Definition
In accounting, a price variance is the difference between the actual price paid for a commodity or service and the standard price that was expected. It highlights discrepancies in the cost expectations and is a critical tool in performance evaluation and cost control. Price variances can be favorable or unfavorable — favorable variance indicates that the actual cost is less than the standard cost, while unfavorable variance means that actual expenses have exceeded the budgeted amount.
Examples
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Direct Materials Price Variance:
- Scenario: A company expected to purchase raw materials at $5 per unit. However, due to market fluctuations, the actual purchase price became $6 per unit.
- Calculation: (Actual Price - Standard Price) x Actual Quantity = ($6 - $5) x 100 units = $100 Unfavorable Variance.
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Sales Margin Price Variance:
- Scenario: A company budgeted to sell a product at $20 per unit but ended up selling it at $22 per unit.
- Calculation: (Actual Selling Price - Budgeted Selling Price) x Actual Quantity Sold = ($22 - $20) x 50 units = $100 Favorable Variance.
Frequently Asked Questions (FAQs)
Q1: What causes price variance? A1: Price variance can be caused by multiple factors including market price fluctuations, changes in supplier pricing, bulk purchase discounts, inflation, and errors in standard cost setting.
Q2: How is price variance used in managerial accounting? A2: Managers utilize price variance to assess purchasing performance, negotiate better pricing with suppliers, and adjust cost control measures for better financial outcomes.
Q3: How does price variance differ from quantity variance? A3: Price variance focuses on the difference between actual price and standard price, whereas quantity variance addresses the difference between the actual quantity used and the standard quantity expected to be used.
Q4: Can price variance be both favorable and unfavorable in the same financial report? A4: Yes, price variance can be both favorable and unfavorable within the same report, depending on the specific categories being analyzed.
Q5: What steps can a company take to minimize unfavorable price variances? A5: Companies can minimize unfavorable price variances by negotiating fixed pricing contracts with suppliers, improving forecast accuracy, bulk purchasing to obtain better rates, and continuous market analysis.
Related Terms
- Direct Materials Price Variance: The variance that arises when there is a difference between the actual cost of raw materials and the standard cost anticipated.
- Standard Cost: A pre-determined or estimated cost used for budgeting and performance evaluation purposes.
- Budget Variance: The difference between budgeted figures and actual figures for a given period.
- Variance Analysis: The process of investigating the reasons behind variances between actual results and standard or budgeted results.
- Favorable Variance: Occurs when actual costs are less than standard costs or when actual revenues exceed expected revenues.
- Unfavorable Variance: Occurs when actual costs exceed standard costs or when actual revenues are less than expected revenues.
Online References
- Investopedia: Price Variance
- Accounting Tools: Price Variance
- Corporate Finance Institute: Variance Analysis
Suggested Books for Further Studies
- “Cost Accounting: A Managerial Emphasis” by Charles T. Horngren, Srikant M. Datar, and Madhav V. Rajan
- “Managerial Accounting” by Ray H. Garrison, Eric Noreen, and Peter C. Brewer
- “Accounting for Decision Making and Control” by Jerold Zimmerman
- “Fundamentals of Cost Accounting” by William N. Lanen, Shannon W. Anderson, and Michael Maher
- “Financial & Managerial Accounting” by Jerry J. Weygandt, Paul D. Kimmel, and Donald E. Kieso
Accounting Basics: “Price Variance” Fundamentals Quiz
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