Purchase price variance

Purchase price variance (PPV) is a difference between standard catalogue price of materials and a price on the received invoice which should be paid to the supplier . Concept is able to be found in areas such as purchasing and production departments. According to Termini "this metric governs how much the company is to spend for materials in support of ongoing operations, whether is be for conversion into products or for company's own consumption like :

• office suppliers,
• production materials,
• maintenance materials,
• outside serviced."

Genesis of PPV

PPV comes from a lack of complete information about future occurrences, due to the fact that budgeting for forward purchases is made at the end of every year. Purchasing and Accounting set prices of material basing on former cost, arising them by up to 2 % . Upcoming fluctuation, for instance, gasoline or raw material prices will increase total prices what is quite unpredictable . Nicholas S. Katko suggest that "in some cases, determining the purchase price variance is difficult". For example, commodity which often change their price and suppliers may change prices without warning. The main impetus is to clarify processes and diminish time without production what improves standards and helps in maintaining quality . PPV in a longer period contributes to free competition, as a consequence of looking for lover prices. It develops new manufacturing, targets, and ideas .

Purchase price variance formula

Purchase Price Variance= "(Budget input price - Actual input price)x Actual quantity purchased"

Importance of PPV

We can distinguish PPV's impact between good called favorable and bad, literally named unfavorable. The first one can be used, when we have spent less money or resources than standards assumed. In opposite, favorable impact occurs in a situation when standard was not reached. Moreover, PPV is a very useful metric to gauge in terms of how successfully the production department works . Furthermore, PPV can press negative influence on quality of production due to cutting costs .

Examples of Purchase price variance

• A PPV can occur when a company purchases a large quantity of materials and receives a bulk discount. In this case, the company would expect to pay the standard catalogue price of the materials but the invoice amount would be lower due to the discount. The difference between the two amounts is the PPV.
• Another example is when a company realizes that the materials it has received from a supplier are of a higher quality than what was specified in the original agreement. In this case, the company may have to pay more for the materials than what was originally agreed upon. The difference between the two amounts is the PPV.
• A third example is when a company agrees to pay a certain amount for a material but the invoice amount is higher than what was agreed upon. The difference between the two amounts is the PPV.

Advantages of Purchase price variance

Purchase Price Variance (PPV) can be a useful tool for corporations to track their expenditures and negotiate better prices with suppliers. PPV allows for better control over the purchasing process and can help to identify areas for cost savings. The following are some of the advantages of using PPV:

• It helps to compare the actual cost of materials with the standard catalogue prices and provides an accurate picture of the actual cost of goods and services. This can be a useful tool for evaluating the effectiveness of the purchasing team.
• It also helps to identify any discrepancies in pricing between suppliers and can be used to negotiate better prices with them.
• PPV can be used to track spending patterns, which can help to identify potential cost savings.
• It also helps to track the performance of individual suppliers and identify areas for improvement.
• It can also be used to identify any potential issues with the supply chain and help to improve the supply chain process.

Limitations of Purchase price variance

Purchase price variance (PPV) can be a useful tool to help businesses monitor their spending, but there are some limitations in its use. These include:

• The PPV calculation does not take into account other factors such as quality, delivery time, or value-added services. This means that suppliers may be able to offer a lower price, but with poorer quality, longer lead times, or fewer services, resulting in an overall higher cost to the business.
• The PPV calculation is only able to compare the cost of the same items from different suppliers, not different items from the same supplier. This means that businesses may miss out on potential savings from switching to a more cost-effective supplier for a different item.
• PPV calculations cannot take into account discounts or other special offers. This means that businesses may be missing out on potential savings from suppliers who are willing to offer discounts on bulk orders or other special offers.
• Finally, PPV calculations cannot take into account the long-term costs associated with a particular supplier. For example, a supplier may offer low prices, but have poor customer service, slow delivery times, or unreliable quality, resulting in long-term costs to the business.

Other approaches related to Purchase price variance

Purchase price variance is an important concept in purchasing and production departments which measures the difference between standard catalogue price of materials and a price on the received invoice. Other approaches related to Purchase price variance include:

• material price variance (MPV) - the difference between the actual price paid and the standard price of the material
• quantity variance (QV) - the difference between the actual quantity of material used and the standard quantity of material
• total purchase cost variance (TPCV) - the difference between the total actual cost and the total standard cost

In conclusion, PPV is an important concept in purchasing and production departments which measures the difference between standard catalogue price of materials and a price on the received invoice. Other related approaches include MPV, QV and TPCV.

Footnotes

Purchase price variance — recommended articles

Joint demand — Inventory value — Step fixed cost — Cost variance — Mixed cost — Differential costing — Cost behavior — Double counting — Standard price

References

• Balakrishnan R.(red.), (2008), Managerial Accounting, John Wiley & Sons, Inc., New Jersey, Hoboken, p.328
• Burton T. T.,(2012), Out of the Present Crisis: Rediscovering Improvement in the New Economy, Productivity Press Book, CRC Press Taylor and Francis Group, Boca Raton, p.180
• Davis E.(red.), (2012), Managerial Accounting,John Wiley & Sons, Inc., New Jersey, Hoboken, p.302
• Hamilton S.,(2003), Maximizing Your ERP System: A Practical Guide for Managers, McGraw-Hill, New York, p.335
• Katko N. S. (2013), The Lean CFO: Architect of the Lean Management System, Productivity Press Book, CRC Press Taylor and Francis Group, Boca Raton, p.111
• Smith D., (1999), The Measurement Nightmare, Productivity Press Book, CRC Press Taylor and Francis Group, Boca Raton, p.59
• Sollish F.(red.), (2005), The Purchasing and Supply Manager's Guide to the C.P.M. Exam, Harbor Light Press,San Francisco, p.20
• Termini M. J.,(2007),Walking the Talk: Moving into Leadership, Society of Manufacturing Engineers, Dearborn,Michigan, p.21, 117

Author: Maria Kucz

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