Skill
workers with high hourly rates of pay may be given duties that require little
skill and call for low hourly rates of pay. This will result in an unfavorable
labor rate variance, since the actual hourly rate of pay will exceed the
standard rate specified for the particular task. In contrast, a favorable rate
variance would result when workers who are paid at a rate lower than specified
in the standard are assigned to the task. Finally, overtime work at premium rates can be reason
of an unfavorable labor price variance if the overtime premium is charged to the labor account. A favorable DL rate variance occurs when the actual rate paid is less than the estimated standard rate. It usually occurs when less-skilled laborers are employed (hence, cheaper wage rate).
We have demonstrated how important it is for managers to be aware not only of the cost of labor, but also of the differences between budgeted labor costs and actual labor costs. This awareness helps managers make decisions that protect the financial health of their companies. A labor variance is a type of cost variance that focuses on labor rates and hours. The comparison that is used to compute a labor variance compares standard versus actual rates and hours for workers, typically on a specific project. These computations are important because they help managers to analyze differences between planned and actual costs related to labor.
The labor rate variance focuses on the wages
paid for labor and is defined as the difference between actual
costs for direct labor and budgeted costs based on the standards. The labor efficiency variance focuses on the quantity of
labor hours used in production. It is defined as the difference
between the actual number of direct labor hours worked and budgeted
direct labor hours that should have been worked based on the
standards. All tasks do not require equally skilled workers; some tasks are more complicated and require more experienced workers than others. This general fact should be kept in mind while assigning tasks to available work force.
- Labor rate variance is the difference between the expected cost of labor and the actual cost of labor.
- Clearly, this is favorable since the actual hours worked was lower than the expected (budgeted) hours.
- If, however, the actual rate of pay per hour is greater than the standard rate of pay per hour, the variance will be unfavorable.
- Lynn was surprised to
learn that direct labor and direct materials costs were so high,
particularly since actual materials used and actual direct labor
hours worked were below budget.
Recall from Figure 10.1 “Standard Costs at Jerry’s Ice Cream” that the standard rate for Jerry’s is $13 per direct labor hour and the standard direct labor hours is 0.10 per unit. Figure 10.6 “Direct Labor Variance Analysis for Jerry’s Ice Cream” shows how to calculate the labor rate and efficiency variances given the actual results and standards information. Review this figure carefully before moving on to the next section where these calculations are explained in detail. Recall from Figure 10.1 that the standard rate for Jerry’s is
$13 per direct labor hour and the standard direct labor hours is
0.10 per unit. Figure 10.6 shows how to calculate the labor rate
and efficiency variances given the actual results and standards
information. Review this figure carefully before moving on to the
next section where these calculations are explained in detail.
Direct Labor Variance Formulas
Since this measures the performance of workers, it may be caused by worker deficiencies or by poor production methods. Labor mix variance is the difference between the actual mix of labor and standard mix, caused by hiring or training costs. The following equations summarize the calculations for direct labor cost variance.
Direct Labor Efficiency Variance
Michelle
was asked to find out why direct labor and direct materials costs
were higher than budgeted, even after factoring in the 5 percent
increase in sales over the initial budget. Lynn was surprised to
learn that direct labor and direct materials costs were so high,
particularly since actual materials used and actual direct labor
hours worked were below budget. In this question, the Bright Company has experienced a favorable labor rate variance of $45 because it has paid a lower hourly rate ($5.40) than the standard hourly rate ($5.50). For Jerry’s Ice Cream, the standard allows for 0.10 labor hours per unit of production. Thus the 21,000 standard hours (SH) is 0.10 hours per unit × 210,000 units produced.
If the company produces 1,000 units, the standard direct labor cost will be $5,000 ($10 x 0.5 x 1,000). This information gives the management a way to
monitor and control production costs. Next, we calculate and
analyze variable manufacturing overhead cost variances. Figure https://intuit-payroll.org/ 10.43 shows the connection between the direct labor rate variance and direct labor time variance to total direct labor variance. Figure 8.4 shows the connection between the direct labor rate variance and direct labor time variance to total direct labor variance.
Causes of a Labor Rate Variance
An adverse labor rate variance indicates higher labor costs incurred during a period compared with the standard. Labor rate variance is the difference between the expected cost of labor and the actual cost of labor. The combination of the two variances can produce one overall total direct labor cost variance. Labor rate variance arises when labor is paid at a rate that differs from the standard wage rate.
What is the difference between labor rate and efficiency variance?
The direct labor rate variance would likely be favorable, perhaps totaling close to $620,000,000, depending on how much of these savings management anticipated when the budget was first established. The quantity variance is found by computing the difference between the actual hours multiplied by the standard rate and the standard hours multiplied the standard rate. The actual rate is not used in this computation because the focus is finding out how the change in hours, if any, had an effect on the total variance. Sometimes the two variances will be in the same direction, both positive or negative, while other times they will be in opposite directions, such as in the example we discussed.
How does Direct Labor Mix Variance occur?
In this case, the actual hours worked are 0.05 per box, the standard hours are 0.10 per box, and the standard rate per hour is $8.00. This is a favorable outcome because the actual hours worked were less than the standard hours expected. If the actual rate of pay per hour is less than the standard rate of pay per hour, the variance will be a favorable variance. If, however, the actual rate of pay per hour is greater than the standard rate of pay per hour, the variance will be unfavorable. This information gives the management a way to monitor and control production costs.
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. The direct labor variance measures how efficiently the company uses labor as well as how effective it is at pricing labor. To estimate how the combination of wages and hours affects total costs, compute the total direct labor variance.
Suppose, for example, the standard time to manufacture a product is one hour but the product is completed in 1.15 hours, the variance in hours would be 0.15 hours – unfavorable. If the direct labor cost is $6.00 per hour, the variance in dollars would be $0.90 (0.15 hours × $6.00). For proper financial measurement, the variance is working capital days normally expressed in dollars rather than hours. 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.
First, calculate the direct labor hourly rate that factors in the fringe benefits, hourly pay rate, and employee payroll taxes. The hourly rate is obtained by dividing the value of fringe benefits and payroll taxes by the number of hours worked in the specific payroll period. If the work performed cannot be connected to a specific employee, then the wages paid are considered indirect.