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.

Formula

Labor cost variance = (Standard hours for actual output x Standard rate) – (Actual hours x Actual rate)

Types of Labor Cost Variance

Labor cost variance can be divided into two types: labor rate variance and labor efficiency variance. In the case of labor rate variance, this is calculated as follows:

Labor rate = Actual time (Standard rate Actual rate) Variance

In addition, labor efficiency is calculated using the formula below:

Labor efficiency = Standard rate (Standard time Actual time) Variance

Labor Rate Variance

This variance arises when labor is paid at a rate that differs from the standard wage rate. A rate variance usually occurs when a person is employed at a rate that is higher or lower than expected. The causes of labor rate variance are:

  • Payment at a higher or lower rate than the standard
  • Changes in employee skills
  • Recruitment of new personnel
  • Changes in compensation methods, etc.

Labor Efficiency Variance

The time taken to do a job indicates the efficiency of workers. Hence, variance arises due to the difference between actual time worked and the total hours that should have been worked. This variance can usually be traced to departmental supervision.

An example is when a highly paid worker performs a low-level task, which influences labor efficiency variance.

Other causes of labor efficiency variance are:

  • Changes in employee skills
  • Extent of supervision
  • Changes in production methods
  • Changes in use of tools
  • Quality of materials
  • Working conditions, etc.

Like material quantity variance, labor efficiency variance can also be divided into two types:

  1. Labor mix variance
  2. Labor yield variance

An overview of these two types of labor efficiency variance is given below.

1. Labor Mix Variance

Labor mix variance is defined as the portion of direct labor efficiency variance that is attributable to the difference between standard and actual group composition of employees. It is calculated as:

Standard rate x (Reversed standard time – Actual time)

In the above formula, revised standard time is calculated as follows:

Revised standard time = (Total time of actual workers / Total time of standard workers) x Standard time

2. Labor Yield Variance

Labor yield variance is defined as the portion of direct labor efficiency variance that is attributable 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

Cleaning up this formula with shorter names for variables, we have:

LYV = (AY – SY) x SC

Example

Calculate the labor variances using the following labor data obtained from XYZ Company for the month of October:

Actual data:

  • Hours Worked = 6,000
  • Labor rate = $0.25 per hour

Standard data:

  • Hours worked = 4,000
  • Labor rate = $0.40 per hour

Solution

Labor cost:

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:

Labor rate variance = Actual time (Standard rate – Actual rate)
= 6,000 (0.40 – 0.25
= $900 (Favorable)

Labor efficiency variance:

Labor efficiency variance = Standard rate (Standard time – Actual time)
= 0.40 (4,000 – 6,000)
= $800 (A)

Frequently Asked Questions

What is the difference between labor rate and efficiency variance?

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.

What are common causes for labor variances?

The most common causes of labor variances are changes in employee skills, supervision, production methods capabilities and tools.

What is the difference between labor yield and mix variances?

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.

What is labor yield?

Labor yield is the ratio of actual output to standard output for an hour's work. If one worker can complete 4 hours' work in 2 hours, then the labor yield is 4/2 = 2.

How do you calculate labor yield variances?

Labor yield surplus / shortage = (actual output – standard output) x Standard Cost per unitif actual output is higher than the standard, as in an efficient production process, then a yield variance will be favorable. Lower yields from a set number of hours' work will result in a loss.

True is a Certified Educator in Personal Finance (CEPF®), author of The Handy Financial Ratios Guide, a member of the Society for Advancing Business Editing and Writing, contributes to his financial education site, 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.

To learn more about True, visit his personal website, view his author profile on Amazon, or check out his speaker profile on the CFA Institute website.