Direct Labour Variances: Efficiency and Rate Impacts on Costing SLM Self Learning Material for MBA

In this case, the actual rate per hour is \(\$9.50\), the standard rate per hour is \(\$8.00\), and the actual hours worked per box are \(0.10\) hours. The difference in hours is multiplied by the standard price per hour, showing a $1,000 unfavorable direct labor time variance. This is offset by a larger favorable direct labor rate variance of $2,550. The net direct labor cost variance is still $1,550 (favorable), but this additional analysis shows how the time and rate differences contributed to the overall variance.

Introduction to Labor Variances

The actual rate of $7.50 is computed by dividing the total actual cost of labor by the actual hours ($217,500 total labor variance formula divided by 29,000 hours). A favorable efficiency variance indicates that fewer labor hours were used than the standard allowed. This could reflect improved worker productivity, better supervision, or process improvements. The following equations summarize the calculations for direct labor cost variance. A gang of workers usually consists of 10 men, 5 women and 5 boys in a factory. They are paid at standard hourly rates of Rs 1.25, Rs 0.80 and Rs 0.70 respectively.

Direct Labor Variance Analysis

• The fact that we expected to build 50 homes is irrelevant to this problem.
• The sum of all the variances calculated above shall equal to the direct labor variance in total.
• If the skilled labor takes less hours to produce more (or even same) number of units, the production will record a favorable labor efficiency planning variance.
• We spent more than we thought, making this an unfavorable variance.
• This is an unfavorable outcome because the actual hours worked were more than the standard hours expected per box.

Labor efficiency is directly linked with the labor skill levels. Ongoing and stable production staff and labor can be assessed for their skill level based on historic outputs. The management can plan accordingly for the labor hours taken to produce each product unit.

Direct labor variance analysis

• Insurance companies pay doctors according to a set schedule, so they set the labor standard.
• A favorable DL rate variance occurs when the actual rate paid is less than the estimated standard rate.
• It is that part of labour cost variance which arises due to the difference between standard labour cost of standard time for actual output and standard cost of actual time paid for.
• Because Band made 1,000 cases of books this year, employees should have worked 4,000 hours (1,000 cases x 4 hours per case).

Standard Labour Cost per unit Actual Yield in units – Standard Yield in units expected from the actual time worked on production. The standard output of ‘X’ is 25 units per hour in a manufacturing department of a company employing 100 workers. Instead of building 50 homes as we expected, we only built 35. When performing variance analysis, the number of units we expected to make is irrelevant.

3: Compute and Evaluate Labor Variances

At the end of each production unit, the management will then account for the actual labor hours against the revised labor hours. Any deviation will be noted as labor rate operational variance as the production operations caused the variance. The total direct labor variance is also found by combining the direct labor rate variance and the direct labor time variance. By showing the total direct labor variance as the sum of the two components, management can better analyze the two variances and enhance decision-making.

The total of both variances equals the total direct labor variance. However, a positive value of direct labor rate variance may not always be good. Direct labor rate variance must be analyzed in combination with direct labor efficiency variance. The direct labor variance measures how efficiently the company uses labor as well as how effective it is at pricing labor. There are two components to a labor variance, the direct labor rate variance and the direct labor time variance.

Any differences in revised budgets and the actual results due to efficiency in labor staff is recorded as labor efficiency operational variance. If we use more hours at the same rate of pay, it would be called a labor efficiency variance. An unfavorable rate variance happens when actual rates exceed standard rates.

Formula to Calculate Labor Variances

To compute the direct labor price variance, subtract the actual hours of direct labor at standard rate ($43,200) from the actual cost of direct labor ($46,800) to get a $3,600 unfavorable variance. This result means the company incurs an additional $3,600 in expense by paying its employees an average of $13 per hour rather than $12. (Figure) shows the connection between the direct labor rate variance and direct labor time variance to total direct labor variance.

We need to multiply this $1 by the total number of labor hours we used. We used 375 labor hours per home and built 35 homes, which totals 13,125 labor hours. We multiply these 13,125 total labor hours by our $1 difference per hour, and our price variance is $13,125.

The reason is that the highly experienced workers can generally be hired only at expensive wage rates. If, on the other hand, less experienced workers are assigned the complex tasks that require higher level of expertise, a favorable labor rate variance may occur. However, these workers may cause the quality issues due to lack of expertise and inflate the firm’s internal failure costs. In order to keep the overall direct labor cost inline with standards while maintaining the output quality, it is much important to assign right tasks to right workers. Total direct labor variance can also be divided into direct labor rate and direct labor efficiency variances.

We might have the same number of hours at a different hourly rate, or more hours at the same rate, or some combination of these factors. Let’s first look at the standard cost variance analysis chart for labor variances. However, it may also occur due to substandard or low quality direct materials which require more time to handle and process. If direct materials is the cause of adverse variance, then purchase manager should bear the responsibility for his negligence in acquiring the right materials for his factory. It is that portion of labour cost variance which is due to the abnormal idle time of workers. This variance is shown separately to show the effect of abnormal causes affecting production like power failure, breakdown of machinery, shortage of materials etc.