Price Variance – Meaning, Calculation, Importance and More

Price Variance is the difference between the actual price and standard price of a product or service. It can be for both cost and revenue. Skiptocontent Home » Budgeting PriceVarianceisthedifferencebetweentheactualpriceandthestandardpriceofaproductorservice.Itcanbeforbothcostandrevenue.Thismeansthisvariancecanbeduetothecostthatthecompanypaysforpurchasingrawmaterialsandthepriceitchargesforitsproductsandservices.Studyingsuchavariationhelpsabusinesstoassessandcontrolitscostandrevenuebetter. PriceVarianceFormulaTocalculatethepricedifference,wesubtracttheactualpricefromthestandardrateandthenmultiplytheresultantnumberbythetotalproductcount.Thereisasimpleformulatocalculatethepricevariance,anditis,TableofContentsPriceVarianceFormulaImportanceDirectMaterialPriceVarianceSellingPriceorRevenueVarianceFinalWordsFrequentlyAskedQuestions(FAQs)(StandardPrice–P)×Q.HerePistheactualprice,andQistheexactquantity.​Basedontheformula,anunfavorablepricevariancewouldmeanthatthecompany’sactualcostshaverisen,andthecompanyhadtopaymoremoneytobuyitsrawmaterials.Ontheotherhand,afavorablevariationwouldsuggestthattherealcostshavecomedown,andthecompanyhadtospendless.ImportanceThisconceptisvitalincostaccountingforevaluatingtheeffectivenessofthecompany’sannualbudgetexercise.Forthepreparationofthebudget,thestandardpriceistheonethatthemanagementestimatestopay.Thereisalwaysapricevarianceinthebudgetastheteampreparesthebudgetmonthsbeforetheactualpurchaseoftherawmaterials. ForExample,CompanyABS,atthestartofthefirstquarter,estimatesthatitwouldrequire1,000unitsofaniteminthesecondquartercosting$4.Onthe1,000units,CompanyABSwouldgeta20%discount,bringingthetotalcostto$3.2($4*(1-20%)).However,attheendofthefirstquarter,themanagementrealizesthatitwouldonlyneed800units.Now,itwouldonlygeta10%discount,bringingthecostto$3.6.Inthiscase,thepricevarianceperproductis$0.40($3.6–$3.2). Apointtonoteisthatacompanymayachieveafavorablepricevarianceonlybymakingabulkpurchase.But,thismayraisethecompany’sinventorycost,thus,wipingthebenefitsgainedfromafavorablevariance.Theoperatingplanofacompanyalsodetermineswhetherornotacompanyhasafavorableorunfavorablevariance.Forinstance,ifthepurchasingdepartmentofacompanyinsistsonbuyinginsmallquantities,itmayresultinunfavorablepricevariance. DirectMaterialPriceVarianceOnecaneasilyapplythepricevarianceconcepttoalltypesofcosts,suchaslaborcosts,overheadcosts,directmaterialscosts,andmore.Letusunderstandhowwecanapplytheideatodirectmaterialcosts.Thepointisifyoucanusetheconceptforonetypeofcost,youcaneasilyapplyittootherkindsofcoststoo.Directmaterialpriceorratevarianceisthedifferencebetweentheactualcostacompanypaystogetdirectmaterialforaperiodandthestandard(estimated)costofdirectmaterial. Followingistheformulatocalculatethisvariance:DirectMaterialPriceVariance=(SP−AP)×AQ.HereSPisthestandardpriceperunitofthedirectmaterial.APistheactualpriceperunitofthedirectmaterial.AndAQistheexactquantityofthedirectmaterialthatacompanypurchased.Foraquickcalculation,useMaterialPriceVarianceCalculator.ThisvariancehelpstoknowtheefficiencyofthePurchaseDepartmentwhenitcomestopurchasingdirectmaterialatalowcost.Afavorabledirectmaterialpricevariancewouldmeanthepurchasingdepartmentwasabletobuytherawmaterialatmoreeconomicalratesthantheestimatedvalue.Apointtorememberisthatafavorabledirectmaterialratevariancemaynotalwaysbeapositivethingforacompany.Itcouldbepossiblethatthepurchasingdepartmentgavetheorderforlowerqualitymaterialtoachievealowercost.Thus,thedirectmaterialratevariancemustbelookedatincombinationwiththedirectmaterialquantityvariance.Iftherawmaterialisoflowquality,itwillresultinanunfavorabledirectmaterialquantityvariance.SellingPriceorRevenueVarianceAssaidabove,thepricevarianceconceptisnotjustforthecost.Wecanalsoapplyittorevenueorsellingpricetoo.Therevenuevarianceiswherethebudgetedrevenueisdifferentfromtheactualrevenue.Itcouldbeduetoachangeintheactualsellingpricesasagainstestimatedoneswhilepreparingbudgets.ForExample,CompanyABCestimatestherevenuesandprofitsforthenextyear(2020)basedonthenumberofunitstheywillproduceandthesellingprice.Afterthefirstquarterof2020,thecompanyrealizesthatthecustomersarenotwillingtopaytheratestheyestimatedbecauseacompetitorhasdroppedthepriceoftheirproduct.NowCompanyABCalsolowerstherateoftheirproduct.Thisactionofreducingpriceresultsinunfavorablesellingpricevariance.Ofcourse,anychangeinrevenueswillaffecttheprofitsalso.Intheabovecase,thevariancewasduetothechangeinsellingprices.Acompanymayalsofacevariationifitsellslowerormoreunitsthantheestimates.FinalWordsDependingsolelyonthevariancenumbertoconcludeisnotatallright.Amanagershouldgointothedetailstodeterminetherealreasonforthedifference.Forinstance,thesalesvariance(above)couldbeduetoinflation.Itcanalsobethatthesellingpricesweretoohigh,resultinginlowersales.ReadVarianceAnalysisformoredetails.FrequentlyAskedQuestions(FAQs)Howtocalculatepricevariance?Thereisasimpleformulatocalculatethepricevariance,anditis,(StandardPrice–ActualPrice)×ActualQuantityWhatispricevariance? PriceVarianceisthedifferencebetweentheactualpriceandthestandardpriceofaproductorservice.Itcanbeforbothcostandrevenue.Whyisvarianceimportant?Thisconceptisvitalincost accounting forevaluatingtheeffectivenessofthecompany’sannualbudgetexercise.ShowReferencesDirectMaterialPriceVariance[Source]WhatisaPriceVariance?-Definition|Meaning|Example[Source]SalesPriceVariance[Source] TAGSFlexibleBudgetVarianceVariances RELATEDPOSTS MaterialVariance MaterialPriceVarianceCalculator CostVariance–Meaning,Importance,CalculationandMore VarianceAnalysis ConversionCost–Meaning,importance,FormulaandMore PrimeCostCalculator SanjayBulakiBorad SanjayBoradisthefounder&CEOofeFinanceManagement.Heispassionateaboutkeepingandmakingthingssimpleandeasy.Runningthisblogsince2009andtryingtoexplain"FinancialManagementConceptsinLayman'sTerms". LeaveaCommentCancelreplyCommentName Email Website Savemyname,email,andwebsiteinthisbrowserforthenexttimeIcomment. Signmeupforthenewsletter! 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