Price variance
/What is a Price Variance?
Price variance is the actual unit cost of a purchased item, minus its standard cost, multiplied by the quantity of actual units purchased. The price variance formula is:
(Actual cost incurred - standard cost) x Actual quantity of units purchased
= Price variance
If the actual cost incurred is lower than the standard cost, this is considered a favorable price variance. If the actual cost incurred is higher than the standard cost, this is considered an unfavorable price variance. However, achieving a favorable price variance might only be achieved by purchasing goods in large quantities, which may put the business at risk of never using some of its inventory. Conversely, the purchasing department may be committed to having very little inventory on hand, and so buys materials in very small quantities, which tends to result in unfavorable price variances. Thus, the operational plan of a business tends to drive the types of price variances that it incurs.
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Problems with Price Variance
The key problem with the price variance is that it is based on a standard cost, which is essentially the opinion of someone within the organization. If the standard cost is set at an unrealistic level, then there will always be a misleading price variance associated with it. Another concern with price variance is that it tends to drive purchasing managers to purchase in bulk in order to improve the variance, which can result in excessive investments in inventory.
Types of Price Variances
The price variance concept can be applied to any type of cost. For example, there is the labor rate variance for labor costs, the purchase price variance for materials, the variable overhead spending variance for variable overhead, and the fixed overhead spending variance for fixed overhead.