Even with a higher direct labor cost per hour, our total direct labor cost went down! So as we discussed, we can analyze the variance for labor efficiency by using the https://simple-accounting.org/ standard cost variance analysis chart on 10.3. It is always important, as you are starting to see, to look at all options as we work through management decisions.
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. Labor rate variance is the difference between actual cost of direct labor and its standard cost.
- 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. - For example, the standard may not reflect the changes imposed by a new union contract.
- According to the total direct labor variance, direct labor costs were $1,200 lower than expected, a favorable variance.
- When we review the results of the labor cost analysis, the one-dollar increase in the amount paid per hour was a good choice because there was a savings of four hundred hours.
Hiring new staff means that they will also be able to push out more total hours worked, resulting in more product. However, the rate that the new staff must be hired at is higher than the actual rate currently paid to employees. They calculate that hiring the extra staff would cost more than raising the hourly rates of the existing employees. So, they set a new standard rate, and existing employees enjoy a pay raise which helps morale. As a result, employees work harder since they have been rewarded for their efforts at the company, and the total hours required for the same amount of production go down.
Direct Material Variances
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. 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 use of the labor variance is questionable in a production environment, for two reasons. First, other costs usually comprise by far the largest part of manufacturing expenses, rendering labor immaterial. 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.
Follow-Up Meeting at Jerry’s Ice Cream
For example, many of the explanations shown in Figure 10.7 “Possible Causes of Direct Labor Variances for Jerry’s Ice Cream” might also apply to the favorable materials quantity variance. After collecting the necessary information described above, you are ready to substitute the numbers into the formula to compute the rate and hours (quantity) variances. There are a number of possible causes of a labor rate variance, which are noted below. Labor rate variance is the total difference between the total paid amount for a certain amount of labor and the standard amount that the labor usually commands. The time it takes to make a pair of shoes has gone from .5 to .6 hours.
This variance occurs because of differences in standard versus actual rates. For instance, rent is usually subject to a lease agreement that is relatively certain. Even though budget and actual numbers may differ little in the aggregate, the underlying fixed overhead variances are nevertheless worthy of close inspection.
The standard hours are the expected number of hours used at the actual production output. If there is no difference between the actual hours worked and the standard hours, the outcome will be zero, and no variance exists. The direct labor variance measures how efficiently the company uses labor as well as how effective it is at pricing labor.
Fixed Factory Overhead Variances
For example, a business may use a subassembly that is provided by a supplier, rather than using in-house labor to assemble several components. A labor standard may assume that a certain job classification will perform a designated task, when in fact a different position with a different pay rate may be performing the work. An overview of these two types of labor efficiency variance is given below. As mentioned earlier, the cause of one variance might influence
another variance. For example, many of the explanations shown in
Figure 10.7 might also apply to the favorable materials quantity
variance. The articles and research support materials available on this site are educational and are not intended to be investment or tax advice.
The human resources manager of Hodgson Industrial Design estimates that the average labor rate for the coming year for Hodgson’s production staff will be $25/hour. This estimate is based on a standard mix of personnel at different pay rates, as well as a reasonable proportion of overtime hours worked. Note that both approaches—the direct labor efficiency variance calculation and the alternative calculation—yield the same result.
When more is spent than applied, the balance (zz) is transferred to variance accounts representing the unfavorable outcome. 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 company capability statement example for job application, but this was offset by significant unfavorable labor efficiency.
Would you prefer to work with a financial professional remotely or in-person?
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. As a result, variance analysis for overhead is split between variances related to variable overhead and variances related to fixed overhead. 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.
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).
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. For example, a company is looking to hire more staff to meet the expected cost of labor in a production facility.