Direct Labor Variances
Like direct material standards, direct labor standards also consist of two components, quantity and price. The direct labor quantity standard is usually referred to as labor efficiency variance while the price standard is referred to as labor rate variance.
Labour Cost Variance = (Standard hours for Actual output x Standard Rate) – (Actual Hours x Actual Rate)
Types of Labor Cost Variance
Labour cost variance can be sub-divided into two types – Labour rate variance and Labour efficiency variance.
1. Labour rate = Actual Time (Standard rate – Actual rate) Variance
2. Labour Efficiency = Standard rate (Standard time – Actual time) Variance
Labor Rate Variance
This variance arises when labor is paid at a rate different from the standard wage rate. A rate variance usually occurs when a person is headed at a rate higher or lower than expected. The causes for labor rate variance are:
- Payment at a rate higher or lower than the standard rate
- Change in the grades of employees
- Inclusion of new workmen
- Change in the method of compensation etc.
Labor Efficiency Variance
The time taken to do a job indicates the efficiency of workers. Hence the variance arises due to the difference between actual time worked and hours which should have been worked. This variance can usually be traced to departmental supervision. An example would be when a highly paid worker performs a
lower level task.
The causes of labor efficiency variance are:
- Change in the skill-grade of the workers.
- Extent of supervision
- Change in the method of production
- Change in tools
- Quality of materials
- Working conditions, etc.
Like Material Quantity variance, Labour efficiency variance can also be divided into two types:
(1). Labor Mix Variance
That portion of direct labor efficiency variance which is due to the difference between standard and actual gang composition of the workers. it is calculated as:
Standard rate x (Reversed Standard time – Actual time)
Revised Standard Time = (Total time of actual workers / Total time of standard workers) x Standard time
(2). Labor Yield Variance
That portion of direct labor efficiency variance which is due to the difference between the standard yield specified and the actual yield obtained. Labor Yield variance can be calculated using the following formula:
Labor Yield Variance = (Actual yield or output – Standard yield or output for actual input) x Standard Cost per unit
LYV = (AY – SY) x SC
Calculate the various Labor variances from the following labor-related information for the XYZ Company for the month of October, as shown below:
Hours Worked = 6,000
Labor rate = $0.25 per hour
Hours worked = 4,000
Labor rate = $0.40 per hour
Labor Cost = (Standard hours for actual output x Standard rate) – (Actual rate x Actual rate)
= (4,000 x 0.40) – (6,000 x 0.25)
= 1600 – 1500
= $100 (Favorable)
Labor Rate Variance = Actual time (Standard rate – Actual rate)
= 6,000 (0.40 – 0.25
= $900 (Favorable)
Labor Efficiency Variance = Standard rate (Standard time – Actual time)
= 0.40 (4,000 – 6,000)
= $800 (A)
About the Author
True Tamplin, BSc, CEPF®
True Tamplin is a published author, public speaker, CEO of UpDigital, and founder of Finance Strategists.
True contributes to his own finance dictionary, Finance Strategists, and has spoken to various financial communities such as the CFA Institute, as well as university students like his Alma mater, Biola University, where he received a bachelor of science in business and data analytics.