What Is Price Variance in Cost Accounting?

Price variance is the actual unit cost of an item less its standard cost, multiplied by the quantity of actual units purchased. The standard cost of an item is its expected or budgeted cost based on engineering or production data. The variance shows that some costs need to be addressed by management because they are exceeding or not meeting the expected costs.

Key Takeaways:

  • Price variance is the actual unit cost of a purchased item, minus its standard cost, multiplied by the quantity of actual units purchased.
  • Price variance is a crucial factor in budget preparation.
  • A price variance shows that some costs need to be addressed by management because they are exceeding or not meeting the expected costs.

How Price Variance Works in Cost Accounting

Price variance is important for budgeting and planning purposes, particularly when companies are deciding what quantities of items to order. The formula for price variance is:

Price Variance=(PStandard Price)×Qwhere:P=Actual PriceQ=Actual Quantity\begin{aligned} &\text{Price Variance} = ( \text{P} - \text{Standard Price} ) \times \text{Q} \\ &\textbf{where:} \\ &\text{P} = \text{Actual Price} \\ &\text{Q} = \text{Actual Quantity} \\ \end{aligned}Price Variance=(PStandard Price)×Qwhere:P=Actual PriceQ=Actual Quantity

Based on the equation above, a positive price variance means the actual costs have increased over the standard price, and a negative price variance means the actual costs have decreased over the standard price.

In cost accounting, price variance comes into play when a company is planning its annual budget for the following year. The standard price is the price a company's management team thinks it should pay for an item, which is normally an input for its own product or service. Since the standard price of an item is determined months prior to actually purchasing the item, price variance occurs if the actual price at the time of purchase is higher or lower than the standard price determined in the planning stage of the company's annual budget.

The most common example of price variance occurs when there is a change in the number of units required to be purchased. For example, at the beginning of the year, when a company is planning for Q4, it forecasts it needs 10,000 units of an item at a price of $5.50. Since it is purchasing 10,000 units, it receives a discount of 10%, bringing the per unit cost down to $5. When the company gets to Q4, however, if it only needs 8,000 units of that item, the company will not receive the 10% discount it initially planned, which brings the per unit cost to $5.50 and the price variance to 50 cents per unit.

Achieving a Favorable Price Variance

A company might achieve a favorable price variance by buying goods in bulk or large quantities, but this strategy brings the risk of excess inventory. Buying smaller quantities is also risky because the company may run out of supplies, which can lead to an unfavorable price variance. Businesses must plan carefully using data to effectively its price variances.