Definition: A price variance is the difference between the actual revenue or cost and the budgeted revenue or cost because of a difference between the actual unit price and the budgeted unit price. In other words, it’s the difference between the amount management expected to profit from a sale and the amount they actually profited because of a change in unit price.
What Does Price Variance Mean?
Let’s take a look at how price variance can be used for both revenues and costs. A revenue price variance occurs when the actual revenues received are different from the budgeted revenues expected because a change in selling price occurred during the period. Assume a manufacturer creates a budget at the end of year one to forecast the next year’s revenues. In this budget, management assumes that specific amount of units will be produced and sold at a specific price.
Based on these assumptions, management can calculate the company’s budgeted revenues and profits for the next year. At some point in year two, the market is no longer willing to pay the prices that management anticipates, so the company is forced to drop its price per unit. Thus, the amount of revenues actually received is less than the budgeted amount. This is considered an unfavorable variance.
Example
The price variance can also be applied to costs. For example, when the manufacturer makes its budget, it assumes that it will be able to purchase materials at a specific price. In reality, the price of materials can go up and down throughout the year. There is no way of knowing what the price of oil, steel, or any other commodity will be in the next year. Thus, the company may pay less for materials than originally anticipated in the budget. This results in a favorable variance because the drop in material prices result in less costs for the manufacturer and increase its profits for the period.
