ABC Company has an annual production budget of 120,000 units and an annual DL budget of $3,840,000. Four hours are needed to complete a finished product and the company has established a standard rate of $8 per hour. The direct labor efficiency variance may be computed either in hours or in dollars. 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 normally expressed in dollars rather than hours.

Next, we calculate and

analyze variable manufacturing overhead cost variances. This information gives the management a way to monitor and control production costs. Next, we calculate and analyze variable manufacturing overhead cost variances. Figure 10.43 shows the connection between the direct labor rate variance and direct labor time variance to total direct labor variance.

- Labor rate variance arises when labor is paid at a rate that differs from the standard wage rate.
- If the tasks that are not so complicated are assigned to very experienced workers, an unfavorable labor rate variance may be the result.
- With either of these formulas, the actual rate per hour refers to the actual rate of pay for workers to create one unit of product.
- A positive DLRV would be unfavorable whereas a negative DLRV would be favorable.

For example, a rush order may require the payment of overtime in order to meet an aggressive delivery date. An overview of these two https://simple-accounting.org/ types of labor efficiency variance is given below. Kenneth W. Boyd has 30 years of experience in accounting and financial services.

Thus positive values of direct labor rate variance as calculated above, are favorable and negative values are unfavorable. In this case, the actual rate per hour is $7.50, the standard rate per hour is $8.00, and the actual hour worked is 0.10 hours per box. This is a favorable outcome because the actual rate of pay was less than the standard rate of pay. As a result of this favorable outcome information, the company may consider continuing operations as they exist, or could change future budget projections to reflect higher profit margins, among other things. With either of these formulas, the actual rate per hour refers to the actual rate of pay for workers to create one unit of product.

Direct labor rate variance is very similar in concept to direct material price variance. Watch this video presenting an instructor walking through the steps involved in calculating direct labor variances to learn more. Hence, variance arises due to the difference between actual time worked and the total hours that should have been worked.

## Labor rate variance definition

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. 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.

## Direct Labor Efficiency Variance

Commonly used direct labor variance formulas include the direct labor rate variance and the direct labor efficiency variance. If we compute for the actual rate per hour used (which will be useful for further analysis later), we would get $8.25; i.e. $325,875 divided by 39,500 hours. 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.

At Finance Strategists, we partner with financial experts to ensure the accuracy of our financial content. Mark P. Holtzman, PhD, CPA, is Chair of the Department of Accounting and Taxation at Seton Hall University. He has taught accounting at the college level for 17 years and runs the Accountinator website at , which gives practical accounting advice to entrepreneurs.

## Question Submitted

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. 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.

## How can companies reduce Direct Labor Mix Variance?

Labor rate variance arises when labor is paid at a rate that differs from the standard wage rate. Labor efficiency variance arises when the actual hours worked vary from standard, resulting in a higher or lower standard time recorded for a given output. 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). However, employees actually worked 3,600 hours, for which they were paid an average of $13 per hour. The direct labor hours are the number of direct labor hours needed to produce one unit of a product. The figure is obtained by dividing the total number of finished products by the total number of direct labor hours needed to produce them.

Labor yield variance arises when there is a variation in actual output from standard. 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. For example, assume that employees work 40 hours per week, earning $13 per hour. Get the sum of the benefits and taxes (100+50) and divide the figure by 40 to get 3.75. Direct labor refers to the salaries and wages paid to workers directly involved in the manufacture of a specific product or in performing a service.

It also shows that the actual rate per hour was $0.50 lower than standard cost (favorable). The total actual cost direct labor cost was $1,550 lower than the standard cost, which is a favorable outcome. Hitech manufacturing company is highly labor intensive and uses standard costing system. The standard time to manufacture a product at Hitech is 2.5 direct labor hours. With either of these formulas, the actual hours worked refers to the actual number of hours used at the actual production output. The standard hours are the expected number of hours used at the actual production output.

As with direct materials variances, all positive variances are

unfavorable, and all negative variances are favorable. The labor

rate variance calculation presented previously shows the actual

rate paid for labor was $15 per hour and the standard rate was $13. This results in an unfavorable variance since the actual

rate was higher than the expected (budgeted) rate.

If the actual hours worked are less than the standard hours at the actual production output level, the variance will be a favorable variance. A favorable outcome means you used fewer hours than anticipated to make the actual number of production units. If, however, the actual hours worked are greater than the standard hours at the actual production output level, the variance will be unfavorable. An unfavorable outcome means you used more hours than anticipated to make the actual number of production units.

When tracking the total cost incurred for a specific project, the direct labor cost must be added since it could constitute a significant portion of the project. Note that both approaches—the direct labor efficiency variance

calculation and the alternative calculation—yield the how to prepare a trial balance same

result. Actual labor costs may differ from budgeted costs due to differences in rate and efficiency. The following equations summarize the calculations for direct labor cost variance. Another element this company and others must consider is a direct labor time variance.

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