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Direct material price variance has to do with the difference in the actual price paid for materials and the price that the buyer had budgeted to make the purchase. The actual difference may be expressed as a positive variance, meaning that the materials cost more than budgeted, or a negative variance in which the goods cost less than the budgeted amount. Calculating a direct material price variance can be very helpful when it comes to managing the costs of materials used in the production of any type of goods or services, and ensuring that the company does generate some sort of net profit.
Calculating the direct material price variance begins with identifying the actual amount included in the budget for a particular item. From there, it is necessary to ascertain the amount spent for that item, making sure that the quantities for both the budget and the purchases are equal. By subtracting the actual costs from the budgeted costs, it is possible to determine what type of direct material variance exists.
The general idea of a direct material price variance can be seen in the example of a pie maker who makes use of frozen pie shells to produce the final product. If the maker needs 500 shells in order to bake the pies and has budgeted $1 US dollar (USD) to buy each shell, that amounts to a line item of $500 USD. In the event that the pie shells cost $1.50 USD each, this means the pie maker will actually spend $750 USD in order to acquire the necessary number of pie shells. As a result, the direct material price variance comes to a total of $250 USD.
At the same time, if the pie maker is able to purchase those 500 pie shells at a rate of $0.75 USD each, this would mean the actual expense came to $375 USD. In this scenario, the cost of purchase was actually lower than the amount budgeted. As a result, the direct material price variance is presented as a negative of $125 USD. While presented as a negative rather than a positive figure, the pie maker actually trimmed materials costs with this variance and increased the amount of profit that is realized off each pie sold.
With situations in which the actual cost of materials and the budget for those same materials in the same quantities are the same, this means the direct material price variance is zero. Typically, businesses want to achieve at least this level of variance. Preferably, the goal is to secure the materials for a unit cost that is under the budgeted amount, making it possible to reduce the costs of producing the finished goods and generate additional net profit for the operation.
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