What is the difference between the actual and standard unit price of an input multiplied by the number of inputs used?

What Is Price Variance in Cost Accounting?

Price variance is the actual unit cost of an item less its standard cost, multiplied by the quantity of actual units purchased. The standard cost of an item is its expected or budgeted cost based on engineering or production data. The variance shows that some costs need to be addressed by management because they are exceeding or not meeting the expected costs.

Key Takeaways:

• Price variance is the actual unit cost of a purchased item, minus its standard cost, multiplied by the quantity of actual units purchased.
• Price variance is a crucial factor in budget preparation.
• A price variance shows that some costs need to be addressed by management because they are exceeding or not meeting the expected costs.

How Price Variance Works in Cost Accounting

Price variance is important for budgeting and planning purposes, particularly when companies are deciding what quantities of items to order. The formula for price variance is:

Price Variance = ( P − Standard Price ) × Q where: P = Actual Price Q = Actual Quantity \begin{aligned} &\text{Price Variance} = ( \text{P} - \text{Standard Price} ) \times \text{Q} \\ &\textbf{where:} \\ &\text{P} = \text{Actual Price} \\ &\text{Q} = \text{Actual Quantity} \\ \end{aligned} ​Price Variance=(P−Standard Price)×Qwhere:P=Actual PriceQ=Actual Quantity​

Based on the equation above, a positive price variance means the actual costs have increased over the standard price, and a negative price variance means the actual costs have decreased over the standard price.

In cost accounting, price variance comes into play when a company is planning its annual budget for the following year. The standard price is the price a company's management team thinks it should pay for an item, which is normally an input for its own product or service. Since the standard price of an item is determined months prior to actually purchasing the item, price variance occurs if the actual price at the time of purchase is higher or lower than the standard price determined in the planning stage of the company's annual budget.

The most common example of price variance occurs when there is a change in the number of units required to be purchased. For example, at the beginning of the year, when a company is planning for Q4, it forecasts it needs 10,000 units of an item at a price of $5.50. Since it is purchasing 10,000 units, it receives a discount of 10%, bringing the per unit cost down to $5. When the company gets to Q4, however, if it only needs 8,000 units of that item, the company will not receive the 10% discount it initially planned, which brings the per unit cost to $5.50 and the price variance to 50 cents per unit.

Achieving a Favorable Price Variance

A company might achieve a favorable price variance by buying goods in bulk or large quantities, but this strategy brings the risk of excess inventory. Buying smaller quantities is also risky because the company may run out of supplies, which can lead to an unfavorable price variance. Businesses must plan carefully using data to effectively its price variances.

What is the Direct Material Variance?

The direct material variance is the difference between the standard cost of materials resulting from production activities and the actual costs incurred. The direct material variance is comprised of two other variances, which are noted below. It is customary to calculate and report these two variances separately, so that management can determine if variances are caused by purchasing issues or manufacturing problems.

Purchase Price Variance

The purchase price variance is the difference between the standard and actual cost per unit of the direct materials purchased, multiplied by the standard number of units expected to be used in the production process. This variance is the responsibility of the purchasing department.

Material Yield Variance

The material yield variance is the difference between the standard and actual number of units used in the production process, multiplied by the standard cost per unit. This variance is the responsibility of the production department.

Accounting for the Direct Material Variance

The direct material variance is usually charged to the cost of goods sold in the period incurred.

Example of the Direct Material Variance

ABC International produces 1,000 green widgets and records an unfavorable direct material variance of $700. Further investigation reveals that the cost to purchase the various components was $3.50 per unit, versus a budgeted amount of $4.00 per unit. This represents a favorable purchase price variance of $500, which is calculated as:

($3.50 actual cost - $4.00 standard cost) x 1,000 standard units

In addition, ABC finds that the purchase price was so low because the raw materials were of unusually low quality, resulting in a great deal of scrap during the manufacturing process. As a result, the company used 1,300 units of raw material to produce 1,000 finished units. This represents an unfavorable material yield variance of $1,200, which is calculated as:

(1,300 actual units - 1,000 standard units) x $4.00 standard cost

Thus, by delving into the two types of variances, it is apparent that the purchasing manager of ABC is at fault; he saved money by purchasing raw materials of excessively low quality, and it resulted in a large unfavorable variance when units were scrapped during production.

Terms Similar to Direct Material Variance

The direct material variance is also known as the direct material total variance.

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