Direct labor rate variance is equal to the difference between actual hourly rate and standard hourly rate multiplied by actual hours worked. This variance is also known as direct labor price variance. To understand the computation of this variance, see the following
formula: Direct labor rate variance = (Actual hours worked × Actual rate) – (Actual hours worked × Standard rate) Or Actual hours worked x (Actual rate – Standard 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. The standard wage rate is $7.80 per hour. Last month, 600 hours were worked to manufacture 1,700 units. Workers were paid @ $7.95 per direct labor hour. Calculate direct labor rate variance of Hitech. = (600 hours × $7.95) – (600 hours × $7.80) Or = 600 hours × ($7.95 – $7.80) 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 standard hourly rate ($7.80). During June 2022, Bright Company’s workers worked for 450 hours to manufacture 180 units of finished product. 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. = (450 hours × $5.40) – (450 hours × $5.50) Or = 450 hours × ($5.40 – $5.50) In this example, 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). Usually, direct labor rate variance does not occur due to change in labor rates because they are normally pretty easy to predict. A common reason of unfavorable labor rate variance is an inappropriate/inefficient use of direct labor workers by production supervisors. All tasks do not require equally skilled workers; some tasks are more complicated and require more experienced workers than others. This general fact should be kept in mind while assigning tasks to
available work force. If the tasks that are not so complicated are assigned to very experienced workers, an unfavorable labor rate variance may be the result. The reason is that the highly experienced workers can generally be hired only at expensive wage rates. If, on the other hand, less experienced workers are assigned the complex tasks that require higher level of expertise, a favorable labor rate variance may occur. However, these workers may cause the quality issues due to lack of expertise
and inflate the firm’s internal failure costs. In order to keep the overall direct labor cost inline with standards while maintaining the output quality, it is much important to assign right tasks to right workers. The responsibility
of unfavorable direct labor rate variance partially lies on production managers, like production supervisors and foremen, because they are the persons who are generally authorized for assigning tasks to workers. Other reasons of labor rate variance include the payment of overtime premium to workers in case of rush orders with aggressive
delivery dates and relying on inaccurate or incomplete data at the time of setting direct labor standards. More from Standard costing and variance analysis (explanations): This is “Direct Labor Variance Analysis”, section 10.4 from the book Accounting for Managers (v. 1.0). For details on it (including licensing), click here. For more information on the source of this book, or why it is available for free, please see the project's home page. You can browse or download additional books there. To download a .zip file containing this book to use offline, simply click here. Has this book helped you? Consider passing it on:  Creative Commons supports free culture from music to education. Their licenses helped make this book available to you. DonorsChoose.org helps people like you help teachers fund their classroom projects, from art supplies to books to calculators. Learning Objective
Question: In addition to investigating the causes of cost overruns for direct materials, the president of Jerry’s Ice Cream wants to know why there were cost overruns for direct labor. What variances are used to analyze these types of direct labor cost overruns? Answer: Similar to direct materials variances, direct labor variance analysis involves two separate variances: the labor rate variance and labor efficiency variance. The labor rate varianceThe difference between actual costs for direct labor and budgeted costs based on the standards. is the difference between actual costs for direct labor and budgeted costs based on the standards. The labor efficiency varianceThe difference between the actual number of direct labor hours worked and budgeted direct labor hours that should have been worked based on the standards. is 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. At Jerry’s Ice Cream, the actual data for the year are as follows:
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 10.6 Direct Labor Variance Analysis for Jerry’s Ice Cream Note: AH = Actual hours of direct labor. AR = Actual rate incurred for direct labor. SR = Standard rate for direct labor. SH = Standard hours of direct labor for actual level of activity. *Standard hours of 21,000 = Standard of 0.10 hours per unit × 210,000 actual units produced and sold. **$273,000 standard direct labor cost matches the flexible budget presented in Figure 10.2 "Flexible Budget for Variable Production Costs at Jerry’s Ice Cream". † $37,800 unfavorable labor rate variance = $283,500 – $245,700. Variance is unfavorable because the actual rate of $15 is higher than the expected (budgeted) rate of $13. ‡ $(27,300) favorable labor efficiency variance = $245,700 – $273,000. Variance is favorable because the actual hours of 18,900 are lower than the expected (budgeted) hours of 21,000. Direct Labor Rate Variance CalculationQuestion: The direct labor rate variance answers the question, did we spend more or less on direct labor than expected? If the variance is unfavorable, we spent more than expected. If the variance is favorable, we spent less than expected. How is the labor rate variance calculated? Answer: As shown in Figure 10.6 "Direct Labor Variance Analysis for Jerry’s Ice Cream", the labor rate variance is the difference between the actual hours worked at the actual rate and the actual hours worked at the standard rate: Key EquationLabor rate variance = (AH × AR) − (AH × SR) Labor rate variance= (AH×AR)−(AH×SR)=(18,900×$15)−(18,900× $13)= $37,800 unfavorable Alternative Calculation. Because we are holding the actual hours constant and evaluating the difference between actual rate and standard rate, the labor rate variance calculation can be simplified as follows: Key EquationLabor rate variance = (AR − SR) × AH Labor rate variance=(AR− SR)×AH=($15−$13)×18,900= $37,800 unfavorable Note that both approaches—direct labor rate variance calculation and the alternative calculation—yield the same result. 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. Direct Labor Efficiency Variance CalculationQuestion: The direct labor efficiency variance answers the question, did we use more or less direct labor hours in production than expected? If the variance is unfavorable, we used more than expected. If the variance is favorable, we used less than expected. How is the labor efficiency variance calculated? Answer: As shown in Figure 10.6 "Direct Labor Variance Analysis for Jerry’s Ice Cream", the labor efficiency variance is the difference between the actual hours worked at the standard rate and the standard hours at the standard rate: Key EquationLabor efficiency variance = (AH × SR) − (SH × SR) Labor efficiency variance=(AH× SR)−(SH×SR)=(18,900×$13)−(21,000×$13) =($27,300) favorable The 21,000 standard hours are the hours allowed given actual production. For Jerry’s Ice Cream, the standard allows for 0.10 labor hours per unit of production. Thus the 21,000 standard hours (SH) is 0.10 hours per unit × 210,000 units produced. Alternative Calculation. Because we are holding the standard rate constant and evaluating the difference between actual hours worked and standard hours, the labor efficiency variance calculation can be simplified as follows: Key EquationLabor efficiency variance = (AH − SH) × SR Labor efficiency variance=(AH−SH)× SR=(18,900−21,000)×$13=($27,300) favorable Note that both approaches—the direct labor efficiency variance calculation and the alternative calculation—yield the same result. 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. Possible Causes of Direct Labor VariancesQuestion: The managerial accountant at Jerry’s Ice Cream is interested in finding the cause of the unfavorable labor rate variance of $37,800. Jerry’s Ice Cream might also choose to investigate the $27,300 favorable labor efficiency variance. Although this could be viewed as good news for the company, management may want to know why this favorable variance occurred. What might have caused the $37,800 unfavorable labor rate variance and $27,300 favorable labor efficiency variance? Answer: Figure 10.7 "Possible Causes of Direct Labor Variances for Jerry’s Ice Cream" contains some possible explanations for the labor rate variance (left panel) and labor efficiency variance (right panel). Figure 10.7 Possible Causes of Direct Labor Variances for Jerry’s Ice Cream 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. 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. Business in Action 10.3© Thinkstock Labor Costs in the Airline Industry 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. 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. How would this unforeseen pay cut affect United’s direct labor rate variance? The direct labor rate variance would likely be favorable, perhaps totaling close to $620,000,000, depending on how much of these savings management anticipated when the budget was first established. After filing for Chapter 11 bankruptcy in December 2002, United cut close to $5,000,000,000 in annual expenditures. As a result of these cost cuts, United was able to emerge from bankruptcy in 2006. Source: Associated Press, “United May Seek End to Union Contracts,” USA Today, November 25, 2004. Follow-Up Meeting at Jerry’s Ice CreamJerry (president and owner), Tom (sales manager), Lynn (production manager), and Michelle (treasurer and controller) were at the meeting described at the opening of this chapter. 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. The group met again a week later to discuss the issue.
As stated earlier, variance analysis is the control phase of budgeting. Using variance analysis for direct materials and direct labor, Jerry’s Ice Cream was able to identify strong points in its operations (quantity of materials used and efficiency of direct labor workforce), and perhaps more important, Jerry’s was able to identify problem areas (price paid for materials and wages paid to employees). This information gives the management a way to monitor and control production costs. Next, we calculate and analyze variable manufacturing overhead cost variances. Key Takeaway
Review Problem 10.4Carol’s Cookies expected to use 0.20 direct labor hours to produce 1 unit (batch) of product at a cost of $12 per hour. Actual results are in for last year, which indicates 390,000 batches of cookies were sold. The company’s direct labor workforce worked 97,500 hours at $11 per hour.
Solution to Review Problem 10.4
What is the labor rate variance quizlet?The Labor Rate Variance is the difference between the actual and the expected cost of labor multiplied by the actual amount of hours worked.
When the standard price is higher than the actual price the materials price variance is?Variance is unfavorable because the actual price of $1.20 is higher than the expected (budgeted) price of $1. $(21,000) favorable materials quantity variance = $399,000 – $420,000.
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Learning Objective.. When the actual quantity of materials used is less than the standard quantity allowed the material quantity variance is labeled as?If there is no difference between the actual quantity used and the standard quantity, the outcome will be zero, and no variance exists. If the actual quantity of materials used is less than the standard quantity used at the actual production output level, the variance will be a favorable variance.
What type of variance results when actual labor hours are different from standard labor hours?The correct answer is (B) Actual hours worked are less than the standard hours allowed. The difference between actual labor hours to standard labor hours required to produce actual output is labor efficiency variance.
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When the actual hourly rate is lower than the standard hourly rate, the labor rate variance is
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