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

## Favorable and unfavorable variance

It usually occurs when less-skilled laborers are employed (hence, cheaper wage rate). 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. In other words, when actual number of hours worked differ from the standard number of hours allowed to manufacture a certain number of units, labor efficiency variance occurs. 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.

## Accounting for Managers

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. Jerry (president and owner), Tom (sales manager), Lynn(production manager), and Michelle (treasurer and controller) wereat the meeting described at the opening of this chapter. Michellewas asked to find out why direct labor and direct materials costswere higher than budgeted, even after factoring in the 5 percentincrease in sales over the initial budget.

## How Are Standard Rates Created?

- According to the total direct labor variance, direct labor costs were $1,200 lower than expected, a favorable variance.
- The standard time to manufacture a product at Hitech is 2.5 direct labor hours.
- Thus positive values of direct labor rate variance as calculated above, are favorable and negative values are unfavorable.
- Dan advises clients on strategic planning, federal and state tax issues, transactional matters, and employee benefits.
- When low skilled workers are recruited at a lower wage rate, the direct labor rate variance will be favorable however, such workers will likely be inefficient and will generate a poor direct labor efficiency variance.

In addition, the difference between the actual and standard rates sometimes simply means that there has been a change in the general wage rates in the industry. Direct labor rate variance is very similar in concept to direct material price variance. The most common causes of labor variances are changes in employee skills, supervision, production methods capabilities and tools.

Recall from Figure 10.1 that the standard rate for Jerry’s is$13 per direct labor hour and the standard direct labor hours is0.10 per unit. Figure 10.6 shows how to calculate the labor rateand efficiency variances given the actual results and standardsinformation. Review this figure carefully before moving on to thenext section where these calculations are explained in detail. Figure 10.43 shows the connection between the direct labor rate variance and direct labor time variance to total direct labor variance. 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.

As with direct materials, the price and quantity variances add up to the total direct labor variance. Direct labor rate variance determines the performance of human resource department in negotiating lower wage rates with employees and labor unions. A positive value of direct labor rate variance is achieved when standard direct labor rate exceeds actual direct labor rate.

Thus positive values of direct labor rate variance as calculated above, are favorable and negative values are unfavorable. Each bottle has a standard labor cost of \(1.5\) hours at \(\$35.00\) per hour. Calculate the labor rate variance, labor time variance, and total labor variance.

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 actual hours worked are the total hours worked by the employees. The formula calculates the differences between rates, given the number of hours worked.

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. Even with a higher direct labor cost per hour, our total direct labor cost went down! Direct labor rate variance arise from the difference in actual pay rate of laborers versus what is budgeted.

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. 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). In situations where goods are produced in small volume or on a customized basis, there may be little point in tracking this variance, since the work environment makes it difficult to create standards or reduce labor costs. If the total actual cost incurred is less than the total standard cost, the variance is favorable. A favorable labor rate variance suggests cost efficient employment of direct labor by the organization.

Next, we calculate and analyze variable manufacturing overhead cost variances. As stated earlier, variance analysis is the controlphase of budgeting. This information gives the management a way tomonitor and control production costs. Next, we calculate andanalyze variable manufacturing overhead cost variances. 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.

Mary’s new hire isn’t doing as well as expected, but what if the opposite had happened? What if adding Jake to the team has speeded up the production setting up a mobile office for your business process and now it was only taking .4 hours to produce a pair of shoes? The time it takes to make a pair of shoes has gone from .5 to .6 hours.

In such situations, a better idea may be to dispense with direct labor efficiency variance – at least for the sake of workers’ motivation at factory floor. However, a positive value of direct labor rate variance may not always be good. When low skilled workers are recruited at a lower wage rate, the direct labor rate variance will be favorable however, such workers will likely be inefficient and will generate a poor direct labor efficiency variance. Direct labor rate variance must be analyzed in combination with direct labor efficiency variance. At first glance, the responsibility of any unfavorable direct labor efficiency variance lies with the production supervisors and/or foremen because they are generally the persons in charge of using direct labor force.

The total actual cost direct labor cost was $1,550 lower than the standard cost, which is a favorable outcome. Direct labor rate variance is equal to the difference between actual hourly rate and standard hourly rate multiplied by the actual hours worked during the period. The variance would be favorable if the actual direct labor cost is less than the standard https://www.bookkeeping-reviews.com/ direct labor cost allowed for actual hours worked by direct labor workers during the period concerned. Conversely, it would be unfavorable if the actual direct labor cost is more than the standard direct labor cost allowed for actual hours worked. A favorable DL rate variance occurs when the actual rate paid is less than the estimated standard rate.

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. United Airlines asked a bankruptcy court to allow a one-time 4 percent pay cut for pilots, flight attendants, mechanics, flight controllers, and ticket agents.

Though unfavorable, the variance may have a positive effect on the efficiency of production (favorable direct labor efficiency variance) or in the quality of the finished products. In this case, two elements are contributing to the unfavorable outcome. Connie’s Candy paid \(\$1.50\) per hour more for labor than expected and used \(0.10\) hours more than expected to make one box of candy. The same calculation is shown as follows using the outcomes of the direct labor rate and time variances. Connie’s Candy paid $1.50 per hour more for labor than expected and used 0.10 hours more than expected to make one box of candy.

For example, the variance can be used to evaluate the performance of a company’s bargaining staff in setting hourly rates with the company union for the next contract period. 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. (Figure) shows the connection between the direct labor rate variance and direct labor time variance to total direct labor variance. As with direct materials variances, all positive variances areunfavorable, and all negative variances are favorable.

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. As mentioned earlier, the cause of one variance might influence another variance. 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. Figure 10.7 contains some possible explanations for the laborrate variance (left panel) and labor efficiency variance (rightpanel).

Mary hopes it will better as the team works together, but right now, she needs to reevaluate her labor budget and get the information to her boss. Let’s say our accounting records show that the line workers put in a total of 2,325 hours during the month. The engineering staff may have decided to alter the components of a product that requires manual processing, thereby altering the amount of labor needed in the production process. For example, a business may use a subassembly that is provided by a supplier, rather than using in-house labor to assemble several components. The actual amounts paid may include extra payments for shift differentials or overtime. For example, a rush order may require the payment of overtime in order to meet an aggressive delivery date.

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. 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.

The standard direct labor rate was set at $5.60 per hour but the direct labor workers were actually paid at a rate of $5.40 per hour. Find the direct labor rate variance of Bright Company for the month of June. In this question, the company has experienced an unfavorable direct labor efficiency variance of $325 during March because its workers took more hours (1,850) than the hours allowed by standards (1,800) to complete 600 units.

On the other hand, if workers take an amount of time that is more than the amount of time allowed by standards, the variance is known as unfavorable direct labor efficiency variance. Actual and standard quantities and rates for direct labor for the production of 1,000 units are given in the following table. 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. 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. 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.

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If actual rate is lower than standard rate, the variance is favorable. The actual rate of $7.50 is computed by dividing the total actual cost of labor by the actual hours ($217,500 divided by 29,000 hours). In this example, the Hitech company has an unfavorable labor rate variance of $90 because it has paid a higher hourly rate ($7.95) than the standard hourly rate ($7.80). If the cost of labor includes benefits, and the cost of benefits has changed, then this impacts the variance.

Lynn was surprised tolearn that direct labor and direct materials costs were so high,particularly since actual materials used and actual direct laborhours worked were below budget. We have demonstrated how important it is for managers to beaware not only of the cost of labor, but also of the differencesbetween budgeted labor costs and actual labor costs. This awarenesshelps managers make decisions that protect the financial health oftheir companies. If the actual rate is higher than the standard rate, the variance is unfavorable since the company paid more than what it expected.

Note that both approaches—the direct labor efficiency variancecalculation and the alternative calculation—yield the sameresult. It is always important, as you are starting to see, to look at all options as we work through management decisions. Actual labor costs may differ from budgeted costs due to differences in rate and efficiency. Watch this video presenting an instructor walking through the steps involved in calculating direct labor variances to learn more.