Problem 20 - Accounting

Question

Orion Manufacturing Company incorporates standards in its accounts and identifies variances at the time the manufacturing costs are incurred. Journalize the entries to record the following transactions: a. Purchased 1,700 units of copper tubing on account at \(54.50 per unit. The standard price is \)56.00 per unit. b. Used 1,000 units of copper tubing in the process of manufacturing 120 air conditioners. Eight units of copper tubing are required, at standard, to produce one air conditioner.

Step-by-Step Solution

Answer

The journal entries reflect a favorable material price variance of \$2,550 and an unfavorable quantity variance of \$2,240 due to excess copper tubing used.

Step 1: Determine Price Variance for Purchase

Calculate the price variance by subtracting the actual price per unit from the standard price per unit and multiplying by the number of units purchased. The formula is: \( (54.50 - 56.00) \times 1700 = -2550 \). This indicates a favorable variance of \$2,550.

Step 2: Journalize Purchase Transaction

Record the journal entry to account for the purchase cost and price variance. The entry is: - Debit: Raw Materials Inventory (at standard): \(56.00 \times 1700 = 95200\)- Credit: Accounts Payable (at actual): \(54.50 \times 1700 = 92650\)- Credit: Materials Price Variance: \(2550\) (indicating favorable variance)

Step 3: Calculate Quantity of Tubing Used

Determine how much tubing was actually used by calculating the excess tubing used over the standard amount. With 1,000 units used for 120 air conditioners, where 960 is the standard (\(8 \times 120 = 960\)), the excess used is 40 units.

Step 4: Journalize Usage Transaction

Record the journal entry for the usage of materials, accounting for the excess usage variance. This requires:- Debit: Work In Process Inventory (standard usage): \(8 \times 56 \times 120 = 53760\)- Debit: Materials Quantity Variance (excess used): \(40 \times 56 = 2240\)- Credit: Raw Materials Inventory (actual usage): \(1000 \times 56 = 56000\)

Key Concepts

Price Variance

Price variance is a key concept in standard costing. It represents the difference between the actual cost and the standard cost of materials. A positive number indicates a favorable variance, meaning the actual cost is lower than the standard cost.

To calculate price variance, you subtract the actual price per unit from the standard price per unit. Multiply the result by the number of units purchased. In our example, the calculation is: \[ (54.50 - 56.00) \times 1700 = -2550 \]This example shows a favorable variance of $2,550, as the company's purchase price was lower than the expected standard cost.

Understanding price variances helps businesses control costs and improve purchasing decisions. Companies strive to achieve favorable variances by negotiating better prices or maintaining preferred supplier relationships.

Journal Entries

Journal entries are essential for recording financial transactions according to accounting standards. They consist of debits and credits to different accounts. Each transaction affects at least two accounts in the ledger.

For the purchase of copper tubing, the journal entry reflects the standard cost and actual cost:

• The **Raw Materials Inventory** account is debited by the standard cost, calculated as \( 56.00 \times 1700 = 95200 \).
• The **Accounts Payable** is credited for the actual amount paid, \( 54.50 \times 1700 = 92650 \).
• A **Materials Price Variance** account is credited due to the favorable price variance of $2,550.

This protocol ensures accurate cost tracking and budgeting.

Recording journal entries correctly is vital for financial reporting and analysis, providing insights into cost management and efficiency.

Raw Materials Inventory

Raw materials inventory accounts hold the cost of the raw materials that haven’t yet been used in production. They play a critical role in manufacturing processes, ensuring that materials are available when needed.

Upon purchasing materials, they are added to the raw materials inventory at the standard cost. For example, copper tubing purchased at a standard cost of \(56.00\) per unit, results in a journal entry debiting raw materials inventory by \(95200\) for the 1700 units.

Understanding the status of raw materials inventory helps avoid production delays and unexpected purchasing costs. Accurate inventory management leads to efficient production cycles and cost savings.

Work In Process Inventory

Work In Process (WIP) Inventory tracks the costs associated with products that are in the manufacturing process but are not yet complete. This includes raw materials, labor, and overhead absorbed into partially finished products.

When raw materials move from inventory to production, they're recorded as debits in the WIP Inventory. For the copper tubing usage, the calculated standard usage is:

• **Standard cost:** \( 8 \times 56 \times 120 = 53760 \)
• The actual cost recorded in the Raw Materials Inventory is \( 1000 \times 56 = 56000 \), showing an excess of 40 units.

Accounting for materials through WIP Inventory helps in precisely allocating costs, managing budgets, and determining production efficiency levels. This monitoring can enhance process improvements and production schedules.