Cost Accounting

Direct Material Variance Analysis

 
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.

 

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: (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)

 

Determining Favourable or Unfavourable Variance

  • Favourable - when the actual price is lower than the budgeted price which will result in 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 change 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 their quantity of direct materials purchased, reducing their bulk discount

 

Worked Example

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

 

Calculate the Direct Material Price Variance.

 

Formula: (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

 

Direct Material Usage Variance

The direct material usage variance measures the difference between the actual quantity of direct material used and the budgeted quantity of direct material used.

 

Formula: (Actual Quantity of Direct Material Used - Budgeted/Standard Quantity of Direct Material Used) * Budgeted/Standard Purchase Price of Direct Materials

(Note: you do not need to remember this as it is included in your formula sheet)

 

Determining Favourable or Unfavourable Variance

  • Favourable - when the actual quantity used is lower than the budgeted/standard quantity used, hence will result in negative answer

  • Unfavourable - when the actual quantity used is higher than the budgeted/standard quantity used, hence will result in a positive answer

 

Possible Explanations for Direct Material Usage Variances

Favourable:

  • The business employed more skilled labour who used less direct material from less wastage

  • The business produced a lower quantity of goods

  • The business utilised more efficient machinery that used less direct material

 

Unfavourable:

  • The business employed more junior, inexperienced employees who used more direct material from higher volumes of wastage

  • The business produced a higher quantity of goods

  • Rundown machinery produced more defected goods

 

Worked Example

Fab Pork Sausages Co. manufactures a variety of pork sausages using pork mince. In a financial year, the company expected to use 100 kg of pork mince at $10kg but instead used 90kg at $12 a kg.

 

Calculate the Direct Material Usage Variance

 

Formula: (Actual Quantity of Direct Material Used - Budgeted/Standard Quantity of Direct Material Used) * Budgeted/Standard Purchase Price of Direct Materials

= (90-100) * $10

= -$100

= -$100 is negative, hence the variance is favourable.

=$100 Favourable

 

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