Definition of Purchase Price Variance
In standard costing, the purchase price variance is the difference between the actual cost per pound (or other unit of measure) for the raw materials the company purchased and the company’s standard cost per pound for the raw materials that were purchased. (The standard cost per pound is the cost that the company expected to pay for the year and was included in the company’s profit plan.) Any price variances for the materials purchased are recorded in the company’s general ledger account Materials Purchase Price Variance.
The company’s general ledger accounts for inventories (raw materials, work-in-process inventory, finished goods) and the cost of goods sold will contain the standard cost per pound for the raw materials.
Example of Reclassifying the Purchase Price Variance
Before a company’s financial statements are issued, the balance in the Materials Purchase Price Variance account must be reclassified or allocated to the following: raw materials inventory, work-in-process inventory, finished goods inventory, and the cost of goods sold.
The allocation should be based on the location of the raw materials which created the purchase 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 at the end of the year. (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.)
