10 7 Direct Labor Variances Financial and Managerial Accounting

The total direct labor variance was favorable $8,600 ($183,600 vs. $175,000). However, detailed variance analysis is necessary to fully assess the nature of the labor variance. As will be shown, Blue Rail experienced a very favorable labor rate variance, but this https://turbo-tax.org/filing-a-joint-tax-return-when-married-living/ was offset by significant unfavorable labor efficiency. A direct labor variance is caused by differences in either wage rates or hours worked. As with direct materials variances, you can use either formulas or a diagram to compute direct labor variances.

The same calculation is shown as follows using the outcomes of the direct labor rate and time variances. When a company makes a product and compares the actual labor cost to the standard labor cost, the result is the total direct labor variance. With either of these formulas, the actual hours worked refers to the actual number of hours used at the actual production output. The standard rate per hour is the expected hourly rate paid to workers. The standard hours are the expected number of hours used at the actual production output.

The Formula for Direct Labor Mix Variance

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. The standard rate per hour is the expected rate of pay for workers to create one unit of product. The actual hours worked are the actual number of hours worked to create one unit of product. If there is no difference between the standard rate and the actual rate, the outcome will be zero, and no variance exists. A labor variance that is a negative number , on the other hand, is unfavorable and can result in profit that is lower than expected. An unfavorable variance occurs when actual direct labor costs are more than standard costs.

Overhead variances are a bit more challenging to calculate and evaluate. As a result, the techniques for factory overhead evaluation vary considerably from company to company. To begin, recall that overhead has both variable and fixed components (unlike direct labor and direct material that are exclusively variable in nature). The variable components may consist of items like indirect material, indirect labor, and factory supplies. Fixed factory overhead might include rent, depreciation, insurance, maintenance, and so forth.

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The labor efficiency variance calculation presented previously shows that 18,900 in actual hours worked is lower than the 21,000 budgeted hours. Clearly, this is favorable since the actual hours worked was lower than the expected (budgeted) hours. The labor efficiency variance is also known as the direct labor efficiency variance, and may sometimes be called (though less accurately) the labor variance. Standard variable overhead rate is the rate that can be determined with the budgeted variable overhead cost dividing by the level of activity which in this case is either labor hours or machine hours.

A negative value of direct labor efficiency variance means that excess direct labor hours have been used in production, implying that the labor-force has under-performed. 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. 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. 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.

of direct labor efficiency variance

Following is an illustration showing the flow of fixed costs into the Factory Overhead account, and on to Work in Process and the related variances. 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. 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.

In closing this discussion of standards and variances, be mindful that care should be taken in examining variances. If the original standards are not accurate and fair, the resulting variance signals will themselves prove quite misleading. But, a closer look reveals that overhead spending was quite favorable, while overhead efficiency was not so good. An unfavorable variance means that labor efficiency has worsened, and a favorable variance means that labor efficiency has increased.

Possible Causes of Direct Labor Variances

More labor hours would create an unfavorable labor efficiency variance, which could decrease your expected profit. Labor price variance equals the standard hourly rate you pay direct labor employees minus the actual hourly rate you pay them, times the actual hours they work during a certain period. This reflects the standard cost allocation of fixed overhead (i.e., 10,200 hours should be used to produce 3,400 units). Notice that this differs from the budgeted fixed overhead by $10,800, representing an unfavorable Fixed Overhead Volume Variance.

• Comparing labor price variance to labor efficiency variance helps you pinpoint areas of strength and weakness in your small business’s labor management.
• Or, one can perform the algebraic calculations for the price and quantity variances.
• Clearly, this is favorable since the actual hours worked was lower than the expected (budgeted) hours.
• This awareness helps managers make decisions that protect the financial health of their companies.
• An unfavorable variance occurs when actual direct labor costs are more than standard costs.

During a particular period, 5,000 actual hours were worked whereas work done was equivalent to 4,400 hours. 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. While calculating labour efficiency variance, abnormal idle time is deducted from actual time expended to ascertain the real efficiency of the workers. Each bottle has a standard labor cost of 1.5 hours at $35.00 per hour.

Labor Variance Factors

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. A good manager will want to explore the nature of variances relating to variable overhead. It is not sufficient to simply conclude that more or less was spent than intended. As with direct material and direct labor, it is possible that the prices paid for underlying components deviated from expectations (a variable overhead spending variance). On the other hand, it is possible that the company’s productive efficiency drove the variances (a variable overhead efficiency variance).

• In this case, the actual hours worked per box are 0.20, the standard hours per box are 0.10, and the standard rate per hour is $8.00.
• This is a variance in labour cost which arises due to substitution of labour when one grade of labour is substituted by another.
• A favorable variance occurs when your actual direct labor costs are less than your standard, or budgeted, costs, reports Accounting Coach.
• At the end of the month, you should go back over your actual spending to see how you did compared to your original plan.
• The unfavorable variance tells the management to look at the production process and identify where the loopholes are, and how to fix them.