Accounting Dictionary

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Materials Price Variance

Definition: The materials price variance is the difference between the actual and budgeted cost to acquire materials, multiplied by the total number of units purchased. The formula is:

(Actual price - Standard price) x Actual quantity used = Material price variance

The key part of this calculation is the standard price, which is decided upon by the engineering and purchasing departments, based on estimates of usage, probable scrap levels, required quality, likely purchasing quantities, and several other factors. Politics can enter into the standard-setting decision, which means that standards may be set so high that it is quite easy to acquire materials at prices less than the standard, resulting in a favorable variance. Thus, the decision-making process that goes into the creation of a standard price plays a large role in the amount of materials price variance that a company reports.

If the standard price is reasonable, then a materials price variance may be caused by such valid factors as rush deliveries, market-driven pricing changes, and buying in unusually large or small volumes.

As an example of the variance, the purchasing staff of ABC Manufacturing estimates that the budgeted cost of a palladium component should be set at $10.00 per pound, which is based on an estimated purchasing volume of 50,000 pounds per year. During the year that follows, ABC only buys 25,000 pounds, which drives up the price to $12.50 per pound. This creates a materials price variance of $2.50 per pound, and a variance of $62,500 for all of the 25,000 pounds that ABC purchases.