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terials Price Variance – Definition and Explanation
Direct Materials Price Variance
What is DM price variance?
In variance analysis, the total direct materials variance may be split into: price variance and quantity variance. Direct materials price variance refers to the variance that arises due to the difference in the actual and standard purchase price of raw materials used in production.
Formula and Example
The formula for direct materials price variance is:
DM price variance = (AP – SP) x AQ
where: AP = actual price, SP = standard price, and AQ = actual quantity.
Example: Based on market quotes, XYZ Company has established a standard price of $5 per kilogram of raw material. Each unit of its product requires 2 kgs. Last month, XYZ used 20,000 kgs. of raw material costing $105,000 to produce 9,600 units. Compute for the direct materials price variance.
|DM price variance||=||(AP – SP) x AQ|
|=||($5.25 – $5) x 20,000 kgs.|
|DM price variance||=||$5,000 unfavorable|
If actual price is greater than standard price, the variance is unfavorable since the company paid more than what it has set. If actual price is less than standard price, the variance is favorable.
Analyzing a Favorable DM Price Variance
A favorable DM price variance occurs when the actual price paid for raw materials is less than the estimated standard price. It could mean that the firm’s purchasing department was able to negotiate or find materials with lower cost. This is generally favorable to the company; however, further analysis is needed since lower price is often attributed to lower quality. Lower quality of materials results to lower quality of finished products, or excessive use of materials (resulting to an unfavorable DM quantity variance).
Also, a higher standard price may simply mean that the general prices in the industry have fallen and that the standard needs to be revised.
Analyzing an Unfavorable DM Price Variance
The DM price variance is unfavorable if the actual price of the materials is higher than the standard price. The purchasing department bought materials that cost too much. While this is usually treated as undesirable, higher actual prices may simply indicate a normal rise of prices in the industry. In such case, the standard price needs to be revised.
Who Has Responsibility over DM Price Variance?
Generally, the purchasing department of the company is responsible for direct materials price variance since it has control over the acquisition of materials, including the selection of suppliers.
Direct Materials Price Variance – Accounting Dictionary (2022). Accountingverse.
More Accounting Terms
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Frequently Asked Questions About what does a favorable direct materials price variance indicate
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The significance of a favorable direct materials price variance
A favorable outcome means you spent less money on the purchase of materials than you anticipated if the actual price paid per unit of material is lower than the standard price per unit.
What is measured by the direct materials price variance?
The direct material variance is the difference between actual costs incurred and the standard cost of materials resulting from production activities.
What does a positive variance signify?
The same as a surplus, which occurs when expenses are lower than available income, a favorable variance occurs when actual income or expenditures exceed or fall below the budget.
A negative direct materials cost variance means what?
Unfavorable direct materials cost variance and unfavorable direct materials usage variance would result if the actual cost of the direct materials was higher than the standard cost or if the actual quantity of the direct materials was higher than the standard quantity.
How can you tell whether a price variance is positive or negative?
A favorable price variance is one in which the actual cost incurred is less than the standard cost; an unfavorable price variance is one in which the actual cost incurred is greater than the standard cost.
Is a positive variance always a good thing?
Receiving a favorable variance (or an unfavorable variance, for that matter) is not always indicative of good performance because it is based on a budgeted or standard amount.
How do you determine whether a favorable materials price variance exists?
If the actual price paid for the materials is less than the standard price, the material price variance will be favorable; however, if the actual price paid for the materials is higher than the standard price, the material price variance will be unfavorable.
What does “favorable” or “unfavorable” mean in terms of variances?
Variance simply refers to the difference between budgeted and actual figures. In the world of accounting, higher revenues and lower expenses are referred to as favorable variances, while lower revenues and higher expenses are referred to as unfavorable variances.
What is the right way to interpret a positive materials yield variance?
In general, a yield variance is unfavorable because it makes it more likely that production process errors will result in extra usage of raw materials. However, a yield variance can be advantageous if the production process produces more finished goods from a given amount of raw materials than anticipated.
What does “favorable variance” or “unfavorable variance” mean?
Budget variances happen because forecasters are unable to completely predict future costs and revenue. Favorable budget variances refer to positive variances or gains; unfavorable budget variances describe negative variance, indicating losses or shortfalls.