One of the requirements of a material accounting system is that it be able to determine just why material budgets were exceeded; this is called variance analysis. When the actual material costs exceed a material budget, there are normally two causes:
1. The articles purchased cost more than was planned, called a "price variance."
2. More articles were consumed than were planned, called a "usage variance."
Price variances (PV) occur when the budgeted price value (BCWS) of the material was different than what was actually experienced (ACWP). This condition can arise for a host of reasons: poor initial estimates, inflation, different materials used than were planned, too little money available to budget, and so on. The formula for price variance (PV) is:
PV = (Budgeted price - Actual price) X (Actual quantity)
Price variance is the difference between the budgeted cost for the bill of materials and the price paid for the bill of materials.
By contrast, usage variances (UV) occur when a greater quantity of materials is consumed than were planned. The formula for usage variance (UV) is:
UV = (Budgeted quantity - Actual quantity) X (Budgeted price)
Normally, usage variances are the resulting costs of materials used over and above the quantity called for in the bill of materials.
Consider the following example: The project manager establishes a material budget of 100 units (which includes 10 units for scrap factor) at a price of $150 per unit. Therefore, the material budget was set at $15,000. At the end of the short project, material actuals (ACWP) came in at $15,950, which was $950 over budget. What happened?
Applying the formulas defined previously,
Price variance (PV) = (BCWS price - ACWP price) X Actual quantity = ($150 per unit - $145 per unit) X 110 units = $550 favorable Usage variance (UV) = (BCWP qty - ACWP qty) X BCWS price = (100 units - 110 units) X $150 per unit = $1,500 unfavorable
The analysis indicates that your purchase price was less than you anticipated, thus generating a cost savings. However, you used 10 units more than planned for, thus generating an unfavorable usage variance. Further investigation indicated that your line manager had increased the scrap factor from 10 to 20 units.
Good business practices indicate that such variance analyses take place to determine why actual material costs exceed the budgeted material values.
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What you need to know about… Project Management Made Easy! Project management consists of more than just a large building project and can encompass small projects as well. No matter what the size of your project, you need to have some sort of project management. How you manage your project has everything to do with its outcome.