What is variance analysis?

Variance analysis is a budgeting tool used to evaluate performance in controlling expenses such as direct material costs or quantities and labour rates or hours.

Variance simply means the difference between the actual and the budgeted price of an expense or the quantity used of an expense.

What is Direct Material Price Variance?

Direct Material Price Variance measures the difference between the actual purchase price of direct materials and the budgeted/expected price of direct materials.

Formula for direct material price variance

DMPV = (Actual Price of Direct Material - Budgeted Price of Direct Material) * Actual Quantity of Direct Material Purchased

(Note: You do not need to remember this as it is on your formula sheet)

Unfavourable and Favourable Direct Material Price Variances

• Favourable - when the actual price is lower than the budgeted price which will result in a negative answer

• Unfavourable - when the actual purchase price is higher than the budgeted price which will result in a positive answer

Possible Explanations of Direct Material Price Variances

• Favourable - The business changed supplier to a competitor who was able to offer a cheaper price - The business purchased a larger quantity of direct materials allowing them to receive a bulk discount - The business purchased generic materials instead of higher quality materials

• Unfavourable - The business switched to more high-quality direct materials - The business changed suppliers who were unable to provide a competitive price - The business reduced the quantity of direct materials purchased, reducing their bulk discount

Worked Example Question

A company manufactures pencils and requires an input of graphite. The company expects the graphite to cost $15/kg and to use around 50 kgs, however, they used 55 kgs of graphite and purchased 60 kgs of graphite at a rate of $18/kg.

Q: Calculate the Direct Material Price Variance.

Solution:

= (Actual Price of Direct Material - Budgeted Price of Direct Material) * Actual Quantity of Direct Material Purchased

= ($18 - $15) * 60

= $3 * 60 = $180

= $180 is positive, hence the variance is unfavourable.

= $180 unfavourable