Accounting for Variances

Recall that a difference between the PO unit price and the invoice price is referred to as a variance. The invoice unit price can differ from the PO unit price for the following reasons:

A variance is recognized at the time of payment, rather than when the invoice is entered in the system, because the NCAS operates on a cash basis. Since payment is often made a month or more after receipt, the adjustment for price variance often occurs after incorrectly valued inventory has been issued to customers.

When a variance occurs, the GL Inventory asset account and the system-maintained inventory value will not reflect the invoiced value because the Inventory asset account was debited at the time of receipt before the variance was known. Therefore, the NCAS generates an adjusting entry to reflect that variance in the Inventory asset account. Depending on whether the price variance is positive or negative, the adjustment to the Inventory account (event ID A010) may be either a debit or a credit with a corresponding offset entry to the Reserve for Inventory account (event ID A020).

The NCAS also automatically adjusts the average cost of the item to reflect the variance. The adjustment is applied to the quantity remaining in inventory at the time of the variance, not to the quantity originally received. Applying the variance to quantity remaining in inventory can result in temporarily high or low average costs. The item is now billed out at the adjusted average cost.

The NCAS calculates the new average cost as follows:

New Average = (Current Avg Cost Quantity Remaining in Inventory) + (Total Variance)
Cost                                          Quantity Remaining in Inventory

The accounting entry for price variance and the average cost adjustment are made during the nightly offline cycle on the payment date. Because the actual variance is not passed to the GL as a separate variance entry, there is no report that shows variance entries. The new average cost calculation is also shown on the Average Cost Changes due to AP Variances (CVARFIX) report.

The Average Cost Changes due to AP Variances (CVARFIX) is located in RMDS in the report group IN285-2. For more information on accessing RMDS reports, refer to Viewing and Printing RMDS Reports Step-by-Step.

For example, 30 days after the burn ointment was received, the vendor was paid $16.80 for eight tubes of antiseptic burn ointment. (The vendor was paid at the rate of the invoice unit price of $2.10 per tube.) The total variance is $0.80 ($0.10 per tube multiplied by eight tubes).

The following entry is generated for the payment to the vendor:
Purchases for Resale (XXMEDICAL)
In addition to the payment entry, the following variance entry is also generated to adjust the value of the Inventory asset account:
Inventory (XXMEDICAL)
Reserve for Inventory (XXMEDICAL)
The average cost of the burn ointment is adjusted for the variance. There are only four tubes remaining in inventory because four tubes have already been issued to a customer. The $0.80 variance is used to calculate the new average cost as follows:

New Average Cost     =     (Current Avg Cost Qty Remaining in Inventory) + (Total Variance)
                                  &nbs p;                             Quantity Remaining in Inventory

                                =                     ($2.00 4 tubes) + ($0.80)
                                  &nbs p;                                     4 tubes

                                =                             ($8.00) + ($0.80)
                                  &nbs p;                                   4 tubes

                                =                                     ($8.80)
                                  &nbs p;                                    4 tubes

                                =                             $2.20 per tube

The remaining four tubes will now be issued to the customer at the new average cost of $2.20 per tube.

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