Direct Material Price Variance: Definition, Formula Explanation, Analysis, And Example

Definition:

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 really important to know how much the price fluctuation had potentially affected the total production costs or project costs.

And sometimes, to make deep analysis, the price fluctuation is adjusted to the production budget and then compare with actual production costs.

Formula:

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 time of 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, actual quantity is the quantity consumed during the period.

Explanation:

The material price variance may also be calculated at the time of material withdrawal 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 which is 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.

Analysis:

The standard price is the price that the company’s purchasing staff assumes that 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.

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Favorable material price variance depicts the effectiveness of the purchasing manager in procuring the materials being cost-effective. The various reasons for favorable material price variance are as follows:

  • Effective negotiation skills were shown by the purchasing manager
  • 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.

Example:

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:

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 standard cost of 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:

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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