August 05, 2022 August 05, 2022/ Steven Bragg
The direct material price variance is the difference between the actual price paid to acquire a direct materials item and its budgeted price, multiplied by the actual number of units acquired. This information is needed to monitor the costs incurred to produce goods. The formula follows:
(Actual price - Budgeted price) x Actual quantity = Direct material price variance
The direct material price variance is one of two variances used to monitor direct materials. The other variance is the direct material yield (or usage) variance. Thus, the price variance tracks differences in raw material prices, and yield variance tracks differences in the amount of raw materials used.
The budgeted price is the price that the company's purchasing staff believes it should pay for a direct materials item, given a predetermined level of quality, speed of delivery, and standard purchasing quantity. Thus, the presence of a direct material price variance may indicate that one of the underlying assumptions used to construct the budgeted price is no longer valid.
Here are several possible causes of a direct material price variance:
Discount Application
A discount is to be retroactively applied to the base-level purchase price at the end of the year by the supplier, based on actual purchase volumes.
Materials Shortage
There is a raw material shortage, which drives up its cost.
New Supplier
The company has changed suppliers, and the replacement supplier charges a different price.
Rush Basis
The company needed the materials on short notice and paid overnight freight charges to obtain them.
Volume Assumption
The company now buys in different volumes than it originally planned. This may be caused by an incorrect initial sales assumption regarding the number of units that will be sold.
As you can see from the list of variance causes, different people may be responsible for an unfavorable variance. For example, a rush order is probably caused by an incorrect inventory record that is the responsibility of the warehouse manager. As another example, the decision to buy in different volumes may be caused by an incorrect sales estimate, which is the responsibility of the sales manager. In most other cases, the purchasing manager is considered to be responsible.
Problems with the Direct Material Price Variance
The direct material price variance can be meaningless or even harmful in some circumstances. For example, the purchasing manager might have engaged in heavy political maneuvering to have the standard price set unusually high, which makes it easier to generate a favorable variance by purchasing at prices below the standard. Also, the variance can cause incorrect behavior by creating an incentive to purchase in bulk in order to obtain the lowest price, even though this means burdening the company with an inordinate amount of inventory that it does not immediately need. Consequently, the variance should only be used when there is evidence of a clear price increase that management should be made aware of.
Example of the Direct Material Price Variance
The purchasing staff of ABC International estimates that the budgeted cost of a chromium 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 direct material price variance of $2.50 per pound, and a variance of $62,500 for all of the 25,000 pounds that ABC purchases.
Terms Similar to Direct Material Price Variance
The direct material price variance is also known as the purchase price variance.
August 05, 2022/ Steven Bragg/
Unfavorable variance is an accounting term that describes instances where actual costs are greater than the standard or projected costs. An unfavorable variance can alert management that the company's profit will be less than expected. The sooner an unfavorable variance is detected, the sooner attention can be directed towards fixing any problems.
- Unfavorable variance is an accounting term that describes instances where actual costs are higher than the standard or projected costs.
- An unfavorable variance can alert management that the company's profit will be less than expected.
- The unfavorable variance could be the result of lower revenue, higher expenses, or a combination of both.
A budget is a forecast of revenue and expenses, including fixed costs as well as variable costs. Budgets are important to corporations because it helps them plan for the future by projecting how much revenue is expected to be generated from sales. As a result, companies can plan how much to spend on various projects or investments in the company.
Companies create sales budgets, which forecast how many new customers for new products and services are going to be sold by the sales staff in the coming months. From there, companies can determine the revenue that will be generated and the costs needed to bring in those sales and deliver on those products and services. Eventually, the company can project its net income or profit after subtracting all of the fixed and variable costs from total revenue. If the net income is less than their forecasts, the company has an unfavorable variance.
In other words, the company hasn't generated as much profit as they had hoped. However, an unfavorable variance doesn't necessarily mean the company took a loss. Instead, it merely means that the net income was lower than the forecasted projections for the period.
The unfavorable variance could be the result of lower revenue, higher expenses, or a combination of both. Oftentimes, an unfavorable variance could be due to a combination of factors. The shortfall could be due, in part, to an increase in variable costs, such as a price increase in the cost of raw materials, which go into producing the product. The unfavorable variance could also be due, in part, to lower sales results versus the projected numbers.
In practice, an unfavorable variance can take any number of forms or definitions. In budgeting or financial planning and analysis scenarios, unplanned deviations from plan invite the same managerial reactions as unfavorable variances in other business applications. When business results deviate from expectations–the ensuing analysis may describe the variance in different ways–but the end result is usually the same: things did not go according to plan.
In finance, unfavorable variance refers to a difference between an actual experience and a budgeted experience in any financial category where the actual outcome is less favorable than the projected outcome. Publicly-traded companies with stocks listed on exchanges, such as the NewYork Stock Exchange (NYSE) typically forecast earnings or net income quarterly or annually. Companies that fail to meet their earnings forecasts essentially have an unfavorable variance within their company–whether it be from higher costs, lower revenue, or lower sales.
A sales variance occurs when the projected sales volumes of a product or service don't meet the goal or projected figures. A company may not have hired enough sales staff to bring in the projected number of new clients. A management team could analyze whether to bring in temporary workers to help boost sales efforts. Management could also offer target-based financial incentives to salespeople or create more robust marketing campaigns to generate buzz in the marketplace for their product or service.
In manufacturing, the standard cost of a finished product is calculated by adding the standard costs of the direct material, direct labor, and direct overhead, which are the direct costs tied to production. An unfavorable variance is the opposite of a favorable variance where actual costs are less than standard costs. Rising costs for direct materials or inefficient operations within the production facility could be the cause of an unfavorable variance in manufacturing.
An unfavorable variance can occur due to changing economic conditions, such as lower economic growth, lower consumer spending, or a recession, which leads to higher unemployment. Market conditions can also change, such as new competitors entering the market with new products and services. Companies could also suffer from lower revenue and sales if new technology advances make their products outdated or obsolete.
It's critical that a company's management team analyze an unfavorable variance and pinpoint the cause. Once the cause is determined, the company can make the necessary changes and get back on target with their plan.
For example, let's say that a company's sales were budgeted to be $200,000 for a period. However, the company only generated $180,000 in sales. The unfavorable variance would be $20,000, or 10%.
Similarly, if expenses were projected to be $200,000 for the period but were actually $250,000, there would be an unfavorable variance of $50,000, or 25%.