Price variance is the difference between the actual price paid by a company to purchase an item and its standard price, multiplied by the number of units purchased. The formula for price variance is:
Price Variance=(Actual Price−Standard Price)×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, it turns out it only needs 8,000 units of that item. It does 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.
(For related reading, see "What Are the Different Types of Costs in Cost Accounting?")