How does purchase price variance work?

Definition

Purchase price variance is the difference between the price you actually paid for materials and the standard price you planned. On the books, it is the invoice gap, set aside so inventory can stay at the expected unit cost.

A coffee roaster who planned $6 a pound and paid $7 has a $1 gap on each pound. That $1 is this variance; it is not extra beans used in the roast.

This figure is a cost difference, usually read on the Income Statement. It is not a liability, and it is not a new selling price.

Where it shows up

Balance Sheet: Related to inventory still carried at the standard price.

P&L: Related to paying more or less than the expected material price.

See also: Standard Cost · Cost Variance · Purchase Order

When you look at your Income Statement, this gap often sits near product cost. An unfavorable balance means invoices ran over the planned price for the pounds you bought.

When the gap is small, suppliers came close to the price you built into the recipe. When it is large, a harvest, a freight spike, or a rush buy likely moved the invoice.

The Balance Sheet may still hold the beans at the standard price. Raw materials inventory does not have to jump every time a bill comes in higher.

On the Statement of Cash Flows, paying the green-bean supplier is the cash event. The variance only labels why that payment did not match the planned dollars per pound.

How it works

The roaster sets a standard price per pound when the recipe is planned. That price is the expected invoice, not a hope written after the bag arrives.

A purchase order names the pounds and the agreed price. When the vendor bill arrives, the bookkeeper compares the billed price to the standard.

If the billed price is higher, the extra dollars are this variance, and it is unfavorable. If the billed price is lower, the leftover is favorable.

Accounts payable still rises for the full invoice. The split is only on the other side: inventory at standard, and this gap for the difference.

Direct materials are the usual subject. Freight that you treat as part of the in-door cost can sit in the same comparison if the standard was built that way.

Stay with the price per unit when you read this number. Extra pounds used in the roast are a usage gap, not this line.

Inventory valuation that uses a standard depends on this split. Without it, every invoice would rewrite the shelf.

Keep the purchase order, the bill, and the standard price list together. Anyone asking why beans ran $200 high should see the $1 per pound, not a blended mess.

Do not treat this gap as proof the bags were short. Short bags are a quantity problem; this line is the price on the bill.

After the period, repeating unfavorable gaps often mean the standard price is stale. Reset the target on purpose; do not let every invoice quietly become the new plan.

Example

A coffee roaster buys 200 pounds of green beans. The standard price is $6 a pound, so the shelf should hold $1,200.

The supplier bills $7 a pound, or $1,400. After the beans are on the floor at actual, the extra $200 is pulled out so inventory sits at the standard.

The variance is recorded:

Debit: Purchase price variance $200

Credit: Inventory $200

Inventory falls by $200 to the $1,200 standard, and the $200 gap hits the P&L. Cash has not moved on this entry; the payable still matches the $1,400 bill.

If the same 200 pounds had billed at $5.50, the entry would flip and inventory would be raised to standard. The favorable $100 would reduce product cost instead of raising it.

Common mix-ups

This gap is not the full cost variance. Cost variance also covers extra pounds used, extra hours, and overhead; this line is only the invoice price versus the standard price.

This gap is not landed cost. Landed cost is the full in-door amount; this line is the difference versus the price you planned.

This gap is not a quantity shortage. Missing pounds or damaged bags are a usage or a loss issue, even if the price on the bill was exactly the standard.

Related terms

• Standard Cost: A pre-set expected cost per unit used for planning and comparison.
• Cost Variance: The gap between actual cost and the standard or budgeted cost.
• Purchase Order: The document authorizing a purchase from a vendor at agreed terms.
• Vendor Bill: The invoice a supplier sends that becomes a payable.
• Direct Materials: Materials that can be traced directly to a finished product.
• Landed Cost: The full cost of getting a purchased item to your door, including freight and duties.
• Variance Analysis: Investigating and explaining differences between two sets of numbers.
• Gross Margin: Gross profit expressed as a percentage of revenue.