budgeted or planned amount. For example, if a company had actual repairs expense of $950 for May but the budgeted amount was $800, the company had a cost variance of $150. Since the actual cost was more than the budgeted amount, the cost variance is said to be unfavorable. When an actual cost is less than the budgeted amount, the cost variance is said to be favorable.

Cost variances are a key part of the standard costing system used by many manufacturers. In such a system the cost variances explain the difference between 1) the standard, predetermined and expected costs of the good output, and 2) the actual manufacturing costs incurred. These cost variances send an early signal to management that the company is experiencing actual costs that are different from the company's plan. Standard costing systems will report a minimum of two cost variances for each of the following manufacturing costs: direct materials, direct labor and manufacturing overhead.

In accounting, relevant range refers to a limited span of volume or activity. To illustrate, let's assume that a manufacturer's monthly production volume is consistently between 10,000 and 13,000 units and between 20,000 and 25,000 machine hours. Within this range of activity it operates smoothly with the same AMOUNT of monthly fixed costs (say $200,000) for SUPERVISORS, rent, depreciation, etc. If the volume were to drop below this range, the company WOULD reduce the number of supervisors, the space rented, etc. so that its total monthly fixed costs would be smaller. If the volume exceeds the range, the company would incur additional fixed costs for more supervisors, space, etc. Hence, this company's relevant range of activity is 10,000 to 13,000 units of product or 20,000 to 25,000 machine hours. It is only in this relevant range that the monthly fixed costs are $200,000.

There are also relevant ranges for VARIABLE costs and selling prices. Volume that is lower and/or higher than the respective relevant range can mean DIFFERENT variable costs per unit and different selling prices per unit.

In short, cost behavior and pricing is complicated. In order to simplify the analysis accountants will often assume that costs and selling prices are linear within the narrow band of activity known as the relevant range.

In accounting, relevant range refers to a limited span of volume or activity. To illustrate, let's assume that a manufacturer's monthly production volume is consistently between 10,000 and 13,000 units and between 20,000 and 25,000 machine hours. Within this range of activity it operates smoothly with the same amount of monthly fixed costs (say $200,000) for supervisors, rent, depreciation, etc. If the volume were to drop below this range, the company would reduce the number of supervisors, the space rented, etc. so that its total monthly fixed costs would be smaller. If the volume exceeds the range, the company would incur additional fixed costs for more supervisors, space, etc. Hence, this company's relevant range of activity is 10,000 to 13,000 units of product or 20,000 to 25,000 machine hours. It is only in this relevant range that the monthly fixed costs are $200,000.

There are also relevant ranges for variable costs and selling prices. Volume that is lower and/or higher than the respective relevant range can mean different variable costs per unit and different selling prices per unit.

In short, cost behavior and pricing is complicated. In order to simplify the analysis accountants will often assume that costs and selling prices are linear within the narrow band of activity known as the relevant range.

Accountants often use negative amounts to indicate an unfavorable variance. For instance, if actual revenues are less than the budgeted revenues, the variance (or difference) will be SHOWN as a negative amount. The reason is that having less revenues than planned is not GOOD. On the other hand, if actual expenses are less than the budgeted amount of expenses, the variance will be shown as a positive amount. The reason is that fewer actual expenses than budgeted is favorable (or good, positive).

Let's illustrate this further with an example. Assume that a company had the following actual amounts in a recent WEEK: revenues $750, expenses $525, net income $225. For the same week, the company had budgeted the following amounts: revenues $900, expenses $700, net income $200. The comparison of actual to budget resulted in the following VARIANCES:

• Revenues variance: unfavorable $150. Presented as (150).
• Expenses variance: favorable $175. Presented as 175.
• Net income variance: favorable $25. Presented as 25.

The net income variance is favorable because the favorable expense variance was $25 greater than the unfavorable revenues variance. The favorable $175 variance exceeded the unfavorable $150 variance resulting in the net variance of $25 favorable.

Our example shows that the positive and negative SIGNS for the variances are logical if you focus is on the company's net income. In other words, ask yourself one of the following questions:

• "Is the difference between the actual and the budgeted amounts good or bad as far as the company's net income?"
• "Is the variance favorable or unfavorable as far as the company's net income?"
• "Does the difference have a positive or negative effect on the company's net income?"

To assist others, it may be helpful to indicate on your report "( ) = an unfavorable effect on net income."

Accountants often use negative amounts to indicate an unfavorable variance. For instance, if actual revenues are less than the budgeted revenues, the variance (or difference) will be shown as a negative amount. The reason is that having less revenues than planned is not good. On the other hand, if actual expenses are less than the budgeted amount of expenses, the variance will be shown as a positive amount. The reason is that fewer actual expenses than budgeted is favorable (or good, positive).

Let's illustrate this further with an example. Assume that a company had the following actual amounts in a recent week: revenues $750, expenses $525, net income $225. For the same week, the company had budgeted the following amounts: revenues $900, expenses $700, net income $200. The comparison of actual to budget resulted in the following variances:

The net income variance is favorable because the favorable expense variance was $25 greater than the unfavorable revenues variance. The favorable $175 variance exceeded the unfavorable $150 variance resulting in the net variance of $25 favorable.

Our example shows that the positive and negative signs for the variances are logical if you focus is on the company's net income. In other words, ask yourself one of the following questions:

To assist others, it may be helpful to indicate on your report "( ) = an unfavorable effect on net income."

In accounting, a variance is the difference between an expected or planned amount and an actual amount. For example, a variance can occur for items contained in a department's expense report. Variance analysis attempts to identify and explain the reasons for the difference between a budgeted amount and an actual amount.

Variance analysis is usually associated with a manufacturer's product costs. In this setting, variance analysis attempts to identify the causes of the differences between a manufacturer's 1) standard costs of the inputs that should have occurred for the actual PRODUCTS it manufactured, and 2) the actual costs of the inputs used for the actual products manufactured.

To illustrate, let's assume that a company manufactured 10,000 units of product (OUTPUT). The company's standards indicate that it should have used $40,000 of materials (an input), but it actually used $48,000 of materials. This unfavorable variance needs to be analyzed. A common variance analysis will divide the $8,000 into a price variance and a quantity variance. The price variance identifies WHETHER the company paid too MUCH for each unit of input. (Perhaps it paid more per pound of the input than it had planned.) The quantity variance identifies whether the company used too much of the input. (Perhaps it used too many pounds of the raw materials for the number of products it manufactured.)

Variance analysis for manufacturing overhead costs is more complicated than the variance analysis for materials. However, the variance analysis of manufacturing overhead costs is very important as manufacturing overhead costs have become a very large percentage of a product's costs.

In accounting, a variance is the difference between an expected or planned amount and an actual amount. For example, a variance can occur for items contained in a department's expense report. Variance analysis attempts to identify and explain the reasons for the difference between a budgeted amount and an actual amount.

Variance analysis is usually associated with a manufacturer's product costs. In this setting, variance analysis attempts to identify the causes of the differences between a manufacturer's 1) standard costs of the inputs that should have occurred for the actual products it manufactured, and 2) the actual costs of the inputs used for the actual products manufactured.

To illustrate, let's assume that a company manufactured 10,000 units of product (output). The company's standards indicate that it should have used $40,000 of materials (an input), but it actually used $48,000 of materials. This unfavorable variance needs to be analyzed. A common variance analysis will divide the $8,000 into a price variance and a quantity variance. The price variance identifies whether the company paid too much for each unit of input. (Perhaps it paid more per pound of the input than it had planned.) The quantity variance identifies whether the company used too much of the input. (Perhaps it used too many pounds of the raw materials for the number of products it manufactured.)

Variance analysis for manufacturing overhead costs is more complicated than the variance analysis for materials. However, the variance analysis of manufacturing overhead costs is very important as manufacturing overhead costs have become a very large percentage of a product's costs.

In accounting, OVERHEAD usually refers to the indirect manufacturing costs. These are the manufacturing costs other than DIRECT materials and direct labor.

The actual overhead refers to the indirect manufacturing costs actually occurring and recorded. These include the manufacturing costs of electricity, gas, water, rent, property tax, production supervisors, depreciation, repairs, maintenance, and more.

The applied overhead refers to the indirect manufacturing costs that have been assigned to the goods MANUFACTURED. Manufacturing overhead is usually applied, assigned, or allocated by using a predetermined annual overhead rate. For EXAMPLE, a manufacturer might estimate that in its upcoming accounting year there will be $2,000,000 of manufacturing overhead and 40,000 machine hours. As a result, this manufacturer sets its predetermined annual overhead rate at $50 per machine hour.

Since the future overhead costs and future number of machine hours were not KNOWN with certainty, and since the actual machine hours will not occur uniformly throughout the year, there will always be a difference between the actual overhead costs incurred and the amount of overhead applied to the manufactured goods. Hopefully, the differences will be minimal at the end of the accounting year.

In accounting, overhead usually refers to the indirect manufacturing costs. These are the manufacturing costs other than direct materials and direct labor.

The actual overhead refers to the indirect manufacturing costs actually occurring and recorded. These include the manufacturing costs of electricity, gas, water, rent, property tax, production supervisors, depreciation, repairs, maintenance, and more.

The applied overhead refers to the indirect manufacturing costs that have been assigned to the goods manufactured. Manufacturing overhead is usually applied, assigned, or allocated by using a predetermined annual overhead rate. For example, a manufacturer might estimate that in its upcoming accounting year there will be $2,000,000 of manufacturing overhead and 40,000 machine hours. As a result, this manufacturer sets its predetermined annual overhead rate at $50 per machine hour.

Since the future overhead costs and future number of machine hours were not known with certainty, and since the actual machine hours will not occur uniformly throughout the year, there will always be a difference between the actual overhead costs incurred and the amount of overhead applied to the manufactured goods. Hopefully, the differences will be minimal at the end of the accounting year.