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What is the Direct Material Price Variance?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material price variance may indicate that one of the underlying assumptions used to construct the budgeted price is no longer valid. What Causes a Direct Material Price Variance?Here are several possible causes of a direct material price variance: Discount ApplicationA 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 ShortageThere is a raw material shortage, which drives up its cost. New SupplierThe company has changed suppliers, and the replacement supplier charges a different price. Rush BasisThe company needed the materials on short notice and paid overnight freight charges to obtain them. Volume AssumptionThe 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 VarianceThe 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 VarianceThe 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 VarianceThe direct material price variance is also known as the purchase price variance. Unit III STANDARD COSTING
ADVANTAGES OF STANDARD COSTING 1. It helps the management in formulating price
and production policy. cost control is taken. Thus reduction of cost is possible by
increasing the profits.
unfavourable performance.
is facilitated. Management must concentrate their attention on variations only.
short period-say a week, a month etc. management. It is a basic for the implementation of an incentive system for the employees. Standard costs form a basis for future planning, preparation of tenders, fixation of price etc. Otherwise, or in the absence of standard cost, decision will be based on actual cost. The prices of material, labour etc, may change from time to time. There must be a fixed cost structure based on normal standard efficiency. Thus it helps the management in formulating price and production policy.
need a constant revision of standard. But revision of standard is more expensive. industries which deal in non-standardised products or jobs according to customer’s requirements.
1. There must be Standard Committee, similar to Budget Committee, in which Purchase Manger, Personnel Manager, and Production Manager are represented. The Cost Accountant coordinates the functions of the Standard Committee. established. The most significant contribution of standard costing to the science and art of management is the presentation of ‘variances’. As a matter of act, without determination and analysis of variances, standard costing is meaningless. The term ‘Variance’ has been derived from the verb ‘To vary’ meaning to differ. In cost accounting, variance means deviation of the actual cost from the standard cost. In standard costing, standard costs are pre-determined and refer to the amounts which ought to be incurred. These become the yardsticks against which actual costs can be compared.
I. MATERIAL COST VARIANCE Where SQ = Standard Qty. MATERIAL COST VARIANCE (OR) MCV = (SQûSP) - (AQûAP) MATERIAL PRICE VARIANCE MATERIAL
USAGE VARIANCE (OR) MPV (OR) MUV MATERIAL MIX VARIANCE MATERIAL YIELD VARIANCE MCV = MPV + MUV ILLUSTRATION 1: The standard material and standard cost per Kg. of material required for the production of one unit of product A is as follows : Material : 5 Kg. per Unit of output at 5 Rs. per Kg as standard cost. 400 units of product A Calculate Material cost variance. Material cost variance : (SQûSP)-(AQûAP) This is the responsibility of the purchase manager. Material price variance is that portion of the direct material cost variance which is the difference
between the standard price specified and the actual price paid for the direct materials used. The formula is : or A favourable variance arises if the actual price is less than the standard price and vice versa. The reasons for direct material price variances are : ILLUSTRATION 2 : The standard cost of a material for manufacturing a unit of particular product is estimated as follows : Variance : It is the deviation caused by the standards due to difference in quantity used. It is calculated by multiplying the difference between the standard quantity specified and the actual quantity used by the standard price. Material Usage or Quantity Variance The reasons for usage variance are : ILLUSTRATION 3 : From the following data calculate material usage variance : When two or more materials are used in the manufacture of a product, the difference between the standard composition and the actual composition of material mix is the Material mix variance. The variance arises due to the actual composition of material and the standard ratio. The formula is : Direct material mix variance = Standard Rate (Standard mix - Actual Mix) i.) When actual weight of mix and standard weight of mix are the same SR (SQ-AQ) Standard is revised due to the shortage of a particular type of material. The formula is : Revised standard quantity = Standard Quantity of each material in total actual material in standard ration. Material Mix Variance : Actual Quantity
Standard Quantity B 60 66 Total 100 116 RSQ for material A
= 40 = 44 units A : 50(44-50) = Rs. 300 (Adverse) Revised material usage variance Material Cost Variance
: Direct Material Yield Variance : ILLUSTRATION : The standard material cost for 100 kg of
chemical D is made up of : MPV (Rs. 40.80)(A) MUV (Rs.60)(A) MMV (Rs. 6.67)(A) MYV (Rs. 53.33)(A) (a) Material Cost Variance : (c) Material Usage Variance : e) Material Yield Variance II. LABOUR VARAINCES The second important element of cost is labour. The management keeps
a close watch on the labour cost in order to keep the cost of production low. The various labour variances are : Rate Variance Either Idle time either LABOUR COST VARIANCE Mix Variance (Gang Composition) either TOTAL EFFICIECNCY VARIANCE Idle time variance Mix variance either LCV = LRV + LEV (a) Labour Cost Variance or Labour Wage Variance (b) Labour or Wage Rate
Variance (c) Labour Time or Labour Efficiency Variance Favourable Factors Unfavourable Factors (d) Idle Time Variance (e) Labour Mix Variance or Gang Composition Variance Relationship ILLUSTRATIION : With the help of following information calculate ILLUSTRATION : Using the following information, calculate the labour variance : b) Labour Rate Variance c) Labour Efficiency Variance d) Idle time variance III. OVERHEAD VARIANCE Fixed Variable Expenditure Volume Expenditure Efficiency Efficiency Capacity Calendar (A) VARIABLE SOVERHEAD VARIANCE = (Actual hours worked - Std. Variable Overhead rate per hour) (B) FIXED OVERHEAD VARIANCE FOV = Actual Output (Fixed Overhead Rate - Actual Fixed Overheads) (a) Fixed Overhead Expenditure Variance (Budgeted or cost variance): It is the portion of the fixed overhead which is incurred during a particular period due tot eh difference between the budgeted fixed overheads and the actual fixed overheads. (b)
Fixed Overhead volume : This variance is the difference between the standard cost of overhead absorbed in actual output and the standard allowance for that output. This variance measures the over or under recovery of fixed overheads due to deviation of actual output from the budgeted output level. CLASSIFICATION OF VOLUME VARIANCES (i) Fixed Overhead Efficiency Variance : (ii) Fixed Overhead Calendar Variance : (iii) Fixed Overhead Capacity Variance ILLUSTRATION : From the following data, calculate overhead variances. Budgeted There was an increase of 5% in capacity. When the actual cost is less than the standard cost it is known as?When the actual cost differs from the standard cost, it is called variance. If the actual cost is less than the standard cost or the actual profit is higher than the standard profit, it is called favorable variance.
When the actual cost is more than standard cost then it is a?This difference between the standard cost vs actual cost is termed as Variance. If the Actual cost is higher than the standard, it creates an unfavorable variance. 2.
When the standard price is higher than the actual price the materials price variance is?Variance is unfavorable because the actual price of $1.20 is higher than the expected (budgeted) price of $1. $(21,000) favorable materials quantity variance = $399,000 – $420,000.
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Learning Objective.. When actual price is higher or lower than the standard price then it is sales price variance sales volume variance sales mix variance sales quantity variance?Sales value variance arises due to one or more of the following reasons: (i) Actual selling price may be higher or lower than the standard price. This is expressed in sales price variance. (ii) Actual quantity of goods sold may be more or less than the budgeted quantity of sales.
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