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Material Price Variance

Material Price Variance Assignment / Homework Help
There are two factors that determine the cost of materials used in the production process. They are the price paid for materials and the quantity of materials used in the production process. We may therefore have a situation where the price paid for materials is either higher or lower than the standard or budgeted price or the quantity of materials used may be either higher or lower than the standard materials required for a particular level of production.

The variance in the price of materials i.e the actual cost of materials differing from the standard cost of materials for a level of activity or production is referred to as "Material Price Variance".

The process of computing this variance is to first compare the standard cost per unit of material with the actual cost paid to purchase the same. The difference is the variance in price and can be favorable or unfavorable. But in order to assess the actual impact of this difference, we must multiply this difference with the actual quantity of materials used in the production. This because, if the quantity of materials used is less or minimal, the variance may be of little consequence. If however, a large quantity of materials is used, the effect of price difference may be large.

Materials Price Variance is therefore computed as the difference between the standard price (SP) and the actual Price (AP) per unit of material multiplied by the quantity of material purchased (QP).

The formula for Material Price Variance is:

(SP AP) * QP

The variance is generally expressed as a number that is either 'favorable' or 'unfavorable' or 'adverse'. If the actual price paid for the materials is lesser than the standard price, the variance is favorable. In the other case, we refer to the variance as unfavorable.

Causes:
The causes for material price variance could be many. A favorable variance may indicate that the purchasing department was efficient to secure a cheaper source of supply for the materials. It could also be due to the purchase of inferior quality of materials or generally declining price of materials in the market. As such, a favorable variance may not necessarily mean that purchasing department was efficient in procuring materials. An 'unfavorable' variance may be due to the failure of the purchasing department to secure the most advantageous source of supply or general price rise in the market (economic conditions) beyond the control of the purchasing department. It may so happen that the unfavorable variance is due to a failure on the part of other department to perform its duties appropriately. For example, bad stock management by the stores department, inability of the sales/marketing department to predict demand accurately, etc, may necessitate purchase of materials at short notice resulting in incurring higher or additional freight and handling charges and sometimes even paying higher price for the materials.

The variance must therefore be analyzed to assess the root cause before concluding on its results and taking any measures. A favorable variance may not necessarily mean good for the company. An unfavorable variance may be beyond the control of the company.

Exapmle:
X Company purchased 500 tons of materials for its production purposes. The price paid for the material was $23,000 per ton. The standard price per ton of material is $22,500. Compute material price variance.

(SP AP) * QP
($22,500 - $23,000) * 500
$250,000 (A) or $250,000 (UF)


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