All expenses, including labor costs, administrative costs, direct material prices, and more, are applicable to the concept of price variance idea. Let's see how the concept may be used to reduce direct material expenses. The idea is that if the notion works for one sort of cost, it will work just as well for other types of costs.
The difference between the actual price a company pays for a certain amount of direct material and the typical (expected) price of the direct material is known as the direct material price or rate variation.
Direct price variance is calculated in the following way:
Direct Material Price Variance = (SP − AP) × AQ
SP – Standard Price per unit
AP – Actual Price per unit
AQ – Quantity of purchased direct material
This variation provides insight into the purchase managers’ effectiveness in finding direct materials at reasonable prices. If there is a positive direct material price variance, the purchasing department will be able to buy the raw material at lower prices than the predicted value.
It's important to keep in mind that a company may not always benefit from a favorable direct material rate variation. Sometimes they have to order lower-quality materials when trying to save costs. Consequently, it is necessary to include both direct material quantity variance and direct material rate variance.