What is price variance in standard costing?
Price variance is a standard costing metric that answers one question: did you pay more or less than expected for the inputs you actually used? It isolates the price effect from the quantity effect, which is why it is always calculated using actual quantity — not budgeted quantity.
Standard costing systems establish a standard price for each input (material, labor, overhead) before the period begins. At period end, the actual price paid is compared to the standard. The difference — multiplied by actual quantity — is the price variance. It tells you whether purchasing or procurement performed above or below the standard set by management.
Price variance appears in two main forms in management accounting:
- Materials Price Variance (MPV) — measures whether the purchasing department paid above or below standard price for raw materials.
- Labor Rate Variance (LRV) — measures whether direct labor was paid above or below the standard wage rate. Same formula, different inputs.
Price variance formula
AP = Actual Price — what was actually paid per unit
SP = Standard Price — the budgeted/expected price per unit
AQ = Actual Quantity — units actually purchased or used
Result is Unfavorable (U) if AP > SP (paid more than standard)
Result is Favorable (F) if AP < SP (paid less than standard)
Here is a full variance waterfall for a raw materials example: standard price $10/unit, actual price $12/unit, 500 units purchased:
The $1,000 unfavorable variance means the purchasing department spent $1,000 more than the standard cost budget allowed for these 500 units. Management will investigate whether this was due to supplier price increases, emergency purchases, or a standard that needs revision.
Favorable vs unfavorable — what it means and what to do
Good news on paper — but investigate why. Was it a bulk discount that won't repeat? Lower-quality materials? A standard that was set too high? Favorable variances aren't always cause for celebration.
Means actual costs exceeded budget for the price component. Common causes: supplier price increases, rush orders, inflation since standard was set, or switching to a more expensive vendor.
The sign convention varies by textbook and company: some express unfavorable as a positive number (cost overrun), others as negative. What matters is the label — always append (F) or (U) to avoid confusion. In income statement terms, an unfavorable variance reduces profit and a favorable variance increases it.
When to investigate a price variance
Most companies apply a materiality threshold — for example, variances over 5% of standard cost or over $500 are flagged for investigation. Small random variances are expected and not worth the investigation cost. Large, consistent, or one-directional variances signal either a process problem or a standard that needs updating.
How to calculate price variance — step by step
Price variance in context — other standard cost variances
Price variance is one of several variances used in standard costing. Understanding which function is responsible for each variance helps direct corrective action.
Notice that price-type variances (Materials Price, Labor Rate) always use actual quantity in the formula — this isolates the price effect. Quantity-type variances (Materials Quantity, Labor Efficiency) always use standard price — this isolates the usage effect. The two effects are kept separate so that each function is held accountable only for what they control.
Four worked examples
Raw material price overrun
Standard price $10/unit. Actual price $12/unit. 500 units purchased.
= $2.00 × 500 = $1,000 U
✗ Unfavorable — paid $2 more per unit than standard
Negotiated below-standard price
Standard price $9/unit. Actual price $8/unit. 200 units purchased.
= −$1.00 × 200 = $200 F
✓ Favorable — paid $1 less per unit than standard
Volume discount on materials
Standard price $5.00/unit. Actual price $4.50/unit. 2,000 units purchased.
= −$0.50 × 2,000 = $1,000 F
→ Favorable — but verify quality wasn't compromised
Overtime premium pushes rate up
Standard rate $20/hr. Actual rate $22/hr. 1,000 hours worked.
= $2.00 × 1,000 = $2,000 U
✗ Unfavorable — overtime or senior workers used more than planned
Common mistakes when calculating price variance
- Using quantity used instead of quantity purchased. Materials price variance should use purchased quantity, not quantity used in production. This keeps the variance in the purchasing department's control. Using quantity used mixes the price effect with the production usage effect.
- Forgetting to label (F) or (U). A bare number like "$1,000" is ambiguous — it could be favorable or unfavorable depending on sign conventions. Always label the result to avoid misinterpretation in reports.
- Treating favorable variance as always good. A large favorable materials price variance might mean lower-quality materials were purchased, which can create quality issues downstream and cause unfavorable quantity variances in production.
- Confusing price variance with quantity variance. Price variance uses actual quantity and compares prices. Quantity variance uses standard price and compares quantities. They answer different questions and different departments are responsible.
- Updating standards too infrequently. If standard prices are outdated — set 18 months ago before inflation — every period will show unfavorable variances that reflect cost environment changes, not procurement performance. Standards should be reviewed at least annually.
FAQ
What is the formula for materials price variance?
Materials Price Variance = (Actual Price − Standard Price) × Actual Quantity Purchased. If actual price exceeds standard, the result is Unfavorable (U). If actual price is below standard, the result is Favorable (F). The same formula applies to Labor Rate Variance using actual and standard hourly wage rates.
Why does price variance use actual quantity, not standard quantity?
Using actual quantity isolates the price effect from the usage effect. If you used standard quantity instead, the variance would be contaminated by how much was used versus how much should have been used — that is a separate quantity variance. Actual quantity keeps price variance squarely in the purchasing department's control.
Where do I find the standard price?
The standard price is set by management before the accounting period and recorded in the standard cost card for each material or labor type. It is typically based on supplier contracts, historical averages, or engineering estimates. Find it in your cost accounting system or the standard cost master file for the relevant material or labor category.
Is a favorable price variance always good news?
Not always. A favorable variance means you paid less than standard, but this could indicate lower-quality materials, an unsustainably low price from a supplier offering a one-time deal, or a standard that was set too high. Always investigate the cause before concluding whether a favorable variance reflects genuine efficiency or potential quality risk.
What is the difference between price variance and quantity variance?
Price variance measures the cost of paying a different price than standard for the actual quantity used. Quantity variance measures the cost of using a different amount than standard, valued at standard price. Price variance is the responsibility of the purchasing function. Quantity variance is the responsibility of production management.
How is price variance recorded in the journal entry?
Debit Raw Materials Inventory at standard cost (SP × AQ). Credit Accounts Payable at actual cost (AP × AQ). The difference — the variance — is recorded as a debit to Materials Price Variance if unfavorable (cost overrun) or a credit if favorable (cost saving). The variance account is closed to Cost of Goods Sold at period end.