Materials cost variance scenario: One type of DM

Scenario 1: One type of DM

A company produces Product A which uses only one direct material.

The following information was available for the month of April:

• Standard DM per unit of Product A: 2 kg
• Standard cost per unit of DM: $150
• Actual production achieved of Product A for the month of April: 134,000 units
• Actual materials purchased and used: 283,000 kg @ $143 per kg

Calculate the direct materials variances:

1. Materials price variance
2. Materials usage variance
3. Materials cost variance

Sign convention: each formula is standard − actual: a positive result is favorable (it raises operating income); a negative result is unfavorable (it lowers income). A favorable price variance can coincide with an unfavorable usage variance, as it does below.

Definitions

SP

Standard price per kg of direct material: $150.

AP

Actual price per kg of direct material: $143.

AQ

Actual quantity of direct material purchased and used: 283,000 kg.

SQ

Standard quantity of direct material allowed for the actual output: $134,000\times 2=268,000$ kg. Always base SQ on the actual units produced (134,000), not on budgeted production. This flexes the standard to actual output, so the usage variance measures efficiency only and contains no volume effect.

Scenario 1.1. Materials price variance

$$\begin{array}{rl}\text{Materials price variance}& =(\text{SP}\times \text{AQ})-(\text{AP}\times \text{AQ})\\ & =(150\times 283,000)-(143\times 283,000)\\ & =42,450,000-40,469,000\\ & =1,981,000(\text{F})\end{array}$$

The variance is favorable because the actual price per unit of direct material ($143) is lower than standard price ($150). Here purchases equal usage; when they differ, the price variance is usually based on quantity purchased.

Scenario 1.2. Materials usage variance

$$\begin{array}{rl}\text{Materials usage variance}& =(\text{SP}\times \text{SQ})-(\text{SP}\times \text{AQ})\\ & =(150\times 268,000)-(150\times 283,000)\\ & =40,200,000-42,450,000\\ & =-2,250,000\text{, i.e., }2,250,000(\text{U})\end{array}$$

SQ is defined above: the standard quantity of DM required for the actual production. The result is negative, so the variance is unfavorable: the actual amount of materials used in production is higher than standard.

Scenario 1.3. Materials cost variance

$$\begin{array}{rl}\text{Materials cost variance}& =(\text{Standard quantity}\times \text{Standard price})-(\text{Actual quantity}\times \text{Actual price})\\ & =(\text{SP}\times \text{SQ})-(\text{AP}\times \text{AQ})\\ & =(150\times 268,000)-(143\times 283,000)\\ & =40,200,000-40,469,000\\ & =-269,000\text{, i.e., }269,000(\text{U})\end{array}$$

The materials cost variance can also be a summation of the price and usage variances:

$$\begin{array}{rl}\text{Materials cost variance}& =\text{Materials price variance}+\text{Materials usage variance}\\ & =1,981,000+(-2,250,000)\\ & =-269,000\text{, i.e., }269,000(\text{U})\end{array}$$

The variance is unfavorable because the actual cost is higher than the standard cost; the favorable price variance only partly offsets the larger unfavorable usage variance. Cheaper material (favorable price) may explain more waste (unfavorable usage), so purchasing and production should be evaluated together rather than crediting purchasing alone.