Classification of the Materials Cost Variance
Variance analysis is a tool of budgetary control by evaluation of performance by means of variances between budgeted amount, planned amount or standard amount and the actual amount incurred/sold. Material Cost Variance gives an idea of how much more or less cost has been incurred when compared with the standard cost.
Two standards must be developed for direct material costs. They are discussed below.
(a) Direct material price variance: Direct material price variance is the difference between the actual purchase price and a standard purchase price of materials. The purchase price standard is usually based on current market prices. When the actual price is more than the standard, there is an unfavorable material price variance. When the actual price is less than the standard, there is a favorable material price variance. Direct materials price variance is calculated in two ways.
(i) Direct materials purchase price variance: This variance is computed at the time is the purchase of materials. The formula of computing direct materials purchase price variance is –
Materials purchase price variance = (actual quantity purchased * actual price) – (actual quantity purchased * standard price)
(ii) Direct materials price usage variance: This variance is computed at the time of use of materials. The formula of computing direct materials usage variance is –
Materials price usage variance = (actual quantity used * actual price) – (actual quantity used * standard price).
(b) Direct materials quantity variance: Direct material quantity variance is also known as usage variance. It measures the differences between the number of materials used in production and the quantity set as a standard. It involves calculating the difference between the standard quantity of materials specified and the actual quantity used, converted into money terms by multiplying by the standard materials price; The formula of computing direct materials usage variance is –
Materials quantity variance = (actual quantity used * standard price) – (Standard quantity allowed * standard price).