# Direct Labor Efficiency Variance

Labor mix variance is the difference between the actual mix of labor and standard mix, caused by hiring or training costs. Actual labor costs may differ from budgeted costs due to differences in rate and efficiency. 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 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.

For each yard of denim purchased, DenimWorks reports a favorable direct materials price variance of \$0.50. 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. (standard hours allowed for production – actual hours taken) × standard rate per direct labour hour. The direct labor efficiency variance can provide useful information for managers to improve their planning and control of the production process.

According to the total direct labor variance, direct labor costs were \$1,200 lower than expected, a favorable variance. To estimate how the combination of wages and hours affects total costs, compute the total direct labor variance. As with direct materials, the price and quantity variances add up to the total direct labor variance.

As mentioned earlier, the cause of one variance might influence another variance. For example, many of the explanations shown in Figure 10.7 “Possible Causes of Direct Labor Variances for Jerry’s Ice Cream” might also apply to the favorable materials quantity variance. The most common causes of labor variances are changes in employee skills, supervision, production methods capabilities and tools. An example is when a highly paid worker performs a low-level task, which influences labor efficiency variance.

## Total Direct Labor Variance

If workers manufacture a certain number of units in an amount of time that is less than the amount of time allowed by standards for that number of units, the variance is known as favorable direct labor efficiency variance. On the other hand, if workers take an amount of time that is more than the amount of time allowed by standards, the variance is known as unfavorable direct labor efficiency variance. 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.

• We commonly see the skilled labor hours as bottleneck measures in various production facilities, so careful analysis for the direct labor efficiency and utilization for the best products can enhance the overall profitability.
• As a result of this unfavorable outcome information, the company may consider retraining its workers, changing the production process to be more efficient, or increasing prices to cover labor costs.
• We have demonstrated how important it is for managers to be
aware not only of the cost of labor, but also of the differences
between budgeted labor costs and actual labor costs.
• If customer orders for a product are not enough to keep the workers busy, the production managers will have to either build up excessive inventories or accept an unfavorable labor efficiency variance.

Errors and inefficiencies are never considered to be assets; therefore, the entire amount must be expensed immediately. In this simple example, this variance shows ADVERSE variance, because the labor took more hours per unit and cost more per unit than the standard or budgeted targets. The variance is unfavorable since more hours than the standard number of hours were required to complete the period’s production. Before we go on to explore the variances related to fixed indirect costs (fixed manufacturing overhead), check your understanding of the variable overhead efficiency variance. If the balance in the Direct Materials Price Variance account is a credit balance of \$3,500 (instead of a debit balance) the procedure and discussion would be the same, except that the standard costs would be reduced instead of increased.

## What is the difference between labor rate and efficiency variance?

If there is no difference between the standard rate and the actual rate, the outcome will be zero, and no variance exists. Labor efficiency variance Usually, the company’s engineering department sets the standard amount of direct labor-hours needed to complete a product. Engineers may base the direct labor-hours standard on time and motion studies or on bargaining with the employees’ union.

## Direct labor variance analysis

If the total actual cost incurred is less than the total standard cost, the variance is favorable. If the outcome is unfavorable, the actual costs related to labor asset protection for the business owner were more than the expected (standard) costs. If the outcome is favorable, the actual costs related to labor are less than the expected (standard) costs.

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. The direct labor (DL) variance is the difference between the total actual direct labor cost and the total standard cost. By using standard cost against both the actual and expected quantity, we get the variance in dollars that is attributed to quantity only.

The standard variable OH rate per DLH is \$0.80 (calculated previously), and the actual variable overhead for the month was \$1,395 for 2,325 actual direct labor hours, giving an actual rate of \$0.60. If the direct labor is not efficient when producing the good output, there will be an unfavorable labor efficiency variance. That inefficiency will likely cause additional variable manufacturing overhead which will result in an unfavorable variable manufacturing overhead efficiency variance. If the inefficiencies are significant, the company might not be able to produce enough good output to absorb the planned fixed manufacturing overhead costs.

## How can you calculate the direct labor efficiency variance?

Note that both approaches—direct labor rate variance calculation
and the alternative calculation—yield the same result. Because Band made 1,000 cases of books this year, employees should have worked 4,000 hours (1,000 cases x 4 hours per case). However, employees actually worked 3,600 hours, for which they were paid an average of \$13 per hour. To arrive at the total cost per unit, we need to multiply the unit of material and labor with the standard rate. It is the estimated price of material and labor that a company need to pay to supplier and workers. Let’s assume that the Direct Materials Usage Variance account has a debit balance of \$2,000 at the end of the accounting year.

He has been a manager and an auditor with Deloitte, a big 4 accountancy firm, and holds a degree from Loughborough University. Mark P. Holtzman, PhD, CPA, is Chair of the Department of Accounting and Taxation at Seton Hall University. He has taught accounting at the college level for 17 years and runs the Accountinator website at , which gives practical accounting advice to entrepreneurs. Tracking this variance is only useful for operations that are conducted on a repetitive basis; there is little point in tracking it in situations where goods are only being produced a small number of times, or at long intervals. Daniel S. Welytok, JD, LLM, is a partner in the business practice group of Whyte Hirschboeck Dudek S.C., where he concentrates in the areas of taxation and business law.

## Direct Labor Variance Formulas

In order to make a proper estimate, management estimates the standard cost base on the unit of labor and material. For example, one unit of cloth requires 0.1Kg of raw material and 1 hour of labor. However, one particular indicator such as direct labor efficiency variance cannot determine the whole process of efficiency or productivity.