Manufacturing Variances Defined & Explained
Manufacturing companies usually have a business goal of increasing the company’s revenue and improving profit margins. To accomplish this a company needs to understand their manufacturing costs and how to manage and improve costs. The cause and effect of costing and manufacturing related processes usually will cause variances. Understanding these variances really starts with understanding what are the variances that are created and the cause of these variances.
If your company is manufacturing a product, you’re more than likely creating manufacturing variances. These variances tell managers where the company is not performing to the standards that were created and agreed to by those responsible in the Engineering, Finance, or Production Departments. There is almost a 100% chance you are creating either favorable or unfavorable manufacturing variances and, quite frankly, none of the variances will ever be favorable because the company is either over-costing or under-costing the production parts.
Let’s review a few of the manufacturing variances and their cause:
Method Variance: The accounting close functions zero out Work in Process (WIP), and then calculates and posts any variance amounts. Any amount remaining in WIP after material, labor, burden, and subcontract rate and usage variance amounts are calculated is posted to Method Variance.
What causes Method Variance:
- Change in Product Structure.
- Change in Routing.
- Use of alternate Product Structures.
- Use of alternate Routings.
- Use of substitute items.
- Non-standard quantity issued to floor stock.
- Costs input in Material This level for manufactured items.
- WIP revaluation not performed after component item costs have changed.
- Work Orders are closed before the changes in Product Structure or Routing take effect.
- The default Work Center in a Backflush Transaction is changed.
- Cumulative Order was created prior to rolling up costs.
Note: A Cumulative Order is essentially a tally sheet of all the costs that go into production. In order to calculate variance of any kind it will compare Standard to Actual Cost. To do this the system takes a snapshot of costs at the time the Cumulative Order is created. If any changes are made to the costs while the Cumulative Order is Active, it is advised to Expire the Order after the costs are changed and before production is next reported to avoid variances of any kind.
Transfer Variance: Inventory activity typically occurs at the site where orders are processed. However, in a multi-site environment, you can ship, receive, or issue inventory from a different site. If the other site has different costs for the item, a variance occurs.
Material Usage Variance: When you issue components to a work order, material costs post to work in process (WIP) as the quantity issued multiplied by the GL cost. When the work order is closed, usage variance can be calculated. Usage variance is calculated as the difference between the actual quantity of each component issued and the standard quantity required, multiplied by the GL cost of that component.
Material Rate Variance: When you issue components to a work order, material costs post to Work in Process (WIP) as the quantity issued multiplied by the GL cost of the material. At the same time, any rate variance is calculated and posted.
Rate variance reflects differences in cost caused by using substitute items or items issued at a different cost (from a different site). It is calculated as the difference between the GL cost of the materials actually used and the GL cost of the material required. When using work orders, the GL cost of each component is copied into the work order bill at the time the work order is released. If costs change, a material rate variance results.
Labor Usage and Labor Rate Variances: When labor is reported in Repetitive and Shop Floor Control, actual labor costs are posted as a credit to the Labor absorption account. The posted amount is calculated as:
Actual hours reported * employee’s actual pay rate
Overtime and shift differential are included if reported. If the employee pay rate is not available, the setup and labor rates at that work center are used.
When the manufacturing order is closed, both labor rate and usage variances can be calculated.
- Rate variance is the difference in labor costs due to the difference between the employee’s actual pay rate, including overtime and shift differential (if reported), and the standard setup and labor rates at the work center. Rate variance can only be calculated if the employee’s actual rate is stored in the employee master file.
- Usage variance is the difference in labor costs due to the difference between the actual hours reported and the standard hours earned (often called an efficiency variance).
Burden Usage and Burden Rate Variances: When labor is reported in Repetitive and Shop Floor Control, actual labor burden costs are posted to the Burden absorption account using the burden rates at the work center reported.
Actual burden cost is calculated as:
- The actual hours reported multiplied by the machine burden rate
- Plus the actual hours reported multiplied by the labor burden rate
- Plus the actual labor cost multiplied by labor burden percentage
When the manufacturing order is closed, both burden rate and usage variances can be calculated.
- Rate variance is the difference in burden costs due to the difference between the employee’s actual pay rate including overtime and shift differential (if reported) and the standard labor rate at the work center reported.
- Usage variance is the difference in burden costs due to the difference between the actual hours reported and the standard hours earned (often called an efficiency variance).
Subcontract Usage and Subcontract Rate Variances: When purchase orders are recorded for subcontract operations, the purchase order receipt posts the standard subcontract cost to Work in Process (WIP) and the actual subcontract expense amount to the PO Receipts accrual account. Any variance is posted as a rate variance. When the work order is closed, a usage variance is calculated.
Rate variance is posted as the difference between the purchase order cost and the standard subcontract cost.
Usage variance is an efficiency variance, calculated as the difference between the subcontracted quantities received and the standard subcontract quantity needed to make this work order quantity complete (received or rejected).
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