Direct Material Price Variance is the difference between the actual price paid for purchased materials and their standard cost at the actual direct material purchased amount.
It helps to monitor the costs incurred to produce the goods.
It is important to know how much the price fluctuation has affected the total production or project costs.
And sometimes, the price fluctuation is adjusted to the production budget and compared with actual production costs to make a deep analysis.
Direct Material Price Variance
= Actual Quantity (Actual Price – Standard Price) OR,
= Actual Cost – Standard Cost
In this formula, if the variance is calculated at the material purchase, the actual quantity is the quantity purchased during a period.
On the other hand, if the variance is calculated at the time of material consumption, the actual quantity is the quantity consumed during the period.
The material price variance may also be calculated when the material is withdrawn from stores.
In this case, the stock accounts are maintained at actual cost, price variances being extracted at the time of material usage rather than purchase.
The method described later is not usually recommended because one of the advantages of a standard costing system is the valuation of all stock at standard costs.
The standard price is the price the company’s purchasing staff assumes it should pay for direct materials after undertaking predefined quality, speed of delivery, and standard purchasing quantity.
Hence, the calculation of direct material price variance indicates that one of the assumptions the standard price is based upon is no longer correct.
Favorable material price variance depicts the effectiveness of the purchasing manager in procuring the materials cost-effectively. The various reasons for favorable material price variance are as follows:
- The purchasing manager showed effective negotiation skills
- Discounts on the purchase when bulk quantity bought
- The decline in market prices in general
- Purchase of materials of lower quality than standard.
- Effective procurement practices in place
Adverse material price variance depicts the ineffectiveness of the purchasing manager in procuring the materials exceeding the standard cost.
The various reasons for adverse material price variance are as follows:
- Ineffective negotiation skills demonstrated by the purchasing manager
- Effective bargaining by the suppliers.
- Increase in market prices in general
- Purchase of higher quality materials than the standard expected
- Loss of purchase discounts due to buying in small orders.
Marvel Inc produced 20,000 items of idols from the Marvel franchise in November 2018. Following raw materials were purchased and consumed by Marvels Inc during the period
|Material||Quantity||Actual Price||Standard Price|
|Cloth||200 kgs||$150 per kg||$140 per kg|
|Paint||300 kgs||$40 per kg||$48 per kg|
|Clay||500 kgs||$20 per kg||$24 per kg|
Material Price variance shall be calculated as follows:
We calculate the actual cost
Actual Cost = Actual Quantity * Actual Price
|Cloth||200 * 150||$ 30,000|
|Paint||300 * 40||$ 12,000|
|Clay||500 * 20||$ 10,000|
Now, we calculate the standard cost of the actual quantity
Standard Cost = Actual Quantity * Standard Price
|Cloth||200 * 140||$ 28,000|
|Paint||300 * 48||$ 14,400|
|Clay||500 * 24||$ 12,000|
Now we calculate the variances as follows:
Material Price Variance = Actual Cost – Standard Cost
|Cloth||30,000 – 28,000||$ 2,000 Adverse|
|Paint||12,000 – 14,400||$ 2,400 Favorable|
|Clay||10,000 – 12,000||$ 2,000 Favorable|
Adding all the materials together,
Material Price Variance = $ 2,400 Favorable