10.2 Integrated Ledgers with Under- and Over-Absorption and Standard Cost Variances
Key Takeaways
Under-absorbed overhead is debited to the statement of profit or loss and credited to the production overhead control account; over-absorbed overhead is the reverse.
In a standard costing ledger, inventories are held at standard cost and each variance is recorded in a separate variance account where it arises.
Adverse variances are debit balances and favourable variances are credit balances; at the period end they are transferred to the statement of profit or loss.
The material price variance is usually recorded when materials are purchased, and the usage variance when materials are issued to work-in-progress.
Labour rate variance arises in the wages control account, while labour efficiency variance arises when standard hours for actual output are charged to work-in-progress.
Why this topic is examined
Syllabus area C4(b) asks you to prepare a set of integrated accounts, showing standard cost variances, including "accounting for over and under absorption of production overhead" and "the treatment of variances in integrated ledger systems". Questions usually ask for the double entry for a particular variance or for the balance transferred to the statement of profit or loss. Section 10.1 introduced the control accounts; this section adds absorption adjustments and variances.
Recording under- and over-absorbed overhead
Production overhead is charged to WIP at a predetermined rate (Section 3.2), so at the period end the production overhead control account usually has a balance:
| Situation | Balance on overhead control account | Entry to clear it | Effect on profit |
|---|---|---|---|
| Under-absorbed (absorbed < actual) | Debit balance | Debit statement of profit or loss; credit production overhead control | Reduces profit |
| Over-absorbed (absorbed > actual) | Credit balance | Debit production overhead control; credit statement of profit or loss | Increases profit |
Tip
Picture the overhead control account: actual overhead is debited, absorbed overhead is credited. If more was spent than absorbed, the debit side is bigger; clear it with a credit and send the debit to profit or loss as an extra cost.
Standard costing in the ledger: the principles
In a standard costing system:
- Inventories are carried at standard cost. Raw materials are held at standard price, and WIP and finished goods at the standard cost of the units they contain.
- Each variance is recorded in its own variance account, at the point where it arises.
- Adverse variances are debits (extra cost); favourable variances are credits (cost saving).
- At the end of the period, variance accounts are transferred to the statement of profit or loss, so actual profit equals standard profit adjusted for variances.
| Variance | Where it arises | Entry if adverse |
|---|---|---|
| Material price (recorded at purchase) | Raw materials control | Debit material price variance; credit payables |
| Material usage | Issue of materials to WIP | Debit material usage variance; credit raw materials control |
| Labour rate | Wages control | Debit labour rate variance; credit wages control |
| Labour efficiency | Charging labour to WIP | Debit labour efficiency variance; credit wages control |
| Overhead expenditure | Overhead control | Debit expenditure variance; credit overhead control |
| Fixed overhead volume (absorption costing) | Overhead control | Debit volume variance; credit overhead control |
For a favourable variance, reverse the entry: credit the variance account.
Worked example: Merlin Ltd, April
Standard cost card (per unit)
| Element | Standard | $ |
|---|---|---|
| Direct materials | 4 kg at $5 | 20 |
| Direct labour | 2 hours at $12 | 24 |
| Fixed production overhead | 2 hours at $8 | 16 |
| Standard production cost | 60 |
Budgeted production is 1,000 units, so budgeted fixed overhead is $16,000.
Actual results for April
- Production: 1,100 units (no opening or closing WIP).
- Materials bought on credit: 5,000 kg for $24,000 ($4.80 per kg). Materials used: 4,500 kg.
- Labour: 2,300 hours paid at $12.50 = $28,750.
- Fixed production overhead incurred: $17,000.
Step 1: calculate the variances
| Variance | Calculation | $ |
|---|---|---|
| Material price (at purchase) | ($5.00 − $4.80) × 5,000 kg | 1,000 F |
| Material usage | (4,400 kg − 4,500 kg) × $5 | 500 A |
| Labour rate | ($12.00 − $12.50) × 2,300 hours | 1,150 A |
| Labour efficiency | (2,200 hours − 2,300 hours) × $12 | 1,200 A |
| Fixed overhead expenditure | $16,000 − $17,000 | 1,000 A |
| Fixed overhead volume | (1,100 − 1,000 units) × $16 | 1,600 F |
(Standard quantity for actual output is 1,100 × 4 kg = 4,400 kg; standard hours are 1,100 × 2 = 2,200.)
Step 2: record the entries
Raw materials control (at standard price)
| Debit | $ | Credit | $ |
|---|---|---|---|
| Payables: 5,000 kg at standard $5 | 25,000 | WIP: 4,400 kg at $5 | 22,000 |
| Material usage variance | 500 | ||
| Closing balance: 500 kg at $5 | 2,500 | ||
| Total | 25,000 | Total | 25,000 |
The purchase is recorded as: debit raw materials $25,000 (standard), credit payables $24,000 (actual), credit material price variance $1,000 (favourable).
Wages control
| Debit | $ | Credit | $ |
|---|---|---|---|
| Bank: actual wages | 28,750 | WIP: 2,200 standard hours at $12 | 26,400 |
| Labour rate variance | 1,150 | ||
| Labour efficiency variance | 1,200 | ||
| Total | 28,750 | Total | 28,750 |
Fixed production overhead control
| Debit | $ | Credit | $ |
|---|---|---|---|
| Bank: actual overhead | 17,000 | WIP: 1,100 units at $16 absorbed | 17,600 |
| Fixed overhead volume variance | 1,600 | Fixed overhead expenditure variance | 1,000 |
| Total | 18,600 | Total | 18,600 |
Overhead was over-absorbed by $600 ($17,600 absorbed − $17,000 actual). In a standard costing system, that $600 is analysed as a $1,600 favourable volume variance and a $1,000 adverse expenditure variance.
Work-in-progress control
| Debit | $ | Credit | $ |
|---|---|---|---|
| Materials at standard | 22,000 | Finished goods: 1,100 units at $60 | 66,000 |
| Labour at standard | 26,400 | ||
| Overhead absorbed at standard | 17,600 | ||
| Total | 66,000 | Total | 66,000 |
Because WIP is charged with standard cost for actual output, the transfer to finished goods is simply units × standard cost.
Step 3: clear the variance accounts
| Variance account | Debit (adverse), $ | Credit (favourable), $ |
|---|---|---|
| Material price | 1,000 | |
| Material usage | 500 | |
| Labour rate | 1,150 | |
| Labour efficiency | 1,200 | |
| Fixed overhead expenditure | 1,000 | |
| Fixed overhead volume | 1,600 | |
| Totals | 3,850 | 2,600 |
The net adverse $1,250 is transferred to the statement of profit or loss, reducing standard profit to actual profit.
Marginal costing ledgers
If the business uses standard marginal costing (the format of BA2's operating statement in Section 8.1), fixed production overhead is not absorbed into WIP. The actual fixed overhead is charged to the statement of profit or loss in full, and the only fixed overhead variance recorded is the expenditure variance. There is no volume variance and no under- or over-absorption.
Important
Common exam traps: (1) recording the material price variance on the quantity used when the question says it is recorded at purchase; (2) charging WIP with actual hours or quantities instead of standard hours or quantities for actual output; (3) crediting an adverse variance account. Adverse variances are always debits.
At the end of a period, production overhead has been over-absorbed by $7,500. What entry clears the production overhead control account?
Debit statement of profit or loss $7,500; credit production overhead control $7,500
Debit production overhead control $7,500; credit statement of profit or loss $7,500
Debit work-in-progress $7,500; credit production overhead control $7,500
Debit production overhead control $7,500; credit finished goods $7,500
Raw materials are held at standard cost. A company buys 2,000 kg of material on credit for $9,400; the standard price is $4.50 per kg. What entries record the purchase?
Debit raw materials $9,400; credit payables $9,400
Debit raw materials $9,000; debit material price variance $400; credit payables $9,400
Debit raw materials $9,400; credit payables $9,000; credit material price variance $400
Debit raw materials $9,000; credit material price variance $400; credit payables $8,600
In a standard costing system, which amount is debited to work-in-progress for direct labour?
Actual hours paid × actual rate
Actual hours worked × standard rate
Standard hours for actual output × standard rate
Budgeted hours × actual rate
Sections you finish are checked off in the contents.