Purchase Price Variance
Standard costing techniques in ERP
In absorption accounting, the measurement of the inflation or deflation of prices on raw material is measured with purchase price variance. A unit of raw material is assigned a standard cost for the year and the variation in landed cost for deliveries is tracked not with a complicated scheme of tracking on a lifo or fifo basis where each molecule of raw material can be allocated to a product that reaches the consumer, but a standard periodic cost is assigned to a unit of purchased goods. For example, if we choose to fix the cost of a #8-32 1/2″ Stainless round slotted head machine screw at $.15 for the year, the portion of the final cost of a product that uses this purchased item need not change just because the landed price for one million screws that week was $.149900 each.
We freeze the standard cost for the screw at $.15 and book a purchase price variance, favorable, of a hundred bucks. The mechanics require an accounting discipline and business logic in the purchasing and accounts payable departments of recording the landed price vs the standard. When an invoice is received from a vendor on the raw material account, the first thing we want to ascertain is that the material was received and that our vendor deserves to be paid for goods that were delivered and accepted for inventory. This means that a given purchase order receipt, which was a debit to inventory on hand for a given part number should be matched up with the invoice. This receipt is marked then as paid and the accounts payable can be processed with no shoe leather put to waste by either the purchasing or accounting departments.
A register of vouchers accepted for a given day then can be generated with the landed cost put against the standard cost to determine the favorable or unfavorable purchase price variance for raw material acquisition.