Note that both approaches—the direct labor efficiency variance calculation and the alternative calculation—yield the same result. A favorable labor rate variance suggests cost efficient employment of direct labor by the organization. Doctors, for example, have a time allotment for a physical exam and base Direct Labor Rate Variance their fee on the expected time. Insurance companies pay doctors according to a set schedule, so they set the labor standard. If the exam takes longer than expected, the doctor is not compensated for that extra time. Doctors know the standard and try to schedule accordingly so a variance does not exist.

The purpose of calculating the direct labor efficiency variance is to measure the performance of the production department in utilizing the abilities of the workers. A positive value of direct labor efficiency variance is obtained when the standard direct labor hours allowed exceeds the actual direct labor hours used. A negative value of direct labor efficiency variance means that excess direct labor hours have been used in production, implying that the labor-force has under-performed. 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.

## Direct Labor Efficiency Variance

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. Additionally, mistakes in setting or applying the standard hours allowed can also lead to an efficiency variance.

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 rate variance can have positive or negative effects on the business, depending on whether it is favorable or unfavorable. A favorable rate variance means that the actual wage rate is lower than the standard wage rate, which implies lower labor costs and higher profits. A unfavorable rate variance means that the actual wage rate is higher than the standard wage rate, which implies higher labor costs and lower profits. The rate variance can also affect the quality and quantity of the output, as well as the morale and satisfaction of the workers. 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.

## What is the difference between labor yield and mix variances?

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. Direct labor rate variance measures the cost of the difference between the expected labor rate and the actual labor rate. If the variance demonstrates that actual labor rates were higher than expected labor rates, then the variance will be considered unfavorable. If the variance demonstrates that actual labor rates were lower than expected labor rates, then the variance will be considered favorable. A positive DLRV would be unfavorable whereas a negative DLRV would be favorable. Commonly used direct labor variance formulas include the direct labor rate variance and the direct labor efficiency variance.

In this article, we will focus on the common causes and effects of direct labor variances, which are one of the main components of standard cost variances. 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. With either of these formulas, the actual hours worked refers to the actual number of hours used at the actual production output. 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.

## Causes of a Labor Rate Variance

The efficiency variance can have positive or negative effects on the business, depending on whether it is favorable or unfavorable. A favorable efficiency variance means that the actual hours worked are lower than the standard hours allowed, which implies higher labor productivity and lower labor costs. A unfavorable efficiency variance means that the actual hours worked are higher than the standard hours allowed, which https://accounting-services.net/bookkeeping-stockton/ implies lower labor productivity and higher labor costs. The efficiency variance can also affect the quality and quantity of the output, as well as the morale and satisfaction of the workers. Standard cost variances are the differences between the actual costs and the budgeted costs of a product or service. They are used to measure the efficiency and performance of a business in managing its resources and processes.

The quantity variance is found by computing the difference between the actual hours multiplied by the standard rate and the standard hours multiplied the standard rate. The actual rate is not used in this computation because the focus is finding out how the change in hours, if any, had an effect on the total variance. Sometimes the two variances will be in the same direction, both positive or negative, while other times they will be in opposite directions, such as in the example we discussed. A labor variance is a type of cost variance that focuses on labor rates and hours. The comparison that is used to compute a labor variance compares standard versus actual rates and hours for workers, typically on a specific project.

## More articles on Product Costing

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. For example, the only person available to do the work may be very skilled, and therefore highly compensated, even though the underlying standard assumes that a lower-level person (at a lower pay rate) should be doing the work. An overview of these two types of labor efficiency variance is given below.