The direct materials price variance is one of the main standard costing variances, and results from the difference between the standard price and the actual price of material used by a business.
It is important to realize that together with the quantity variance the price variance forms part of the total direct materials variance.
The variance is calculated using the direct materials price variance formula which takes the difference between the standard material unit price and the actual material unit price, and multiplies this by the quantity of units. The quantity of units will either be the quantity used in production or the quantity purchased, depending on the point at which the variance is to be calculated.
Direct materials price variance = (Standard price – Actual price) x Actual quantity
Example of Direct Materials Price Variance
Suppose, for example, a manufacturer uses plastic sheets in the manufacture of a product. They set the standard price for material at 4.00 per sheet, and later purchase 2,000 sheets from a supplier at an actual price of 3.80 per sheet. As can be seen the direct materials price variance is given as follows:
Direct materials price variance = (Standard price - Actual price) x Actual quantityDirect materials price variance = (4.00 - 3.80) x 2,000Direct materials price variance = 400
Additionally this is summarized in the table below:
Quantity | Price | Cost | |
---|---|---|---|
Standard | 2,000 | 4.00 | 8,000 |
Actual | 2,000 | 3.80 | 7,600 |
Price variance | 2,000 | 0.20 | 400 |
In this example, the direct materials variance is positive (favorable), as the actual price per sheet (3.80) was lower than the standard price (4.00), and therefore the business paid less for the material than it expected to.
Variance Analysis Accounting Journals
The standard costing journal entries to post the purchase of the material and record the direct materials variance is as follows:
Account | Debit | Credit |
---|---|---|
Raw materials inventory | 8,000 | |
Direct materials price variance account | 400 | |
Accounts payable | 7,600 | |
Total | 8,000 | 8,000 |
The posting to accounts payable reflects the actual amount (7,600) due to the supplier. In the standard costing system, the material costs are posted at the standard cost of 8,000 represented by the debit to the raw materials inventory account. Consequently the difference between the two postings is the variance of 400, which is posted to the direct materials variance account as a credit representing the favorable variance.
Reasons for the Direct Materials Price Variance
Any major direct materials price variance needs to be investigated by the business in order to find the specific reason for the variation from the expected standard price, the most common causes include the following:
- Firstly the standard price was based on a particular volume discount from the supplier, and actual purchases are made at a different volume discount level.
- Alternative materials with a different price have been substituted as a replacement for the original material
- The supplier has changed their prices and the standard has not been amended to reflect this.
- The supplier itself has been changed and the standard price has not been amended to allow for this.
- Finally an incorrect actual price has been used in the variance calculation
Clearing the Direct Materials Price Variance Account
The financial statements of the business must ultimately show the actual costs incurred by the business. At the end of an accounting period, having investigated the direct material price variances using the variance report, the balance on the direct materials price variance account needs to be cleared using the rules discussed in our standard costing and variance analysis tutorial and are available for download in PDF format here. These rules can be summarized as follows:
- Firstly for small, insignificant direct materials price variances it is not worth the time and effort apportioning the balance, so simply transfer it to the cost of goods sold account.
- For larger unfavorable variances (debit balances) which result from errors and inefficiencies in the business, transfer them to the cost of goods sold account, as apportioning them to an inventory account would incorrectly increase the value of the inventory.
- Finally for all other significant direct materials price variances (debit or credit balances), split them between inventory accounts and the cost of goods sold account in proportion to the amount of the material remaining on that account.
Variance Apportionment Example
As shown above the direct materials price variance was favorable leaving a credit balance of 400 on the variance account. To illustrate assume for simplicity that this was the only direct materials price variance for the year.
If the balance is considered insignificant in relation to the size of the business, then it can simply be transferred to the cost of goods sold account.
Account | Debit | Credit |
---|---|---|
Direct materials price variance | 400 | |
Cost of goods sold | 400 | |
Total | 400 | 400 |
If however it is considered to be significant in relation to the size of the business, then the variance is analyzed between the inventory accounts (raw material, work in process, and finished goods) and the cost of goods sold account.
To illustrate suppose 40% of the material purchased remained in the raw material inventory, and 60% had been used in production and the items sold. In this case the direct materials price variance account balance split is as follows:
Account | Percent | Amount |
---|---|---|
Raw materials inventory | 40% | 160 |
Cost of goods sold | 60% | 240 |
Total | 100% | 400 |
Furthermore the bookkeeping journal to post the transaction to clear the direct materials variance account is as follows:
Account | Debit | Credit |
---|---|---|
Direct materials price variance | 400 | |
Raw material inventory | 160 | |
Cost of goods sold account | 240 | |
Total | 400 | 400 |
The credit balance on the direct materials price variance account (400) splits between the raw materials inventory account (160) and the cost of goods sold account (240). This reduces both accounts by the appropriate amount, and clears the variance account balance.
Last modified January 23rd, 2023 by Michael Brown
About the Author
Chartered accountant Michael Brown is the founder and CEO of Double Entry Bookkeeping. He has worked as an accountant and consultant for more than 25 years and has built financial models for all types of industries. He has been the CFO or controller of both small and medium sized companies and has run small businesses of his own. He has been a manager and an auditor with Deloitte, a big 4 accountancy firm, and holds a degree from Loughborough University.
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Posted By: Michael Brown Standard Costing, Tutorials, Variance Analysis
January 23, 2023
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