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A price variance reflects the difference between what was paid for inputs and what should have

been paid for inputs. A usage variance shows the cost difference between the quantity of actual input
and the quantity of standard input allowed for the actual output of the period. The quantity difference is
multiplied by a standard price to provide a monetary measure that can be recorded in the accounting
records. Usage variances focus on the efficiency of results or the relationship of input tooutput.
A total variance is the difference between total actual cost incurred and total standard cost
applied to the output produced during the period.
If the actual price or quantity amounts are larger than the standard price or quantity amounts, the
variance is unfavorable (U); if the standards are larger than the actuals, the variance is favorable (F).
The material price variance (MPV) indicates whether the amount paid for material was below or
above the standard price.
Standards have generally been set after comprehensive investigation of prices and quantities for the
various cost elements. Traditionally, these standards were almost always retained for at least one year
and, sometimes, for multiple years. Currently, the business environment (which includes suppliers,
technology, competition, product design, and manufacturing methods) changes so rapidly that a
standard may no longer be useful for management control purposes for an entire year.10 Company
management must consider whether to incorporate changes in the environment into the standards
during the year in which significant changes occur. Ignoring the changes is a simplistic approach that
allows the same type of cost to be recorded at the same amount all year. Thus, for example, any
material purchased during the year would be recorded at the same standard cost regardless of when the
purchase was made. This approach, although making recordkeeping easy, eliminates any opportunity to
adequately control costs or evaluate performance. Additionally, such an approach could create large
differentials between standard and actual costs, making standard costs unacceptable for external
reporting. Changing the standards to reflect price or quantity changes would make some aspects of
management control and performance evaluation more effective and others more difficult. For instance,
budgets prepared using the original standards would need to be adjusted before appropriate actual
comparisons could be made against them. Changing of standards also creates a problem for
recordkeeping and inventory valuation. At what standard cost should products be valuedthe standard
in effect when they were produced or the standard in effect when the financial statements are prepared?

Although production-point standards would be more closely related to actual costs, many of the
benefits discussed earlier in the chapter might be undermined. If possible, management may consider
combining these two choices in the accounting system. The original standards can be considered
frozen for budget purposes and a revised budget can be prepared using the new current standards.
The difference between these budgets would reflect variances related to business environment cost
changes. These variances could be designated as uncontrollable (such as those related to changes in the
market price of raw material) or internally initiated (such as changes in standard labor time resulting
from employee training or equipment rearrangement). Comparing the budget based on current
standards with actual costs would provide variances that would more adequately reflect internally
controllable causes, such as excess material and/or labor time usage caused by inferior material
Price Variance Based on Purchases versus on Usage
The price variance computation has traditionally been based on purchases rather than on usage. This
choice was made so as to calculate the variance as quickly as possible relative to the cost incurrence.
Although calculating the price variance for material at the purchase point allows managers to see the
impact of buying decisions more rapidly, such information may not be most relevant in a just-in-time
environment. Buying materials in quantities that are not needed for current production requires that the
materials be stored and moved, both of which are nonvalue-added activities. The trade-off in price
savings would need to be measured against the additional costs to determine the cost-benefit
relationship of such a purchase. Additionally, computing a price variance on purchases, rather than on
usage, may reduce the probability of recognizing a relationship between a favorable material price
variance and an unfavorable material quantity variance. If the favorable price variance resulted from
the purchase of low-grade material, the effects of that purchase will not be known until the material is
actually used.
The material usage variance in a standard costing system results from using more or less than the
standard quantity of direct materials specified for the actual goods produced. If the actual quantity of
the input direct materials is more than the standard quantity allowed for the good output, the variance is
unfavorable and the Material Usage Variance account will have a debit balance . If the actual quantity
of the input direct materials is less than the standard quantity allowed for the good output, the variance
is favorable and a credit will be entered in the Materials Usage Variance account.
When preparing the financial statements, a debit balance in the Materials Usage Variance account
(which means an unfavorable variance) will have to be added to the standard cost of the products. If the
standard costs associated with the variance are in the goods that have been sold, the debit balance in the
variance account will be added to the Cost of Goods Sold, an income statement expense. (This is
reasonable, because the standard cost is too low compared to the actual cost of the materials.) If the
output associated with the variances is entirely in finished goods inventory, then the debit balance in
the variance account will be added to the finished goods inventory amount reported on the balance
sheet. Again, this is necessary because the standard cost of the finished goods inventory is too low. If
the products are in work in process, finished goods inventory, and cost of goods sold, you would assign
the variance to all three categories based on the proportions associated with the variance amounts.
Accountants refer to this as prorating the variances. If the variance amount is insignificant, accountants
will simply assign these small variances to the cost of goods sold. This is reasonable if most of the
goods that were produced have been sold. Generally, inventories are small in relation to the quantities
Credit balances in the variance accounts represent favorable variances and will reduce the standard

costs that are reported as debit balances in inventory on the balance sheet or as cost of goods sold
expense on the income statement. The favorable variances will be prorated as discussed above or
simply credited to cost of goods sold when the variances are not significant or material in amount.
Do variance accounts have an impact on financial statements? Or are they for performance
evaluation only?
Since the financial statements must reflect the cost principle, both the standard costs and the variances
must be included in the financial statements.
For example, if a direct material has a standard cost of $400 but the company paid $422, the financial
statement must report $422 (the standard cost of $400 plus the price variance of $22).
How the variances are reported on the financial statements is discussed in the last part of our
Explanation of Standard Costing.
Variances should be reported in your financial package on your income statement (P&L) as part of your
COGS. They should be recognized as they occur.
Variances also impact your balance sheet because your inventory is typically based on a frozen
standard cost which does not account for variances. Most companies have a schedule of when they
make inventory valuation adjustments. Your inventory policies are going to effect how and when you
adjust. You will need to make an adjustment to essentially roll your variance into your standards for
proper valuation.
The part of your question that has me a little confused is what you mean by "Capitalize" a variance.
Typically when someone talks about capitalizing, I assume they are speaking of a fixed assets. The
deprecation for that asset could be a mfg variance, but that is handled the same way as all mfg
variances. Your depreciation policy will determine how the expense is allocated, and over what period
of time.
Title: Chief Financial Officer
Company: Professional Plumbing Group
(Chief Financial Officer at Professional Plumbing Group) | Feb 7, 2014
Standard cost is not an acceptable GAAP costing method, but it is used by many companies to analyze
actual costs and performance. As a result, the variances have to be adjusted on the balance sheet and
income statement in order to approximate the GAAP costing method officially adopted by the
company. As a result, while you will put most variances into inventory initially, how you amortize them
needs to fit that principle.
There are two instances where you would adjust the "normal" practice of amortizing variances from the
balance sheet into the income statement (COGS). The first is when your costs are running in excess of
realizable value. In that case you may not be able to "capitalize" any unfavorable variances in order to
stay under the lower of cost or market rules. The second is when you have a significant unusual and
costly event in your manufacturing - an extended shutdown due to operational issues or market events
were our most common. I don't know what the new codification number is because we still refer to
these variances as "FAS 151 variances." Those unusual spike costs are required to be expensed
Inventory cost variances can occur with standard costing as well as actual costing methods. Some
variances occur due to inventory velocity (the inventory has been received, valued, and moved prior to
the vendor payable for example), some are due to the variance from planned inventory value, some are

due to actions taken related to inventory (such as rework), and some can be due to re-valuation. You
can add others - such as currency revaluation variance - but I believe those four categories cover the
majority of scenarios.
Each variance category is different in its treatment for P&L and balance sheet purposes. The goals
around timing the move of variances to the P&L are to minimize risk related to inventory value
manipulation (possible with standard cost) and to optimize the match for COGS (actual revenue, actual
COGS). Reality is more complicated than theory with inventory - so general rules are usually worked
out with your auditors.
Some general rules related to variance categories:
1) PPV Variances. These can occur in any inventory model. Some people distinguish between PPV
Purchase (the difference between the PO price and the standard cost - an operations decision) and PPV
Invoice (the difference between the PO and what the vendor invoices you - an evaluation of your
procurement processes). Both of these variances are usually considered part of the inventory actual cost
- so they are often capitalized and moved to the P&L as inventory is sold. The most common model - if
you have the data to support it - is to amortize these variances to the P&L based on your inventory turn
2) Process Variances. These occur when goods are reworked or when your BOM includes costs that are
not actually occurred for the goods production (such as an alternative quality process that is included at
times). From an inventory value perspective these types of transactions do not add value to the
resulting inventory - so they are usually treated as period expenses.
3) Yield or Scrap Variances. These occur with deviation from plan (standard cost) and in actual costing
systems as well. They are also usually treated as part of actual inventory cost (since there is
manipulation risk here) and are treated the same as the PPV variances.
4) Revaluation of inventory is more complex in its treatment - and it is different from a pure purchase
or manufacturing variance. In general a write down is taken as a period P&L expense, while a write up
is amortized over inventory turns. However if you have very volatile inventory valuation (say you are
selling computer memory) you may have revaluation both ways that occurs so often it is always a
period expense. Or say you use something in your manufacturing process like gold that has an
independent value you will have separate potential rules for that
In standard costing, how is the purchase price variance reclassified to arrive at actual cost?
I assume that the purchase price variance was recorded at the time that the raw materials were
purchased. If that price variance is significant, it should be reclassified to the following: raw materials
inventory, work-in-process inventory, finished goods inventory, and cost of goods sold. The
reclassification is also known as prorating the variance or allocating the variance.
The reclassification of the purchase price variance should be based on the location of the raw materials
which had created the price variance. If those raw materials were recently purchased and are entirely in
the raw materials inventory, then all of the price variance should be assigned to the raw materials
inventory. If the price variance occurred throughout the year, the variance should be assigned to the raw
materials inventory, work-in-process inventory, finished goods inventory, and cost of goods sold based
on the quantity of the raw materials in each of these categories.
If the amount of the purchase price variance is very small and/or the inventory turnover rates are very
high, the entire amount of the price variance might be reclassified entirely to the cost of goods sold.
What is Purchase Price Variance?
Any company that is engaged in selling products has to take care of the manufacturing or production

cost of the products, the distribution and other costs involved in the entire supply chain. Purchase Price
Variance (PPV) can be defined as the price difference between the amount that is paid to a supplier to
buy a product and the actual cost of the product. If the actual cost has increased, it is known as positive
variance and on the contrary, if the actual cost has declined, it is called as negative variance. The actual
price is the amount, which the manufacturers want the company to pay for the item by considering the
quality, quantity and delivery. Purchase Price Variance is entirely based on the standard price, which in
turn is based on various factors that do not match the purchasing situation of the company. The ultimate
goal of any business is to purchase the materials for a cost that is below the budgeted amount.
The difference between the actual amount paid per product and the budgeted amount per product
multiplied by the number of purchased products is known as purchase price variance. The production
cost of the company is highly influenced by the purchase price variance of the materials; therefore, its
also called as material purchase price variance. To learn more about these concepts and how to actually
manage them, check out this introductory course on accounting.
How to Calculate Purchase Price Variance
Purchase price variance is calculated to know the efficiency of a purchasing department in buying the
raw material at low cost. An increased value of PPV means that the material is purchased for a lesser
amount than the standard price. A negative value of PPV means that the material is purchased for a
higher amount than the standard price fixed by the company. It is not always good to have a positive or
favourable PPV, as the quality of the materials might affect your product; hence, PPV should be
analyzed with direct material quantity variance. Sometimes, your purchasing department might
purchase the materials for a very low price than the standard price, which will be offset by the direct
material quantity variance due to the compromised material quality. Find out more about standard
prices and raw material cost implications in our this course on financial accounting.
Purchase price variance = (actual price standard price) X quantity.
Lets understand how to calculate purchase price variance by way of the following example:
Say for example, the manufacturing and purchasing staff of XYZ Company decides that the standard
cost should be set to $3.00, which is based on the volume of 5,000 that is being purchased for the
coming year. During the year, if the company buys 4000 products, it can take advantage of a
purchasing discount and ends up paying $3.50 per product. This creates a purchase price variance of
$0.50 per product, resulting in a variance of $1,500 for all the 4000 products.
How is Purchase Price Variance Reclassified?
Your purchase department would have measured the PPV at the time of purchasing of raw materials. If
there is a significant price variance, it should be reclassified into the inventory of raw materials,
inventory of work-in-process, the cost of the products and inventory of the finished products. The
reclassification of purchase price variance is also known as allocating the variance. If the amount of
PPV is very small, then with higher inventory turnover rates the entire amount of PPV should be
reclassified to the price of the products. Also, the reclassification should be based on the location of the
raw materials that created the price variance in the first place.
Causes of Purchase Price Variance
Purchase price variance is not mandatory in a manufacturing environment, wherein the raw materials
are purchased from the suppliers and delivered to the company when required. There are a number of
reasons for purchase price variance, some of which are listed below:

Layering issue The cost of the product is taken from the layering system of the inventory
such as first-in-first-out. As a result, the actual cost varies by a substantial margin from the
present market price.
Shortage of materials The shortage of commodity items increases the cost of the product.
On the basis of demand Companies often incur excess shipping charges to get materials
from suppliers on short notice.
Assumption of the volume The cost of the product is derived on the basis of purchasing
volume than the amount at which the company buys.
Benefits of Purchase Price Variance
There are a number of possibilities that cause price variance of a product. PPV can help you measure
the effectiveness of your companys product spending. If you are in the business of commodity selling,
you should undertake the developing standards for purchasing materials. Once you have formulated the
pricing of the purchased material and received approval for the budget from the management, you can
update that price as standard price of those materials at the beginning of the financial year. You will be
able to recognize the purchase price variance, as you start receiving the inventory in the warehouse.
In short, most businesses have a standard costing system that simplifies the inventory valuation.
However, the main problem with these standards is that they trigger unintended consequences down the
supply chain. Get more insights into accounting principles, to better understand its impact on your
business, with this course.
Purchasing has a role to play in adjusting the cost of the materials and drive for high quality materials.
The key is to understand the relation between the actual cost of the product, standards and variances
with their potential consequences for better supply chain management.
Exide a single product company uses standards to control costs. The materials, labor and variable
manufacturing overhead costs to produce one unit of product are given below:
Variable Overhead
Standard 4 Kg $7.2 = $28.8
1.6 hours $9 = $14.4 1.6 hours $3.6 = $5.76 $48.96
4.4 Kg $6.7 = $29.48 1.4 hours $9.7 = $13.58 1.4 hours $4.30 = $6.02 $49.08
During the most recent month, 4,800 units were produced. Exide purchased 21,120 kg of materials
from vendors and put into production. The vendors of raw materials are very reliable therefore the
company does not maintain any materials inventory.
1. Compute materials, labor and variable overhead variances. (Exide company recognizes
materials price variance at the time of purchase of materials.)
2. Prepare journal entries to record materials and labor variances.
(1) Computation of variances:
= (21,120 kg $ 6.7) (21,120 kg $ 7.2)
= $141,504 $152,064
= $10,560 Favorable
= (21,120 kg $7.2) (19,200 kg $7.2)

= $152,064 $138,240
= $13,824 Unfavorable
= (6,720* $9.7) (6,720 $9)
= $65,184 $60,480
= $4,704 Unfavorable
*4800 units 1.4 actual hours per unit
(6,720 hours $9) (7,680* hours $9)
= $60,480 $69,120
= $8,640 Favorable
*4800 units 1.6 standard hours per unit
= (6,720 hours $4.3) (6,720 hours $3.6)
= $28,896 $24,192
= $4704 Unfavorable
= (6,720 hours $3.6) (7,680 hours $3.6)
= $24,192 $27,648
= $3,456 Favorable
(2) Journal Entries:
Recording materials variances:
Direct materials
Direct materials price variance
Accounts payable
Work in process
Direct materials quantity variance
Direct materials
Recording labor variances:
Work in process
Direct labor rate variance
Direct labor efficiency variance
Wages payable