In a standard cost system the materials price variance is obtained by multiplying the

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.

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Expectations don’t always line up with reality. When your manufacturing business uses more or less material than expected, quantify it with the materials quantity variance.

Reality doesn’t always line up with expectations. Think back to the last Big Mac you saw on a McDonald’s commercial and the last Big Mac you saw in person, and you’ll know what I mean.

Businesses calculate variances to understand the difference between estimated and actual total manufacturing costs.

Overview: What is a materials quantity variance?

A materials quantity variance compares the actual and expected direct material used in manufacturing a product. You have an unfavorable materials quantity variance when you use more material than expected. It’s favorable when you use less material than planned.

Direct materials are the building blocks of the production process. With the help of machinery and other equipment, workers create finished goods that once started as raw materials. If your business makes fancy bow ties, the direct material is silk, for instance.

The materials quantity variance is one of several cost accounting metrics that manufacturers review to measure manufacturing efficiency. Keeping an eye on variances helps manufacturers identify and remedy issues as they crop up. It also sharpens the accuracy of future production budgets.

Accountants communicate in dollars and cents, so the materials quantity variance is expressed as a dollar amount. To find the materials quantity variance, use the following formula:

Materials Quantity Variance = (Standard Quantity Units – Actual Quantity Units ) ✕ Standard Cost Per Unit

The standard cost is the amount your business expected to pay for each unit of raw material. We’ll discuss this in detail later, but companies that use the standard costing system to value their inventory correct their inventory account balances with the materials quantity variance.

3 common causes of materials quantity variance

You’re most likely to run into an unfavorable materials quantity variance because of one of the following issues.

1. Abnormal spoilage

Don't expect 100% of your raw materials to end up in the final product. Some spoilage -- the loss of raw materials in the manufacturing process -- is normal and acceptable. Excessive loss of raw materials during production, called abnormal spoilage, is cause for concern, however.

Abnormal spoilage increases the amount of raw material consumed in manufacturing, creating an unfavorable materials quantity variance. Low-quality raw materials, broken machinery, and inadequately trained workers may be to blame for abnormal spoilage.

Say you’re a professional baker who’s famous for your delectable peach cobbler. You expect about 5% of the peaches you order from a local farm to go bad between purchasing and baking day. When 20% of your peaches go rotten, you’re facing abnormal spoilage.

Your materials quantity variance will increase because you’ll have to buy more peaches to make the same number of cobblers.

2. Inadequately trained workers

A material quantity variance points to a lack of efficiency during the manufacturing process. If it’s not because of defective materials, look into how your factory workers are trained. Factory workers who receive insufficient training won’t work at maximum efficiency, wasting more material than is necessary for production.

3. Inaccurate standard material quantity

Don’t immediately blame inferior raw materials or your factory workers for an unfavorable materials quantity variance. When you calculate the variance, you’re comparing actual material usage to what you expected. It could be that the expectation you created in the product development process is askew.

How to calculate materials quantity variance

Find the materials quantity variance by multiplying the standard cost by the difference between the standard and actual quantities.

Materials Quantity Variance = (Standard Quantity Units – Actual Quantity Units ) ✕ Standard Cost Per Unit

Let’s find the materials quantity variance for the prime ingredient in your bakery’s carrot cakes: carrots.

1. Estimate the standard material quantity

Before you start production, estimate the amount of direct material used in one product or manufacturing run.

Businesses that use the standard costing system to value inventory need to estimate standard prices and quantities for all direct materials. You’ll use those figures to track the manufacturing process in your accounting software. Direct materials move from raw materials to work in process (WIP) to finished goods as they’re transformed into saleable products.

As raw materials move into production, you record a transfer from the raw materials stage to the WIP stage. When the product is finished, it goes from WIP to finished goods. You use estimated prices and quantities to show the movement on your books.

To make a batch of carrot cakes, you expect to use 60 pounds of carrots. Your standard material quantity is 60 pounds.

2. Determine the actual material quantity

Next, find out how much direct material you used on baking day.

Your pastry chef told you he accidentally dropped a bowl with 15 pounds of carrots. He used a total of 75 pounds of carrots:

60 pounds for cakes + 15 pounds dropped

3. Subtract standard quantity from actual quantity

Take the difference between your standard and actual quantity. For your carrot cake, the difference between the standard and actual quantity is -15 pounds:

60 pounds standard quantity – 75 pounds actual quantity = -15 pounds

When you get a negative difference, you say there’s an unfavorable variance. A positive difference is called a favorable variance. So, your carrots quantity variance is an unfavorable 15 pounds.

While we haven’t finished the calculation, it’s smart to pause here for some analysis. You multiply the difference by the standard cost in the next step, turning the material quantity variance into a dollar amount. If that doesn’t help you understand what went wrong to cause a variance, stop here.

4. Multiply the difference by the standard cost

Finish the materials quantity variance calculation by multiplying the difference of the standard and actual quantities by the standard cost.

The standard cost is the amount your business expected to pay for each unit of direct materials. For example, your bakery might expect to pay its local farm $1 per pound of carrots. Therefore, your materials quantity variance is an unfavorable $15:

15 pounds variance ✕ $1 standard cost per pound = $15

Ignore how much you actually paid for raw materials; we’re just trying to quantify the actual vs. expected quantity. To evaluate the price difference, you’re looking for a different accounting formula called the direct material price variance.

2 best practices for recording materials quantity variances

Follow these tips for recording the materials quantity variance for direct materials. Let’s continue rolling with the carrot cake example from above.

1. Record a materials quantity variance journal entry

Under the standard costing system, you record inventory at its standard quantity and use a separate account to show variances. Prepare a journal entry once you finish the materials quantity variance calculation.

In the carrot cake example, we used more carrots than expected. We want our WIP inventory account to reflect the standard quantity, 60 pounds of carrots. We record a variance of 15-pound at $1 per pound with the following journal entry:

Debit unfavorable variances, and credit favorable variances. Make sure debits equal credits in every journal entry.

2. Close variances to the cost of goods sold

Before the year is out, you want to clear out all variance accounts to the cost of goods sold. Variances are temporary accounts, meaning they must have a zero balance at the end of the accounting period.

To close the variance account, record the following journal entry:

The debits and credits would be reversed for favorable materials quantity variances.

Variances are windows to the inventory’s soul

You can uncover issues in your company’s manufacturing process by looking at your direct materials quantity variance. You’ll have a truer sense of your company’s total manufacturing costs when you properly account for variances in price, quantity, and efficiency.

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