Direct Material Price Variance
Direct material price variance is the difference between actual cost of direct material and the standard cost. Actual cost of material is the amount the company paid to supplier to get input for the prodution. Standard cost is the amount the company expect to pay to get the same quantity of material. The difference of actual and standard cost raise due to the price change, while the material quantity remains the same. It is one of the variances which company need to monitor beside direct material usage variance.
Material Price Variance Formula
| \[Direct\ Material \ Price\ Variance = (Standard Price – Actual Price) * Quantity \] |
What is the process of material price variance calculation?
| Process of material price variance | |
|---|---|
| 1. Calculate the actual cost | The company needs to calculate the actual direct material cost. Actual cost = actual quantity * actual price. It could be done quarterly or annually. |
| 2. Calculate the Expected Cost | It is the standard cost of the actual quantity. Expected Cost = Actual quantity * Standard Cost |
| 3. Compare and calculate variance | We compare both figures and find the variance if any. |
Material Price Variance example
Company A manufacture the shoes, the company has to calculate the standard cost the following:
| Item | Price |
| Leather | $ 200 |
| Rubber | $ 150 |
| Textiles | $ 100 |
Step 1: Calculate the actual cost:
Due to the market fluctuates, the price of the three materials has changed. The quantity is still the same as expectation. During January 20X9, the company pay the following
| Material | Quantity | Actual Price | Amount |
|---|---|---|---|
| Leather | 20 tons | $ 220 | 4,400 |
| Rubber | 15 tons | $ 130 | 1,950 |
| Textiles | 10 tons | $ 110 | 1,100 |
- Calculate the standard cost
It is the multiplying of actual quantity with the standard price.
| Material | Quantity | Standard cost | Amount |
|---|---|---|---|
| Leather | 20 tons | $ 200 | 4,000 |
| Rubber | 15 tons | $ 150 | 2,250 |
| Textiles | 10 tons | $ 100 | 1,000 |
Calculate the variance
The difference between standard cost and actual cost
| Material | Standard Cost | Actual Cost | Variance | |
|---|---|---|---|---|
| Leather | 4,000 | 4,400 | (400) | unfavorable |
| Rubber | 2,250 | 1,950 | 300 | Favorable |
| Textiles | 1,000 | 1,100 | (100) | unfavorable |
Double entries:
| Date | Chart of Account | Debit | Credit |
|---|---|---|---|
| Inventory – DM – Leather | 4,000 | ||
| Direct Material Price Variance | 400 | ||
| Account Payable | 4,400 | ||
| Inventory – DM – Rubber | 2,250 | ||
| Direct Material Price Variance | 300 | ||
| Account Payable | 1,950 | ||
| Inventory – DM – Textiles | 1,000 | ||
| Direct Material Price Variance | 100 | ||
| Account Payable | 1,100 |
Impact of direct material price variance to Financial Statement
The total price variance during January is $ 200 ($ 400 – $ 300 + $ 100), and it will impact the cost of goods sold in statement of profit and lose. It will reduce the net income for the period.
Material Price Variance Favorable or Unfavorable
The material price variance shows us two separate stories.
The standard cost is not reflected in the real situation. We need to double-check the working paper of standard cost. The manager may try to overstate it to protect himself from being punished if something goes wrong during the production (unexpected waste or error). However, setting too high standard costs will impact our selling price. Our selling price is higher than the competitors and for sure it will impact the sale quantity.
One more, the favorable variance may arise from the purchase of low-quality material. It will impact our company’s long term reputation. The purchasing department and production manager need to do proper inspect all the material during delivery. Only high quality materials are used in the production.
For the unfavorable variance there is something happen as follows:
- Standard cost set too low
- The price increase
- Purchase of high-quality material
How to Reduce Material Price Variance (unfavorable)
| Reason | Possible Solution |
|---|---|
| Increase in the market price | The company should prepare a proper agreement with suppliers to prevent any price change in the future. |
| Change suppliers | The company should have multiple suppliers which will help to balance risk if one them go bankrupt or facing any serious issue. It will increase our bargaining power and prevent any unreasonable price increase. |
| Insufficient of purchasing department | We need to provide them proper training to ensure that they can perform their job more efficient. The staff must be able to negotiate the price with suppliers. |
| Bulk discount | Purchasing and production department need to agree on a schedule which ensure that company can take advantage regarding to bulk purchase. |
| Standard Cost | The standard cost of material must reflect the real situation in the company. Setting too low will demotivate the employee and cause adverse variance. |