Direct Labor Efficiency Variance Definition and Explanation

Figure 10.43 shows the connection between the direct labor rate variance and direct labor time variance to total direct labor variance. 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. 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.

However, they spend 5.71 hours per unit (200,000 hours /35,000 units) on the actual production. Due to the unexpected increase in actual cost, the company’s profit will decrease. Management needs to investigate and solve the issue by reducing the actual time spend or revising the standard cost.

If the total actual cost incurred is less than the total standard cost, the variance is favorable. 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. Information relating to direct labor cost and production time is as follows.

What is Variance Analysis? Definition, Explanation, 4 Types of Variances

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. Another element this company and others must consider is a direct labor time variance.

For this reason, labor efficiency variances are generally watched more closely than labor rate variances. In a 42 hour week, the department produced 1,040 units of X despite the loss of 5% of the time paid due to abnormal reason. The hourly rates actually paid were Rs 6.20, Rs 6 and Rs 5.70 respectively to 10, 30 and 60 workers. When the actual cost differs from the standard cost, it is called variance. These include shift premiums, overtime payments and production down times, labor union influences, overstaffing and understaffing.

• At Finance Strategists, we partner with financial experts to ensure the accuracy of our financial content.
• If the variance demonstrates that actual labor rates were higher than expected labor rates, then the variance will be considered unfavorable.
• The pay cut was proposed to last as long as the company
  remained in bankruptcy and was expected to provide savings of
  approximately $620,000,000.
• With either of these formulas, the actual hours worked refers to the actual number of hours used at the actual production output.
• Use the following information to calculate direct labor efficiency variance.

It is the estimated price of material and labor that a company need to pay to supplier and workers. Note that both approaches—direct labor rate variance calculation
and the alternative calculation—yield the same result. Generally, the production department is responsible for direct labor efficiency variance. For example, if the variance is due to low-quality of materials, then the purchasing department is accountable. The labor efficiency variance is also known as the direct labor efficiency variance, and may sometimes be called (though less accurately) the labor variance. Possible causes of an unfavorable efficiency
variance include poorly trained workers, poor quality materials, faulty
equipment, and poor supervision.

Who Has Responsibility over DL Efficiency Variance?

An adverse labor efficiency variance suggests lower direct labor productivity during a period compared with the standard. The above formula for direct labour efficiency variance includes the following components. Direct labor efficiency variance pertain to the difference arising from employing more labor hours than planned. Based on the above information, the direct labour efficiency variance for Red Co. will be as follows. Later in Part 6 we will discuss what to do with the balances in the direct labor variance accounts under the heading What To Do With Variance Amounts. An unfavorable variance means that labor efficiency has worsened, and a favorable variance means that labor efficiency has increased.

Who is Responsible for the Labor Efficiency/Usage Variance?

Direct Labor Variance Analysis The labor rate variance is $1,000 unfavorable, meaning that the company is spending $1,000 more on labor than expected. Labor Cost Variance is the difference between the standard cost of labor for the actual output and the actual cost of labor for the production. The labor efficiency in hours is the difference between the total actual hours and standard hours. The total labor actual and standard hours were calculated as per step 1 and step 2 above.

Standard Costing Outline

Total actual and standard direct labor costs are calculated by multiplying number of hours by rate, and the results are shown in the last row of the first two columns. The standard direct labor hours allowed (SH) in the above formula is the product of standard direct labor hours per unit and number of finished units actually produced. Unfavorable efficiency variance means that the actual labor hours are higher than expected for a certain amount of a unit’s production. Favorable variance means that the actual labor hours’ usage is less than the actual labor hour usage for a certain amount of production. Use the following information to calculate present value formula. If the actual amount paid to workers is more than the standard amount allowed, an unfavorable labor rate variance occurs.

Direct Labor Time Variance

If this cannot be done, then the standard number of hours required to produce an item is increased to more closely reflect the actual level of efficiency. The most common causes of labor variances are changes in employee skills, supervision, production methods capabilities and tools. An example is when a highly paid worker performs a low-level task, which influences labor efficiency variance. As a result, the techniques for factory overhead evaluation vary considerably from company to company.

If the outcome is unfavorable, the actual costs related to labor were more than the expected (standard) costs. If the outcome is favorable, the actual costs related to labor are less than the expected (standard) costs. If the actual hours worked are less than the standard hours at the actual production output level, the variance will be a favorable variance.