Direct Materials Price Variance


Direct Materials Price Variance:

Learning Objective of the articles:

  1. Define and explain “direct materials price variance” and its significance.
  2. How is it calculated? How direct materials price variance is interpreted?
  3. What are the reasons / causes of unfavorable or favorable materials price variance?

Contents:

  1. Definition and explanation of direct materials price variance
  2. Formula
  3. Example
  4. Isolation of variance
  5. Who is responsible for direct materials price variance?
  6. Exercises

Definition and Explanation of Direct Materials Price Variance:

Direct materials price variance is the difference between the actual purchase price and standard purchase price of materials. Direct materials price variance is calculated either at the time of purchase of direct materials or at the time when the direct materials are used. When this variance is computed at the time of purchase of materials it is called direct materials purchase price variance. When this variance is computed at the time of usage this is typically called direct materials price usage variance.

Direct materials price variance formula:

Following formula is used to calculate materials price variance:

[Materials Price Variance = (Actual quantity purchased × Actual price) − (Actual quantity purchased × Standard price)]

This formula is usually preferred and used by managers because it permits calculation of materials purchase price variance very quickly.

Example:

Colonial Pewter Company provides the following information:

Standard price of material is $4.00 per pond and 6,500 pounds of materials have bee purchased at a cost of $3.80 per pound. This cost figure includes freight and handling and is net of quantity discount. All the materials purchased has been used and an output of 2000 units is produced during the period.

Required: Calculate materials price variance.

Calculation of direct materials price variance:

= (6,500 pounds × $3.80) − (6,500 pounds × $4.00)

= $24,700  − $26,000

= $1,300 Favorable

A favorable material price variance of $1,300 exists because the actual price of materials purchased is less than the standard price of materials purchased. A material price variance is called unfavorable materials price variance if the actual price of materials purchased is more than the standard price of materials purchased.

Variance analysis reports are often issued in a tabular format. An example of such a variance report follows along with an explanation for the materials price variance that has been calculated above for Colonial Pewter Company.

Colonial Pewter Company
Performance Report – Purchasing Department

Item Purchased Quantity Purchased Actual Price Standard Price Difference in Price Total Price Variance Explanation
1 2 3 4 5 Bargained for an especially good price
(2) – (3) (1) × (4)
Pewter 6,500 pounds $3.80 $4.00 $0.20 $1,300Favorable

Most companies compute materials price variance when the materials are purchased than they are used in production. There are two reasons for this practice. First, delaying the computation of the price variance until the materials used would result in less timely variance report. Second, by computing the price variance when the materials are purchased, the materials are carried in the inventory accounts at their standard costs. This greatly simplifies book keeping. When the materials price variance is computed at the time of purchase of materials it is typically called materials purchase price variance.

Isolation of Variances:

At what point should variances be isolated and brought to the attention of management? the answer is, the earlier the better. The sooner deviations from standard are brought to the attention of management, the sooner problems can be evaluated and corrected. Once the performance report has been prepared, what does management do with the price variance data? The most significant variances should be viewed as “red flags,” calling attention to the fact that an exception has occurred that will require some explanation and perhaps follow-up effort. Normally, the performance report itself will contain some explanation of the reason for the variance, as shown above, In the case of Colonial Pewter Company, the purchasing department explained that favorable price variance resulted from bargaining for an especially good price.

Who is Responsible for Material Price Variance?

Generally speaking, the purchase manager has control over the price paid for goods and is therefore responsible for any price variation. Many factors influence the price paid for the goods, including number of units ordered in a lot, how the order is delivered, and the quality of materials purchased. A deviation in any of these factors from what was assumed when the standards were set can result in price variance. For example purchase of second grade materials rather than top-grade materials may be a reason of favorable price variance, since the lower grade material will generally be less costly but perhaps less suitable for production and can be a reason of unfavorable materials quantity variance.

However, someone other than purchasing manager could be responsible for materials price variance. For example, production is scheduled in such a way that the purchasing manager must request express delivery. In this situation the production manager should be held responsible for the resulting price variance.

Exercises:

Exercise 1: Materials Variance Analysis
The Schlosser Lawn Furniture Company uses 12 meters of aluminum pipe at $0.80 per meter as standard for the production of its Type A lawn chair. During one month’s operations, 100,000 meters of the pipe were purchased at $0.78 a meter, and 7,200 chairs were produced using 87,300 meters of pipe. The materials price variance is recognized when materials are purchased. Calculate materials price variance.

Solution:

Meters of pipe Unit Cost Amount
Actual quantity purchased 100,000 $0.78 actual $78,000
actual quantity purchased 100,000 $0.80 standard $80,000
——— ——— ———
Materials purchase price variance 100,000 $(0.02) $(2,000) fav.
======= ======= =======

Exercise 2: Materials Variance Analysis
The standard price for material 3-291 is $3.65 per liter. During November, 2,000 liters were purchased at $3.60 per liter. The quantity of material 3-291 issued during the month was 1775 liters and the quantity allowed for November production was 1,825 liters. Calculate materials price variance, assuming that:

  1. It is recorded at the time of purchase (Materials purchase price variance).
  2. It is recorded at the time of issue (Materials price usage variance).

Solution:

Liters Unit cost Amount
Actual quantity purchased 2,000 3.60 actual $7,200
Actual quantity purchased 2,000 3.65 standard 7,300
——— ———- ———
Materials purchase price variance 2,000 $ (0.05) $(100) fav.
====== ====== ======
Actual quantity used 1775 3.60 actual $6390.00
Actual quantity used 1775 3.65 standard $6478.75
——— ——— ———
Materials price usage variance 1775 $(0.05) (88.75)
====== ====== =======

You may also be interested in other articles from “standard costing and variance analysis” chapter

  1. Standard Costs and Management By Exception
  2. Setting Standard Costs – Ideal Versus Practical Standards
  3. Direct Materials Price and Quantity Standards
  4. Direct Materials Price Variance
  5. Direct Materials Quantity Variance
  6. Direct Labor Rate and Efficiency Standards
  7. Direct Labor Rate/Price Variance
  8. Direct Labor Efficiency | Usage | Quantity Variance
  9. Manufacturing Overhead Standards
  10. Overall or net factory overhead variance.
  11. Controllable variance
  12. Volume variance
  13. Spending variance
  14. Idle capacity variance
  15. Efficiency variance
  16. Spending variance
  17. Variable efficiency variance
  18. Fixed efficiency variance
  19. Idle capacity variance
  20. Mix and Yield Variance – Definition and Explanation
  21. Materials Mix and Yield Variance
  22. Labor Yield Variance
  23. Factory Overhead Yield variance
  24. Variance Analysis and Management By Exception
  25. Managerial importance and usefulness of variance analysis
  26. Advantages and Disadvantages of Standard Costing System
  27. Standard Costing Discussion Questions and Answers
  28. Standard Costing and Variance Analysis Formulas
  29. Standard Costing and Variance Analysis Problems and Solution
  30. Standard Costing and Variance Analysis Case Study

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