This figure can vary considerably, based on assumptions regarding the setup time of a production run, the availability of materials and machine capacity, employee skill levels, the duration of a production run, and other factors. Thus, the multitude of variables involved makes it especially difficult to create a standard that you can meaningfully compare to actual results. Before we go on to explore the variances related to indirect costs (manufacturing overhead), check your understanding of the accountant reviews. The direct labor efficiency variance is similar in concept to direct material quantity variance.

It is necessary to analyze direct labor efficiency variance in the context of relevant factors, for example, direct labor rate variance and direct material price variance. It is quite possible that unfavorable direct labor efficiency variance is simply the result of, for example, low quality material being procured or low skilled workers being hired. In case of low quality direct material, the direct material price variance will likely be favorable and in the later case, the direct labor rate variance will probably be favorable; both at the expense of direct labor efficiency variance.

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Suppose, for example, the standard time to manufacture a product is one hour but the product is completed in 1.15 hours, the variance in hours would be 0.15 hours – unfavorable. If the direct labor cost is $6.00 per hour, the variance in dollars would be $0.90 (0.15 hours × $6.00). For proper financial measurement, the variance is normally expressed in dollars rather than hours. Figure 8.4 shows the connection between the direct labor rate variance and direct labor time variance to total direct labor variance.

- In this case, the actual rate per hour is $9.50, the standard rate per hour is $8.00, and the actual hours worked per box are 0.10 hours.
- In this case, two elements are contributing to the unfavorable outcome.
- As a result of this favorable outcome information, the company may consider continuing operations as they exist, or could change future budget projections to reflect higher profit margins, among other things.
- Four hours are needed to complete a finished product and the company has established a standard rate of $8 per hour.
- The first option is not in line with just in time (JIT) principle which focuses on minimizing all types of inventories.

If direct materials is the cause of adverse variance, then purchase manager should bear the responsibility for his negligence in acquiring the right materials for his factory. The Purple Fly has experienced a favorable direct labor efficiency variance of $219 during the second quarter of operations because its workers were able to finish 1,200 units in fewer hours (3,780) than the hours allowed by standards (3,840). From the payroll records of Boulevard Blanks, we find that line workers (production employees) put in 2,325 hours to make 1,620 bodies, and we see that the total cost of direct labor was $46,500.

## Types of Labor Cost Variance

The same calculation is shown as follows using the outcomes of the direct labor rate and time variances. 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.

The combination of the two variances can produce one overall total direct labor cost variance. Possible causes of an unfavorable efficiency variance include poorly trained workers, poor quality materials, faulty equipment, and poor supervision. Another important reason of an unfavorable labor efficiency variance may be insufficient demand for company’s products. The labor efficiency variance is also known as the direct labor efficiency variance, and may sometimes be called (though less accurately) the labor variance. The standard number of hours represents the best estimate of a company’s industrial engineers regarding the optimal speed at which the production staff can manufacture goods.

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. Doctors, for example, have a time allotment for a physical exam and base their fee on the expected time. Insurance companies pay doctors according to a set schedule, so they set the labor standard.

## Labor Efficiency Variance

There are two components to a labor variance, the direct labor rate variance and the direct labor time variance. 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. The company used 39,500 direct labor hours and paid a total of $325,875. 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.

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This is a favorable outcome because the actual rate of pay was less than the standard rate of pay. As a result of this favorable outcome information, the company may consider continuing operations as they exist, or could change future budget projections to reflect higher profit margins, among other things. With either of these formulas, the actual rate per hour refers to the actual rate of pay for workers to create one unit of product. The standard rate per hour is the expected rate of pay for workers to create one unit of product. The actual hours worked are the actual number of hours worked to create one unit of product.

Note that in contrast to direct labor, indirect labor consists of work that is not directly related to transforming the materials into finished goods. Examples include salaries of supervisors, janitors, and security guards. The articles and https://www.kelleysbookkeeping.com/15-blank-check-templates/ research support materials available on this site are educational and are not intended to be investment or tax advice. All such information is provided solely for convenience purposes only and all users thereof should be guided accordingly.