Quantity and Price Variance

An important reason for separating standards into two categories - price and quantity - is that different managers are usually responsible for buying and for using inputs and these two activities occur at different points in time. In the case of raw materials the purchasing manager is responsible for the price, and this responsibility is exercised at the time of purchase. In contrast, the production manager is responsible for the amount of raw materials used, and this responsibility is exercised when the materials are used in production, which may be many weeks or months after the purchase date. It is important, therefore, that we cleanly separate discrepancies due to deviations from price standards from those due to deviations from quantity standards. Differences between standard prices and actual prices and standard quantities and actual quantities are called variances. The act of calculating and interpreting variances is called variance analysis.

Direct Materials Price Variance:

Direct materials price variance is the difference between the actual purchase price and standard purchase price of materials. Direct materials price variance is calculated either at the time of purchase of direct materials or at the time when the direct materials are used. When this variance is computed at the time of purchase of materials it is called direct materials purchase price variance. When this variance is computed at the time of usage this is typically called direct materials price usage variance.

Direct materials price variance formula:

Following formula is used to calculate materials price variance:

[Materials Price Variance = (Actual quantity purchased × Actual price) − (Actual quantity purchased × Standard price)]

This formula is usually preferred and used by managers because it permits calculation of materials purchase price variance very quickly.

Example:

Colonial Pewter Company provides the following information:

Standard price of material is $4.00 per pond and 6,500 pounds of materials have bee purchased at a cost of $3.80 per pound. This cost figure includes freight and handling and is net of quantity discount. All the materials purchased has been used and an output of 2000 units is produced during the period.

Required: Calculate materials price variance.

Calculation of direct materials price variance:

= (6,500 pounds × $3.80) − (6,500 pounds × $4.00)

= $24,700  − $26,000

= $1,300 Favorable

A favorable material price variance of $1,300 exists because the actual price of materials purchased is less than the standard price of materials purchased. A material price variance is called unfavorable materials price variance if the actual price of materials purchased is more than the standard price of materials purchased.

Most companies compute materials price variance when the materials are purchased than they are used in production. There are two reasons for this practice. First, delaying the computation of the price variance until the materials used would result in less timely variance report. Second, by computing the price variance when the materials are purchased, the materials are carried in the inventory accounts at their standard costs. This greatly simplifies book keeping. When the materials price variance is computed at the time of purchase of materials it is typically called materials purchase price variance.

Isolation of Variances:

At what point should variances be isolated and brought to the attention of management? the answer is, the earlier the better. The sooner deviations from standard are brought to the attention of management, the sooner problems can be evaluated and corrected. Once the performance report has been prepared, what does management do with the price variance data? The most significant variances should be viewed as "red flags," calling attention to the fact that an exception has occurred that will require some explanation and perhaps follow-up effort. Normally, the performance report itself will contain some explanation of the reason for the variance, as shown above, In the case of Colonial Pewter Company, the purchasing department explained that favorable price variance resulted from bargaining for an especially good price.

Who is Responsible for Material Price Variance?

Generally speaking, the purchase manager has control over the price paid for goods and is therefore responsible for any price variation. Many factors influence the price paid for the goods, including number of units ordered in a lot, how the order is delivered, and the quality of materials purchased. A deviation in any of these factors from what was assumed when the standards were set can result in price variance. For example purchase of second grade materials rather than top-grade materials may be a reason of favorable price variance, since the lower grade material will generally be less costly but perhaps less suitable for production and can be a reason of unfavorable materials quantity variance.

However, someone other than purchasing manager could be responsible for materials price variance. For example, production is scheduled in such a way that the purchasing

manager must request express delivery. In this situation the production manager should be held responsible for the resulting price variance.

Direct Materials Quantity Standards:

Standard quantity per unit of direct materials is the amount of direct materials or raw materials that should be required to complete a single unit of product, including allowances for normal waste, spoilage, rejects, and similar inefficiencies.

Quantity of usage standards are generally developed from materials specifications prepared by the department of engineering (mechanical, electrical, or chemical) or product design. In a small or medium sized company, the superintendent or even the foremen will state basic specifications regarding type, quantity, and quality of raw materials need and operations to be performed.

Quantity standards should be set after the most economical size, shape, and quality of the product and the results expected from the use of various kinds and grades of materials have been analyzed The standard quantity should be increased to include allowances for acceptable levels of waste, spoilage, shrinkage, seepage, evaporation, and leakage. The determination of spoilage or waste should be based on figures that prevail after the experimental and developmental stages of the product have been passed.

The standard quantity per unit for direct materials should reflect the amount of material required for each unit of finished product, as well as an allowance for unavoidable waste, spoilage, and other normal inefficiencies.

Who is Responsible for Material Quantity Variance?

Excessive usage of materials that is usually a reason of unfavorable direct materials quantity variance may be due to inferior quality of materials,  untrained workers, poor supervision etc. Generally speaking production managers are held responsible for this variance. However purchasing department may also be held responsible for purchasing materials of inferior quality to economize on prices. Where purchasing department  purchases low grade direct materials at low prices to show a favorable materials price variance, the materials quantity variance is usually unfavorable due to inferior quality of direct materials.

A word of caution is in order. Variance analysis should not be used as an excuse to conduct which hunts or as a means of beating line managers and workers over the head. The emphasize must be on control in the sense of supporting the line managers and assisting them in meeting the goals that they have participated in setting for the company. In short, the emphasize should be positive rather than negative. Excessive dwelling on what has already happened, particularly in terms of trying to find someone to blame, can destroy morale and kill any cooperative spirit.

Overall or Net Factory Overhead Variance:

Overall or net factory overhead variance is the difference between actually incurred factory overhead and expenses charged into process using the standard factory overhead rate.

Formula of Overall or Net Factory Overhead Variance:

Overall or net overhead variance is calculated by the following formula:

[Actual overhead – Overhead charged to production]

Direct Labor price variance

Direct Labor price variance is also termed as direct labor rate variance. This variance measures any deviation from standard in the average hourly rate paid to direct labor workers. In other words, direct labor rate variance is the difference between the amount of actual hours worked at actual rate and actual hours worked at standard rate.

Who is responsible for the labor rate variance?

Since rate variances generally arise as a result of how labor is used, production supervisors bear responsibility for seeing that labor price variances are kept under control.

Problem 1:

Materials Variance Analysis:

The Schlosser Lawn Furniture Company uses 12 meters of aluminum pipe at $0.80 per meter as standard for the production of its Type A lawn chair. During one month's operations, 100,000 meters of the pipe were purchased at $0.78 a meter, and 7,200 chairs were produced using 87,300 meters of pipe. The materials price variance is recognized when materials are purchased.

Required: Materials price and quantity variances.Solution:

 Meters of pipe Unit Cost Amount

Actual quantity purchased 100,000 $0.78 actual $78,000

actual quantity purchased 100,000$0.80

standard$80,000

  ----------- ----------- -----------

Materials purchase price variance 100,000 $(0.02) $(2,000) fav.

  ======= ======= =======

Actual quantity used 87,300 0.80 standard $69,840

Standard quantity allowed 86,400 0.80 standard $69120

  ------------- ------------- -------------

Materials quantity variance 900 0.80 $720 Unfav

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Problem 2:

Materials Variance Analysis:

The standard price for material 3-291 is $3.65 per liter. During November, 2,000 liters were purchased at $3.60 per liter. The quantity of material 3-291 issued during the month was 1775 liters and the quantity allowed for November production was 1,825 liters. Calculate materials price variance, assuming that:

Required: Materials price variance, assuming that:

It is recorded at the time of purchase (Materials purchase price variance).

It is recorded at the time of issue (Materials price usage variance).

Solution:Liters Unit cost Amount

Actual quantity purchased 2,000 3.60 actual $7,200

Actual quantity purchased 2,000 3.65 standard 7,300

  --------- ------------- ---------

Materials purchase price variance 2,000 $ (0.05) $(100) fav.

  ====== ====== ======

Actual quantity used 1775 3.60 actual $6390.00

Actual quantity used 1775 3.65 standard $6478.75

  -------- ----------- -----------

Materials price usage variance 1775 $(0.05) (88.75)

  ====== ====== =======

Problem 3:

Labor Variance Analysis:

The processing of a product requires a standard of 0.8 direct labor hours per unit for Operation 4-802 at a standard wage rate of $6.75 per hour. The 2,000 units actually required 1,580 direct labor hours at a cost of $6.90 per hour.

Required: Calculate:

labor rate variance or Labor price variance.

Labor efficiency or usage or quantity variance.

Solution:  Time Rate Amount

Actual hours worked 1,580 $6.90 actual $10,902

Actual hours worked 1.580 $6.75 standard 10,665

-------- -------- --------

Labor rate variance 1,580 $0.15 $237 unfav.

  ===== ===== =====

Actual hours worked 1,580 $6.75 standard $10,665

Standard hours allowed 1,600 $6.75 standard $10,800

  ---------- ------------ -----------

Labor efficiency variance (20) 6.75 standard $(135) fav.

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