Materials price variance definition
/What is the Materials Price Variance?
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 variance is used to spot instances in which a business may be overpaying for raw materials and components. However, it is only useful if the budgeted cost in the calculation has a reasonable basis.
How to Calculate the Materials Price Variance
To calculate the materials price variance, subtract the standard price of an item from its actual price, and then multiply the remainder by the actual quantity used. The formula is as follows:
(Actual price - Standard price) x Actual quantity used = Material price variance
Understanding the Materials Price Variance
The key part of the materials price variance 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.
Materials Price Variance Best Practices
A reasonable best practice to consider when using the materials price variance is to ensure that it is being properly calculated. This means defining each element of the calculation, to ensure that the same information is used in each subsequent calculation. In addition, be sure to pull the baseline data from the same database each time for each calculation. In addition, run the calculation as soon as possible after a purchase has been made, since this makes it easier to track down the causes of any resulting variances. This also makes it easier for management to remediate any variances as promptly as possible, thereby keeping expenses down.
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Causes of the Materials Price Variance
If the standard price is reasonable, then a materials price variance may be caused by such valid factors as the following:
Rush deliveries
Market-driven pricing changes, such as changes in the prices of commodities
Bargaining power changes by suppliers, who may be able to impose higher prices than expected
Buying in unusually large or small volumes in comparison to what was expected when the standard was created
A change in the quality of the materials purchased
Example of the Materials Price 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.