Direct materials refer to the tangible components or raw materials used directly in manufacturing a finished product. They are physically identifiable and traceable materials in the final product. Similarly, direct materials are a critical part of the production process, as they get transformed with other materials to create the end product.
Companies must track the price paid for these materials to ensure they don’t exceed the budget. While the quantity may differ due to differences in production levels, the prices are more crucial. Companies can use direct materials price variance to track it.
What is Direct Materials Price Variance?
The direct materials price variance is a concept in managerial accounting that measures the difference between the actual and the standard cost of direct materials. It arises due to differences in the price paid for direct materials compared to the standard price predetermined by the company. As the name implies, it does not account for indirect materials used in production.
The direct materials price variance is crucial for cost control and performance evaluation. It allows companies to identify and analyze the reasons behind the differences in actual and standard costs of direct materials and take appropriate corrective actions to manage costs effectively. Several factors can impact direct materials price variance, including the following.
- Changes in market prices
- Supplier negotiations
- Quality issues
- Other external or internal factors affect the cost of acquiring direct materials for production.
How to Calculate Direct Materials Price Variance?
The formula for direct materials price variance is the same as other similar variances. However, it only accounts for materials the company can directly trace to a specific product. Nonetheless, the direct materials price variance formula is as below.
Direct materials price variance = (Actual direct materials quantity purchased x Actual rate per unit) – (Actual direct materials quantity purchased x Standard rate per unit)
Alternatively, the direct materials price variance formula may look as below.
Direct materials price variance = (Actual rate – Standard rate) x Actual direct materials quantity purchased
How to interpret the Direct Materials Price Variance?
Direct materials price variance can either be favourable or unfavourable. If the direct materials price variance is positive, it indicates that the actual cost of direct materials was lower than the standard cost. It may result from favourable factors such as lower market prices for raw materials, negotiating better supplier deals, or using lower-cost materials. It could also indicate effective cost management, purchasing efficiencies, or favourable exchange rates for imported materials.
If the variance is negative, it indicates that the actual cost of direct materials was higher than the standard cost. It may result from unfavourable factors such as higher market prices for raw materials, unexpected price increases from suppliers, poor supplier performance, or higher freight or handling charges. It could also indicate problems with purchasing, inventory management, or quality control that result in higher costs.
Example
A company, Red Co., purchased 10,000 units of direct materials during the period. The actual rate for these purchases was $10 per unit. However, the standard rate estimated at the start of that period was $8. Based on the above information, the direct material price variance for Red Co. is as follows.
Direct materials price variance = (Actual rate – Standard rate) x Actual direct materials quantity purchased
Direct materials price variance = ($10 – $8) x 10,000 units
Direct materials price variance = $20,000 (Adverse/Unfavorable)
Conclusion
Direct materials price variance refers to the difference between the standard price and the actual price paid for direct materials during a period. It is a crucial part of variance analysis for many companies. Essentially, it shows whether a company has incurred more or less for direct materials than anticipated through the standard rate.
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