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Price Variance Meaning
Price variance refers to the difference between the actual price paid for a product, material, or service and the expected price for that exact item. It plays a significant role in preparing a budget and helps a business become aware of the costs that need to be addressed as they have either exceeded the cost or remained short of meeting the expected price.
Moreover, it helps companies make appropriate decisions while deciding the number of items to order from the supplier. It could be used for both revenue and cost so a firm can evaluate and manage its revenue plus price in a better manner. Hence, this concept is used in cost accounting and financial management to assess the impact of cost fluctuations on a company's financial performance.
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- The price variance is a pricing strategy for goods and services indicated by the difference between the standard price and the accurate price multiplied by the actual quantity of products purchased.
- It is crucial for budget planning and aids in making a company aware of the expenditures that must be handled appropriately since they have either gone over budget or fallen short of expectations.
- Its formula is the standard price multiplied by the difference between the actual price and the standard price of the item ordered or purchased by the firm.
- Moreover, it occurs when the actual and estimated price of goods, services, materials, or labor vary from that of the standard price. At the same time, quantity variance occurs when the actual and estimated quantity of goods, services, materials, or labor vary from that of standard quantity.
Price Variance Explained
Price variance is a measure that quantifies the difference between the actual cost of a resource and the expected or budgeted cost of that resource. The concept is primarily used in cost accounting to decide how much of an item must be purchased. However, purchase price variance analysis, along with other variance analyses, plays a crucial role in managing procurement costs, making informed decisions, and optimizing cost structures.
Moreover, the price variance is not limited to cost but can be applied to revenue or selling price. While using revenue simply means the variance in actual income and the estimated revenue. Hence, the sales price variance helps assess whether the substantial revenue generated aligns with the expected or budgeted revenue based on the standard selling price.
Therefore, price variance accounting is not limited to just materials; it can also apply to other cost elements like labor, overhead, and more. One must be aware that price variance:
- Establishes efficacy of purchase department.
- Favorable variance means the purchasing department could buy raw materials at lower economic rates than the forecasted value.
- Unfavorable variance means the purchasing department could buy raw materials at higher inflated rates than the forecasted value.
Furthermore, a positive price variance indicates that the actual cost was lower than the standard cost, which could be due to favorable factors such as negotiating better prices with suppliers, and cost-saving initiatives. Conversely, a negative price variance suggests that the actual cost was higher than the standard cost, which might be due to factors like inflation, unexpected price increases, or inefficiencies in procurement. Besides, a purchase manager should only partially depend on variance parameters but instead go into full detail to know the actual reason for the differences in cost.
Formula
The price variance is an integral part of cost accounting. It gets used in budget preparation and planning for lacing orders of an item. Hence, we must know the material price variance formula to calculate as shown below:
Price Variance= (P−Standard Price) ×Q
Where:
P=Actual Price
Q=Actual Quantity
If upon using the above formula, one gets:
- The positive value of price variance.
- The negative value of price variance.
- The material price variance formula or purchase price variance also gets derived similarly.
Therefore, the result indicates whether the variance is favorable (positive) or unfavorable (negative), and it provides insights into how well the organization is managing costs compared to the budgeted or standard costs.
Examples
Let's use a few examples to understand the topic.
Example #1
Scenario:
Imagine a technology company called Quera that develops and sells software applications. The company budgets a standard cost of $50,000 for developing one software application, which includes costs for software engineers, project management, and overhead. Tech Innovators plans to create ten applications this quarter.
Actual Data:
- Actual Cost: The actual cost for developing one software application, including software engineers, project management, and overhead, is $48,000.
- Actual Quantity: Tech Innovators successfully developed ten applications during the quarter.
Calculation:
Using the formula for price variance:
Price Variance = (P- Standard Cost) × Actual Quantity
= ($48,000 - $50,000) × 10 Price Variance = -$20,000 (Favorable)
Interpretation: In this example, the calculated variance is -$20,000, indicating a favorable variance. Therefore, this means that the actual cost per application was $2,000 less than the standard budget. The negative value indicates that Quera achieved cost savings.
Conclusion: The favorable price variance of -$20,000 demonstrates that the firm successfully managed its development costs for each software application. The company can allocate resources more efficiently and enhance its profitability by achieving cost savings. Hence, this example underscores the significance of cost control in the technology sector, where effective project management and resource allocation are critical.
Example #2
Leading supplier of procurement market intelligence solutions, SpendEdge, has announced the conclusion of their most recent success story on obtaining visibility into $70 million of potential future purchases for a beverages brand. Hence, the case study demonstrates how the soft drink company was able to manage transaction volumes and track purchase price variance for raw materials.
The Outcome of the Case Study: The specialists at SpendEdge examined the customer's manufacturing and procurement data and offered in-depth insights to assist the client in creating a procedure for obtaining raw data from outside manufacturers. To compare the purchase order prices to internal price norms, they performed a buy price variance study. Therefore, this made it easier for the client to cut back on unnecessary spending, forecast sales costs, and lower product expenditures.
Price Variance vs Quantity Variance
Let us use the table below to compare the two:
| Price Variance | Quantity Variance |
|---|---|
| It occurs when the actual and estimated price of goods, services, materials, or labor vary from that of the standard price. | Quantity variance is when the actual and estimated quantity of goods, services, materials, or labor varies from the standard quantity. |
| This variance gets based on the standard cost that may vary with the opinion of the staff. | Moreover, it can be any arbitrary number. |
| Standard cost adversely affects the favorable or unfavorable price variance. | This variance is based on the standard cost that may vary with the opinion of the staff. |
| Bulk ordering for favorable price variance leads to high costs. | The baseline decides the favorable or unfavorable quantity variance. |
| Hence, it gets calculated by multiplying the difference between the estimated and actual price used multiplied by the standard cost. | Therefore, it gets calculated by multiplying the difference between the estimated and actual quantity used multiplied by the standard cost. |
Frequently Asked Questions (FAQs)
It is the difference between the standard or baseline price and the actual amount paid for a service or an item to purchase. It can be either unfavorable or favorable, which could be tracked monthly, quarterly, or yearly.
The purchase manager has the responsibility for material price variance. However, supervisors and production managers are responsible for labor efficiency and the number of materials. Moreover, department managers have the responsibility of handling the variances arising from purchases in a firm.
This analysis provides insights into how actual costs align with budgeted costs. It aids in refining budgeting processes and adjusting financial plans to account for unexpected cost fluctuations.
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