Purchase Price Variance
Purchase Price Variance (PPV) is a financial metric that measures the difference between the actual price paid for an item and its standard or planned cost. It’s used in cost accounting to monitor and manage costs related to purchasing goods and services.
PPV is calculated as:
PPV = (Actual Cost – Standard Cost) x Quantity Purchased
If the actual cost is higher than the standard cost, the variance is unfavorable because the company had to pay more than planned. If the actual cost is lower than the standard cost, the variance is favorable because the company paid less than what was budgeted.
PPV is a useful metric for businesses to track their procurement efficiency and cost control. However, it’s important to note that a favorable PPV isn’t always a good thing. For example, if a company consistently has a favorable PPV because it’s purchasing cheaper, lower-quality materials, this could lead to issues with product quality down the line.
Similarly, an unfavorable PPV might be justified if it results from purchasing higher-quality materials that lead to better product performance, lower defect rates, or higher customer satisfaction. Therefore, PPV should always be interpreted in the context of the company’s overall strategy and performance.
Example of a Purchase Price Variance
Imagine a furniture manufacturer, “WoodCraft”, which makes wooden chairs. The standard cost they’ve set for the wood needed for one chair is $20. However, due to a spike in lumber prices, the actual cost for the wood rises to $25 per chair.
Let’s say in a particular month, WoodCraft purchases enough wood to manufacture 100 chairs. Here’s how we’d calculate the Purchase Price Variance (PPV):
- Standard Cost per unit = $20
- Actual Cost per unit = $25
- Quantity Purchased = 100 units
So, the PPV is:
PPV = (Actual Cost – Standard Cost) x Quantity Purchased
PPV = ($25 – $20) x 100
PPV = $500
Since the actual cost is higher than the standard cost, this results in an unfavorable variance of $500. This means that WoodCraft spent $500 more than they had planned to for the wood for these 100 chairs.
This unfavorable PPV could signal that WoodCraft needs to revisit their cost standards, negotiate better prices with their suppliers, or find ways to offset the increased costs, perhaps by improving operational efficiency or increasing their sales prices.
