Direct Materials Price Variance

The direct materials price variance is a standard costing measure that shows how much more or less a business paid for its direct materials than planned. It is calculated as the difference between the actual price per unit of material and the standard price, multiplied by the actual quantity. Most companies calculate it on the quantity purchased, so that price differences are identified as soon as materials are bought.

It is one half of the total direct materials variance. The other half is the direct materials usage variance, which measures whether more or less material was used than the standard allows for actual output. The price variance is sometimes called the purchase price variance, and it is the materials counterpart of the direct labor rate variance.

A furniture maker plans on paying $4 a board foot for oak. If a supplier raises the price to $4.50, every board costs more than the budget assumed. If the buyer finds a deal at $3.80, every board costs less. The price variance adds up these differences across all the wood bought in the period.

It looks only at what was paid for each unit, not at how much wood went into the furniture. That way the buying team can be asked about prices, and the workshop can be asked separately about waste.

The variance is calculated as:

• $\text{AP}$ is the actual price paid per unit of material.
• $\text{SP}$ is the standard price per unit.
• $\text{AQ}$ is the actual quantity, either purchased or used, depending on the company's policy.

A manufacturer's standard is 3 pounds of resin per unit at $4.00 a pound. In June it buys 7,000 pounds for $26,600, or $3.80 a pound. The price variance on purchases is $(3.80 - 4.00) \times 7{,}000 = -1{,}400$, a $1,400 favorable variance. If the company instead measured the variance only on the 6,300 pounds used in June, it would be $0.20 \times 6{,}300$, or $1,260 favorable.

When the variance is isolated at purchase, Raw Materials Inventory is carried at standard price. For the June purchase the entry is:

• Debit Raw Materials Inventory $28,000 (7,000 pounds times $4.00).
• Credit Direct Materials Price Variance $1,400.
• Credit Accounts Payable $26,600.

Isolating the variance at purchase has two advantages: it reports price differences promptly, when the purchasing manager can still act, and it keeps all later inventory records at standard cost, which simplifies bookkeeping. An unfavorable variance would be recorded as a debit. At period-end, variances are usually closed to cost of goods sold if immaterial, or allocated between inventories and cost of goods sold if material, so that inventory in the financial statements approximates actual cost.

• Market prices. Commodity prices, tariffs, exchange rates and inflation move actual prices away from standards set months earlier.
• Purchase quantities. Buying in larger lots can earn volume discounts, while rush orders in small quantities usually cost more.
• Supplier choice. Switching suppliers changes prices, and sometimes quality as well.
• Material grade. Buying a higher or lower grade than specified changes the price and may affect usage and labor.
• Freight and terms. Expedited shipping and lost purchase discounts raise the effective cost when they are included in the material price.

Responsibility usually rests with the purchasing department. However, a favorable price variance can be a false saving. Cheaper material that is harder to work with may cause more waste, an unfavorable usage variance and longer labor hours. Buying in bulk to win a discount ties up cash and raises the carrying cost of inventory. Managers therefore review all materials and labor variances together rather than rewarding purchasing for price alone.

The variance is only as meaningful as the standard price. If standards are not updated when market prices shift permanently, the variance reports a persistent difference that no one can control. In industries with volatile commodity prices, some companies separate the effect of market movements from the effect of buying decisions, for instance by comparing the price paid with the market price on the purchase date.

• Institute of Management Accountants