Material variance has two definitions, one relating to direct materials and the other to the size of a variance. They are:
- Related to materials. This is the difference between the actual cost incurred for direct materials and the expected (or standard) cost of those materials. It is useful for determining the ability of a business to incur materials costs close to the levels at which it had planned to incur them. However, the expected (or standard) cost of materials can be a negotiated figure or only based on a certain purchase volume, which renders this variance less usable. The variance can be further subdivided into the purchase price variance and the material yield variance. They are:
- Purchase price variance. This is concerned solely with the price at which direct materials were acquired. The calculation is: (Actual price - Standard price) x Actual quantity
- Material yield variance. This is concerned solely with the number of units of the materials used in the production process. The calculation is: (Actual unit usage - Standard unit usage) x Standard cost per unit
- Related to size of variance. A variance is considered to be material if it exceeds a certain percentage or dollar amount. This approach to the material variance is commonly used by auditors, who (for example) may ask to see explanations of all variances exhibiting a change of at least $25,000 or 15% from the preceding year. A variation on the concept is to consider a transaction material if its presence or absence would alter the decisions of a user of a company's financial statements.