Rate variance definition
/What is a Rate Variance?
A rate variance is the difference between the actual price paid for something and the expected price, multiplied by the actual quantity purchased. The concept is used to track down instances in which a business is overpaying for goods, services, or labor. However, excessive attention to rate variances can have the negative effect of only focusing on cost reductions. Instead, it can make more sense to pay somewhat more for higher quality, which tends to reduce the total amount of expenses incurred. The formula is:
(Actual price - Standard price) x Actual quantity = Rate variance
Labor Rate Variance
The "rate" variance designation is most commonly applied to the labor rate variance, which involves the actual cost of direct labor in comparison to the standard cost of direct labor. An unfavorable variance means that the cost of labor was more expensive than anticipated, while a favorable variance indicates that the cost of labor was less expensive than planned. This information can be used for planning purposes in the development of budgets for future periods, as well as a feedback loop back to those employees responsible for the direct labor component of a business. For example, the variance can be used to evaluate the performance of a company's bargaining staff in setting hourly rates with the company union for the next contract period.
The labor rate variance is calculated as the difference between the actual labor rate paid and the standard rate, multiplied by the number of actual hours worked. The formula is as follows:
(Actual rate - Standard rate) x Actual hours worked = Labor rate variance
Purchase Price Variance
The "rate" variance uses a different designation when applied to the purchase of materials, and may be called the purchase price variance or the materials price variance. The purchase price variance is used to discover changes in the prices of goods and services. It can be used to spot instances in which the purchases being made differ in price from your planning levels. By using the variance, you can identify cases in which it can make sense to look for a different supplier, or to start pricing negotiations with an existing one. The variance can also indicate areas on which to focus when you want to reduce costs.
The purchase price variance is the difference between the actual price paid to buy an item and its standard price, multiplied by the actual number of units purchased. The formula is:
(Actual price - Standard price) x Actual quantity = Purchase price variance