- What is direct materials price variance?
- What are the possible reasons of this variance?
In managerial accounting, variance means deviation of actual costs from standard costs. Materials price variance is the result of deviation of actual price paid for materials from what has been set as standard. Direct materials price and quantity standards are set after keeping in mind the current market prices and anticipated changes in materials prices in near future. However things do not always happen as expected. The actual price of materials may significantly deviate from standard price. Moreover, the expenses associated with the order (freight, duties, handling expenses etc.) may increase or reduce the price of materials available for use. The business may have to pay more or less price than what has been considered as normal at the time of setting standards.
If the actual price paid for materials is more than the standard price, an unfavorable materials price variance occurs. On the other hand, if the actual price paid for the materials is less than the standard price, a favorable materials price variance occurs.
An example is given below for more explanation:
The Aptex company manufactures and sells small speakers that are used in mobile phones. The speakers are sold in bulk to mobile manufacturing companies where complete mobiles are produced. The direct material of Aptex company is a thin copper coil. One meter of the copper coil is the standard requirement to manufacture one speaker.
The standard cost to manufacture one speaker is as follows:
|Direct materials: 1meters × $1.50 per meters||$1.50|
During the month of June, Aptex purchased 5,000 meters of copper coil @ $1.70 per meter and produced 2,500 speakers using 3,000 meters of copper coil.
The materials price variance for the month of June can be calculated using the following formula/equation:
= (5,000 × $1.70) – (5,000 × $1.50)
= $8,500 – $7,500
= 1,000 Unfavorable
Aptex has an unfavorable materials price variance for June because the actual price paid ($8,500) is more than the standard price allowed ($7,500) for 5,000 meters of copper coil.
This variance can also be computed by using the factored form of above formula:
AQ × (AP – SP)
5,000 meters × ($1.70 – $1.50)
5,000 meters × $0.20
Reasons of direct materials price variance:
A favorable or unfavorable material price variance may occur due to one or more of the following reasons:
- Order size: Some suppliers allow discount on large orders. The materials purchased in large quantities may reduce the the unit price and a favorable price variance may occur.
- Rise in price: The rise in the general price level may increase the input costs of the vendor and as a result vendor may increase the price of the materials. The rise in price is very common reason of an unfavorable variance.
- Urgent needs: If production department does not indicate the need of materials on time, the purchasing department may have to order on urgent basis that may increase the price of materials and other expenses associated with the order.
- Quality: A favorable price variance may be the result of purchasing low quality materials and an unfavorable variance may be the result of purchasing high quality materials.
- Inefficient standard setting: Inefficiencies in terms of forecasting and environmental scanning during standard setting process can be a reason of huge variances.
- Transportation: Transportation is a part of total direct materials cost. Any change in the transportation expenses can change the total and per unit cost of direct materials available for use and can become the reason of favorable or unfavorable direct materials price variance.
- The role of just in time manufacturing: A company that operates under just in time (JIT) manufacturing system may have to face shortage of direct materials due to a sudden increase in demand for the product. The orders in rush normally increase the costs. In that case company will have to either accept an unfavorable materials price variance or lost sales.
- Inefficient or unreliable Suppliers: A deviation from standard material costs may be the result of inefficient or unreliable vendors. For example, if suppliers of raw materials are unable to meet the demand, the company may have to look for another supplier who may be more costly.
Responsibility of the variance:
Purchasing department is responsible to place orders for direct materials so this variance is generally considered the responsibility of purchase manager. However, the above reasons clarify that the materials price variance may or may not be the result of inefficiencies of the purchasing department.
The occurrence of variances is very normal. They occur for almost all cost elements and should not be used to find someone to blame. Sometimes they may not be very significant and sometimes they may be the result of the factors that are beyond the control of managers. Variances are tools to control costs, improve efficiencies and should be used positively.