Purchase Price Variance

Purchase Price Variance (PPV) reflects the difference between the actual amount paid for a product or service and the standard or expected amount for the same. It is a crucial metric in cost accounting. This value indicates the impact of fluctuations in purchase prices on the company's finances.

When the actual cost deviates from the predetermined standard cost, a PPV arises. Monitoring and analyzing this variance is crucial for managerial decision-making. It provides insights into the efficiency of procurement processes, supplier relationships, and overall cost management. Moreover, businesses can enhance their financial control and optimize resource utilization by managing this variance effectively.

• Purchase price variance is a significant cost accounting measure and it is the difference between the actual price paid for a product or service and the standard or expected price. 
• This value represents the influence of fluctuating purchasing prices on the company's finances. It provides insights into the efficiency of procurement procedures, relationships with vendors, and overall expense planning. 
• Additionally, by efficiently managing the variance, organizations may enhance their financial management and optimize their utilization of resources.
• This strategy helps prevent cost overruns and is necessary for financial planning.

Purchase price variance represents the difference between the actual cost incurred for acquiring goods or services and the standard cost that was anticipated or budgeted. The variance acts as a financial indicator and offers insights into the efficiency of a company's procurement processes and its ability to manage costs effectively.

When a business purchases items, it establishes a standard cost based on several factors, including historical data, market trends , and negotiated agreements with suppliers. This standard cost serves as a benchmark against which the actual purchase cost is measured. The PPV arises when there is a disparity between the anticipated cost and the actual cost paid.

This variance could result from unexpected price fluctuations, quality issues requiring additional expenditures, and other unforeseen circumstances. Monitoring and analyzing PPV is essential for managerial decision-making. Addressing this variance involves a combination of strategic sourcing, supplier relationship management, and ongoing cost analysis. It helps businesses enhance their financial control, optimize resource allocation, and maintain competitiveness in the market.

The factors that contribute to PPV are:

• Fluctuations in supplier prices are a primary factor that influences PPV. Changes in the cost of raw materials or components can directly impact the overall purchase cost.
• Variances in the quantity of items purchased compared to the standard quantity can contribute to this value. It may result from changes in production requirements, order sizes, or unexpected changes in demand.
• If the quality of received goods differs from the expected standard, additional costs may be incurred to rectify or address quality issues. This may contribute to an unfavorable PPV.
• Delays, disruptions, or inefficiencies in supplier performance may impact costs. For instance, if a supplier fails to meet delivery deadlines, it may result in increased expenses.
• Discounts or rebates negotiated with suppliers can influence PPV. If a company secures better terms than initially anticipated, it can lead to a favorable variance.

One can calculate it by using the purchase price variance formula. The formula is as follows:

PPV = ( Actual Cost Incurred - Standard Cost ) x Actual Quantity

When PPV is favorable, it implies that the company paid a lesser price than the expected cost. An unfavorable PPV shows that the actual costs exceeded the expected cost, leading to an increase in the expenses.

Let us study the following purchase price variance examples to understand this concept:

Example #1

Suppose Hexagon Technologies is a software company. The company's IT department needs to upgrade the laptops for several team members. The department purchases twenty new laptops from the company's regular supplier. The supplier offers a significant discount that reduces the price of each laptop from $2,000 to $1,500 per unit.

Thus, according to the purchase price variance formula,

PPV = ( Actual Cost Incurred - Standard Cost ) x Actual Quantity

Standard cost = $2,000

Actual cost = $1,500

Actual quantity = 20

Thus, the PPV on the purchase is $10,000 for 20 units.

Example #2

Suppose Roxy Ltd is a company that budgets $1,000 as the standard cost to purchase a specific quantity of raw materials for production. However, a supplier offered them a promotional discount, and the company ended up paying only $900 for the same quantity. In this scenario, the company saved money compared to the anticipated expenses. However, due to an unexpected price surge in transportation costs, Roxy Ltd paid $5,000 more for the same quantity of raw materials, resulting in an unfavorable PPV.

The importance of PPV is as follows:

• It helps in evaluating the effectiveness of cost control measures. Organizations can identify areas where they are either saving or overspending by comparing actual purchase costs with the standard costs. This process enables them to take corrective actions.
• Monitoring PPV ensures that actual costs align with budgeted or standard costs. This measure is crucial for financial planning and helps in avoiding budget overruns. It aids in contributing to overall financial stability.
• Purchase price variance analysis allows businesses to assess the performance of their suppliers. It provides insights into how well the suppliers adhere to negotiated prices and contract terms. This method helps in supplier selection and relationship management.
• Understanding PPV aids in making strategic sourcing decisions. Businesses can use this information to negotiate better terms with suppliers, explore alternative sourcing options, and enhance overall procurement strategies.

Here are the main differences between the two:

Purchase Price Variance

• PPV is a measure that assesses the difference between the actual cost of purchased goods or services and the standard cost that was budgeted or expected.
• It is concerned with the per-unit cost of the items purchased and how it compares to the anticipated standard cost.
• PPV is often influenced by factors such as changes in supplier pricing, negotiations, or fluctuations in the cost of raw materials.
• Monitoring PPV helps in identifying cost-saving opportunities and areas where the company might be overspending. It contributes to effective cost control.

Invoice Price Variance

• Invoice Price Variance (IPV) is a metric related to procurement and cost management. It explicitly addresses discrepancies between the actual invoiced amount and the standard cost.
• It focuses on the overall amount invoiced for a set of goods or services. This value encompasses the unit price differences and also factors like quantity and discounts.
• IPV requires a review of invoices to ensure that the amounts billed align with the agreed-upon terms, including any negotiated discounts or rebates.
• The variance is vital for maintaining financial accuracy, as discrepancies in invoiced amounts can impact financial statements and profitability calculations.

This article has been a guide to what is Purchase Price Variance. We explain its formula, how to calculate it with examples and its comparison with invoice price variance. You may also find some useful articles here -

• Variance In Accounting
• Price Appreciation
• Production Volume Variance