As a professor teaching cost accounting from books that use this definition, students often ask exactly this question. Since unfavorable variances reduce Net Income, it seems consistent for these variances to be negative. They are income decreasing, and negative numbers are how we indicate decreases.
Defining positive and negative for many accounting concepts is somewhat arbitrary. If a company recognizes a new expense, should that be positive because the magnitude of the expense increases or negative because retained earnings and stockholders' equity decrease? Both sides have reasonable arguments backing them, and some students in every class will form mental models based on each of these conceptions.
A more consistent framework is thinking about debits and credits in a double-entry bookkeeping system, as Janina points out. If we accept the natural balances for different account types, then whether the amount recognized as an expense is positive or negative, recording the journal entry requires a debit to the expense. The debit increases the debit balance of the T-account for the expense and, after closing, reduces the credits closed to retained earnings. Debiting the expense has the effect of being positive for the expense and negative for retained earnings. By using debits and credits, we can sidestep individuals' interpretations of the numbers on a number line. It doesn't particularly matter how students conceptualize expenses as integers as long as they recognize they need to debit the expense. In fact, on exams, I changed to exclusively asking for journal entries to recognize the variances rather than asking for a number for the variance. Students could calculate variances closed to expenses using Actual - Standard or Standard - Actual, as long as their journal entries debited unfavorable variances.
Switching the terms in the parentheses is not an idea from out-of-left-field and would help a subset of my students understand variances better. However, it is not how the earliest versions of the textbooks introduced things, so it did not become the standard and an attempt to change the currently accepted version would require a discussion similar to this one that many students would find abstruse and really be for any reviewers or editors and likely relegated to a footnote. It is much easier simply to replicate commonly accepted practice and present the formulas as they have traditionally been calculated.
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Joshua Anderson
Academic
Chicago IL
United States
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Original Message:
Sent: 02-28-2024 09:40 AM
From: Douglas Woikey
Subject: Labor and Material Variances
I know this might be an elementary question but I have a question on labor and material variances.
From what I have seen of most textbooks, labor and material price and efficiency variances are calculated as follows:
Price Variance = Actual Quantity * (Actual Price - Standard Price)
Efficiency Variance = Standard Price * (Actual Quantity - Standard Quantity)
In both of these cases, a positive number is an unfavorable variance while a negative number is a favorable variance.
I feel it is more intuitive by reversing the terms in the parentheticals--for example Price Variance would be (Standard Price - Actual Price) * Actual Quantity. Has anyone seen this way of calculation in reference materials?
Doug Woikey CMA