In a manufacturing company, the purchasing and accounting departments usually set a standard price for materials meeting certain engineering specifications. When setting a standard price, they consider factors such as market conditions, vendors’ quoted prices, and the optimum size of a purchase order. A direct materials cost variance (sometimes called a materials price variance or MPV) occurs when a company pays a higher or lower price than the standard price set for materials.

The direct materials cost variance is the difference between actual cost (AC) and standard cost allowed (SC) multiplied by the actual quantity of materials purchased (AQ). In equation form, the direct materials cost variance can be done in two ways:

Direct materials cost variance = (Actual Cost – Standard Cost) x Actual Quantity purchased

OR

(Actual Cost x Actual Quantity purchased) – (Standard Cost x Actual Quantity purchased)

Let’s look again at Boulevard Blanks’ partial income statement that compares budget to actual for the month of July:

For Boulevard Blanks, let’s assume that the standard cost of lumber is set at $6 per board foot and the standard quantity for each blank is four board feet. Based on production and sales being equal at 1,620 units, the total standard cost would have been $38,880. We see that in the budget for direct materials.

However, we also see that the actual total cost of direct materials was only $38,080. That means we came in under budget for that line item by $800. We call that a favorable budget variance because it increased our bottom line (obviously, other things also decreased the bottom line as well). Was that favorable variance of $800 a result of lower prices for our raw materials, or did our employees get more blanks out of the wood we bought (maybe they found a better way to arrange the patterns on the planks of wood)?

Let’s say our accounting records show that the company bought 6,800 board feet of lumber for that $38,080.

The actual unit cost of raw materials then was $38,080 / 6,800 = $5.60.

Let’s compute the direct materials cost variance:

Actual cost per unit was $5.60

Standard cost was $6.00

Actual quantity of materials bought/used was 6,800 board feet.

(AC – SC) * AQ = ($5.60 – $6.00) * 6,800 = (-$0.40) * 6,800 = -$2,720.00

The direct materials cost variance was a negative $2,720.

Alternatively:

(AC * AQ) – (SC * AQ) = ($5.60 * 6,800) – ($6.00 * 6,800) = $38,080 – $40,800 = -$2,720

We actually paid $38,080 for materials we expected to pay $40,800 for. Our purchasing department was able to find materials for less than our standard, saving us a significant amount of money, which in turn improves the bottom line, which means this is a favorable variance. We could interpret the negative number as “below expectations” which is possibly a good thing when it comes to cost. However, it is also possible that we gained those cost reductions by buying lesser quality raw materials which could hurt us in the long run.

Still, we would list this variance as $2,720 Favorable. Reporting the absolute value of the number (without regard to the negative sign) and a “Favorable” label makes this easier for management to read. We can also see that this is a favorable variance just based on the fact that we paid $5.60 per board food for our materials instead of the $6 that we used when building our budget.

Before we take a look at the direct materials efficiency variance, let’s check your understanding of the cost variance.