# 10 7 Direct Labor Variances Financial and Managerial Accounting

The total of both variances equals the total direct labor variance. In this case, the actual rate per hour is $7.50, the standard rate per hour is $8.00, and the actual hour worked is 0.10 hours per box. 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.

## Chapter 8 LO 3 β Compute and Evaluate Labor Variances

- The materials price variance ofΒ $ 6,000 is considered favorable since the materials were acquired for a price less than the standard price.
- This variance occurs because of differences in standard versus actual rates.
- Figure 8.4 shows the connection between the direct labor rate variance and direct labor time variance to total direct labor variance.
- Unfavorable variances occur when an organization pays more for something than was planned.
- During June 2022, Bright Companyβs workers worked for 450 hours to manufacture 180 units of finished product.
- He represents clients before the IRS and state taxing authorities concerning audits, tax controversies, and offers in compromise.

Maryβs new hire isnβt doing as well as expected, but what if the opposite had happened? What if adding Jake to the team has speeded up the production process and now it was only taking .4 hours to produce a pair of shoes? The time it takes to make a pair of shoes has gone from .5 to .6 hours. Mary hopes it will better as the team works together, but right now, she needs to reevaluate her labor budget and get the information to her boss. 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.

## What youβll learn to do: Discuss different types of labor variances

We started by learning that variances could be favorable when they resulted in smaller payments out of the company, or unfavorable when more money had to be paid. We then learned how to calculate variances for labor, materials and overhead costs. Remember that the total materials variance can be found by multiplying the standard cost by the standard quantity then subtracting the product of the actual cost and the actual quantity. The total overhead variance is the sum of the fixed overhead variance and the variable overhead variance. Finally, the total direct labor variance is calculated by multiplying the standard rate by the standard quantity of hours, then subtracting the product of the actual rate and the actual number of hours. A labor variance exists when the actual cost of labor for manufacturing a product differs from the standard, or forecast, cost of labor.

## Calculating Labor Variances

For Jerryβs Ice Cream, the standard allows for 0.10labor hours per unit of production. Thus the 21,000 standard hours(SH) is 0.10 hours per unit Γ 210,000 units produced. The materials price variance of $ 6,000 is considered favorable since the materials were acquired for a price less than the standard price. If the actual price had exceeded the standard price, the variance would be unfavorable because the costs incurred would have exceeded the standard price. We do not show variances with a negative or positive but at the absolute value with favorable or unfavorable specified.

This information gives the management a way tomonitor and control production costs. Next, we calculate andanalyze variable manufacturing overhead cost variances. Here, the actual rate is the hourly rates that are currently used. The actual hours worked are the total hours worked by the employees. The formula calculates the differences between rates, given the number of hours worked.

If the actual hours worked are less than the standard hours at the actual production output level, the variance will be a favorable variance. A favorable outcome means you used fewer hours than anticipated to make the actual number of production units. If, however, the actual hours worked are greater than the standard hours at the actual production output level, the variance will be unfavorable. An unfavorable outcome means you used more hours than anticipated to make the actual number of production units.

In this case, two elements are contributing to the unfavorable outcome. Connieβs Candy paid $1.50 per hour more for labor than expected and used 0.10 hours more than expected to make one box of candy. The same calculation is is land a current or long shown as follows using the outcomes of the direct labor rate and time variances. Connieβs Candy paid \(\$1.50\) per hour more for labor than expected and used \(0.10\) hours more than expected to make one box of candy.

This estimate is based on a standard mix of personnel at different pay rates, as well as a reasonable proportion of overtime hours worked. Figure 10.7 contains some possible explanations for the laborrate variance (left panel) and labor efficiency variance (rightpanel). Still unsure about material and labor variances, watch this Note Pirate video to help. Since the actual labor rate is lower than the standard rate, the variance is positive and thus favorable. Direct labor rate variance is very similar in concept to direct material price variance. The variance is unfavorable since more hours than the standard number of hours were required to complete the periodβs production.

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. In a perfect world, actual costs would always align with the standard costs in a budget. Instead, accountants and other business professionals use variances to provide for inevitable budgetary changes, particularly in spending. Variances exist when an actual expense differs from the standard cost which was budgeted for. Favorable variances occur when an organization spends less for something than was planned.

Primarily, it reviews the differences between the expected costs of labor and the actual costs of labor. It can also aid the planning and development of new budgets and serve as a means of gaining information on company performance. This information can be used to set new hourly rates for employees. However, a positive value of direct labor rate variance may not always be good. Direct labor rate variance must be analyzed in combination with direct labor efficiency variance. Direct labor rate variance determines the performance of human resource department in negotiating lower wage rates with employees and labor unions.

The labor price variance is found by subtracting the actual paid rate from the standard budgeted rate and then multiplying it by the actual hours worked. The labor quantity variance is found by multiplying the standard rate by the difference of the standard hours budgeted minus the actual worked hours budgeted. In all cases you must make sure to pay attention to negative numbers; it could mean the difference between lower costs or higher costs. In this case, the actual hours worked per box are \(0.20\), the standard hours per box are \(0.10\), and the standard rate per hour is \(\$8.00\). 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. This is an unfavorable outcome because the actual rate per hour was more than the standard rate per hour.

If more materials were used than the standard quantity, or if a price greater than the standard price was paid, the variance is unfavorable. Materials usage variance Because the standard quantity of materials used in making a product is largely a matter of physical requirements or product specifications, usually the engineering department sets it. But if the quality of materials used varies with price, the accounting and purchasing departments may perform special studies to find the right quality.

The standard rate per hour is the expected hourly rate paid to workers. 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. The unfavorable labor rate variance is not necessarily caused by paying employees more wages than they are entitled to receive. Favorable rate variances, on the other hand, could be caused by using less-skilled, cheaper labor in the production process. Typically, the hours of labor employed are more likely to be under managementβs control than the rates that are paid.

If the outcome is favorable, the actual costs related to labor are less than the expected (standard) costs. The variance is positive and unfavorable because the actual rate paid exceeded the standard rate allowed. An adverse labor rate variance indicates higher labor costs incurred during a period compared with the standard. If we use more hours at the same rate of pay, it would be called a labor efficiency variance. If the cost of labor includes benefits, and the cost of benefits has changed, then this impacts the variance. If a company brings in outside labor, such as temporary workers, this can create a favorable labor rate variance because the company is presumably not paying their benefits.

The other two variances that are generally computed for direct labor cost are the direct labor efficiency variance and direct labor yield variance. A direct labor variance is caused by differences in either wage rates or hours worked. As with direct materials variances, you can use either formulas or a diagram to compute direct labor variances. As stated earlier, variance analysis is the controlphase of budgeting.

We have demonstrated how important it is for managers to beaware not only of the cost of labor, but also of the differencesbetween budgeted labor costs and actual labor costs. This awarenesshelps managers make decisions that protect the financial health oftheir companies. Labor rate variance is the difference between the expected cost of labor and the actual cost of labor. This variance occurs because of differences in standard versus actual rates. If the outcome is unfavorable, the actual costs related to labor were more than the expected (standard) costs.

A favorable outcome means you paid workers less than anticipated. If, however, the actual rate of pay per hour is greater than the standard rate of pay per hour, the variance will be unfavorable. An unfavorable outcome means you paid workers more than anticipated. According to the total direct labor variance, direct labor costs were $1,200 lower than expected, a favorable variance. 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.

Direct Labor Rate Variance is the measure of difference between the actual cost of direct labor and the standard cost of direct labor utilized during a period. Labor yield variance arises https://www.bookkeeping-reviews.com/ 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.

To compute the direct labor quantity variance, subtract the standard cost of direct labor ($48,000) from the actual hours of direct labor at standard rate ($43,200). This math results in a favorable variance of $4,800, indicating that the company saves $4,800 in expenses because its employees work 400 fewer hours than expected. Direct labor rate variance is equal to the difference between actual hourly rate and standard hourly rate multiplied by the actual hours worked during the period. The variance would be favorable if the actual direct labor cost is less than the standard direct labor cost allowed for actual hours worked by direct labor workers during the period concerned. Conversely, it would be unfavorable if the actual direct labor cost is more than the standard direct labor cost allowed for actual hours worked. The difference between the standard cost of direct labor and the actual hours of direct labor at standard rate equals the direct labor quantity variance.

The standard materials cost of any product is simply the standard quantity of materials that should be used multiplied by the standard price that should be paid for those materials. Actual costs may differ from standard costs for materials because the price paid for the materials and/or the quantity of materials used varied from the standard amounts management had set. These two factors are accounted for by isolating two variances for materialsβa price variance and a usage variance.

After filing for Chapter 11 bankruptcy inDecember 2002, United cut close to $5,000,000,000in annual expenditures. As a result of these cost cuts, United wasable to emerge from bankruptcy in 2006. Our mission is to empower readers with the most factual and reliable financial information possible to help them make informed decisions for their individual needs. This team of experts helps Finance Strategists maintain the highest level of accuracy and professionalism possible. At Finance Strategists, we partner with financial experts to ensure the accuracy of our financial content. Our Spending Variance is the sum of those two numbers, so $6,560 unfavorable ($27,060 β $20,500).

The favorable will increase profit for company, but we may lose some customers due to high selling price which cause by overestimating the labor standard rate. However, we do not need to investigate if the variance is too small which will not significantly impact the decision making. The actual hours used can differ from the standard hours because of improved efficiencies in production, carelessness or inefficiencies in production, or poor estimation when creating the standard usage. Another element this company and others must consider is a direct labor time variance. The most common causes of labor variances are changes in employee skills, supervision, production methods capabilities and tools.

Note that both approachesβthe direct labor efficiency variancecalculation and the alternative calculationβyield the sameresult. Since both the rate and efficiency variances are unfavorable, we would add them together to get the TOTAL labor variance. If we had one favorable and one unfavorable variance, we would subtract the numbers. The variance is unfavorable because more materials were used than the standard quantity allowed to complete the job. If the standard quantity allowed had exceeded the quantity actually used, the materials usage variance would have been favorable.

An error in these assumptions can lead to excessively high or low variances.

Figure 10.6 shows how to calculate the labor rateand efficiency variances given the actual results and standardsinformation. Review this figure carefully before moving on to thenext section where these calculations are explained in detail. Labor rate variance The labor rate variance occurs when the average rate of pay is higher or lower than the standard cost to produce a product or complete a process. The labor rate variance is similar to the materials price variance.

As a result, employees work harder since they have been rewarded for their efforts at the company, and the total hours required for the same amount of production go down. In this case, the actual rate per hour is \(\$7.50\), the standard rate per hour is \(\$8.00\), and the actual hour worked is \(0.10\) hours per box. If the actual rate of pay per hour is less than the standard rate of pay per hour, the variance will be a favorable variance.

The labor efficiency variance occurs when employees use more or less than the standard amount of direct labor-hours to produce a product or complete a process. The labor efficiency variance is similar to the materials usage variance. The standard labor cost of any product is equal to the standard quantity of labor time allowed multiplied by the wage rate that should be paid for this time. Here again, it follows that the actual labor cost may differ from standard labor cost because of the wages paid for labor, the quantity of labor used, or both. Thus, two labor variances existβa rate variance and an efficiency variance.

This is a favorable outcome because the actual hours worked were less than the standard hours expected. 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. With either of these formulas, the actual hours worked refers to the actual number of hours used at the actual production output.

Labor rate variance is the difference between actual cost of direct labor and its standard cost. The difference due to actual amount paid and the standard rate per hour while the time spends during production remains the same. Figure 8.4 shows the connection between the direct labor rate variance and direct labor time variance to total direct labor variance. The direct labor variance measures how efficiently the company uses labor as well as how effective it is at pricing labor.

It is always important, as you are starting to see, to look at all options as we work through management decisions. Letβs continue our discussions surrounding labor rates and hours. The labor standard may not reflect recent changes in the rates paid to employees. For example, the standard may not reflect the changes imposed by a new union contract.

Standard costs are used to establish theflexible budget for direct labor. The flexible budget is comparedto actual costs, and the difference is shown in the form of twovariances. It is defined as the differencebetween the actual number of direct labor hours worked and budgeteddirect labor hours that should have been worked based on thestandards. To compute the direct labor price variance, subtract the actual hours of direct labor at standard rate ($43,200) from the actual cost of direct labor ($46,800) to get a $3,600 unfavorable variance. This result means the company incurs an additional $3,600 in expense by paying its employees an average of $13 per hour rather than $12.

A favorable labor rate variance suggests cost efficient employment of direct labor by the organization. So as we discussed, we can analyze the variance for labor efficiency by using the standard cost variance analysis chart on 10.3. This variance occurs when the time spends in production is the same between budget and actual while the cost per hour change. We assume that the actual hour per unit equal to the standard hour but we need to pay higher or lower due to various reasons. The unfavorable will hit our bottom line which reduces the profit or cause the surprise loss for company.