admin Let’s also assume that the quality of the low-cost denim ends up being slightly lower than the quality to which your company is accustomed. This lesser quality denim causes the production to be a bit slower as workers spend additional time working around flaws in the material. In addition to this decline in productivity, you also find that some of the denim is of such poor quality that it has to be discarded. Further, some of the finished aprons don’t pass the final inspection due to occasional defects not detected as the aprons were made. Direct labor efficiency variance pertain to the difference arising from employing more labor hours than planned.
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. The actual rate can differ from the standard or expected rate because of supply and demand of the workers, increased labor costs due to economic changes or union contracts, or the ability to hire employees at a different skill level. 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. If, however, the actual rate of pay per hour is greater than the standard rate of pay per hour, the variance will be unfavorable.
This information gives the management a way to
monitor and control production costs. Next, we calculate and
analyze variable manufacturing overhead cost variances. 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.
Direct Labor Rate Variance Calculation
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.
- According to the total direct labor variance, direct labor costs were $1,200 lower than expected, a favorable variance.
- As a result of these cost cuts, United was
able to emerge from bankruptcy in 2006. - 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.
- Standard cost is the amount a cost should be under a given set of circumstances.
- It is the estimated price of material and labor that a company need to pay to supplier and workers.
Consequently this variance would be posted as a credit to the direct labor efficiency variance account. Additionally full details of the journal entry required to post the variance, standard cost and actual cost can be found in our direct labor variance journal tutorial. Because of the cost principle, the financial statements for DenimWorks report the company’s actual cost.
Direct Labor Variances FAQs
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. Figure 8.4 shows the connection between the direct labor rate variance and direct labor time variance to total direct labor variance. Even though the answer is a negative number, the variance is favorable because employees worked more efficiently, saving the organization money. What we have done is to isolate the cost savings from our employees working swiftly from the effects of paying them more or less than expected. Figure 10.43 shows the connection between the direct labor rate variance and direct labor time variance to total direct labor variance. 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 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. After filing for Chapter 11 bankruptcy in
December 2002, United cut close to $5,000,000,000
in annual expenditures. As a result of these cost cuts, United was
able to emerge from bankruptcy in 2006.
For Jerry’s Ice Cream, the standard allows for 0.10
labor hours per unit of production. Thus the 21,000 standard hours
(SH) is 0.10 hours business debt reduction per unit × 210,000 units produced. The standard cost usually includes variable costs such as direct material and direct labor.
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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. 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. 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. Another key component of any efficiency variance is the basis upon which the standard is set. For example, the number of units of direct material could assume the absence of scrap, when in fact a standard amount of scrap is normally realized, causing a continuing negative efficiency variance.
Trial Balance
This in turn can also cause an unfavorable fixed manufacturing overhead volume variance. The productivity of labor is an important measure for any manufacturing business, variance in standard and actual direct labor hours can provide the management with useful information about the skills level of the labor force. The availability of direct labor hours is often scarce in bulk production so utilizing the labor hours to maximize the profits is important for sales and production targets too. 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. Based on the time standard of 1.5 hours of labor per body, we expected labor hours to be 2,430 (1,620 bodies x 1.5 hours).
Accounting professionals have a materiality guideline which allows a company to make an exception to an accounting principle if the amount in question is insignificant. 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. Note that both approaches—the direct labor efficiency variance calculation and the alternative calculation—yield the same result.
The efficiency of labor is the optimum of labor hours available to the best use of the profit-making products in a product mix. In any manufacturing process, the management may decide to use temporary or hour-based labor in case of direct labor shortage or for the production increment purpose. However, in the long term, direct labor efficiency analysis holds more significance in control measures and performance appraisals. 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 management’s control than the rates that are paid.
This would be a theoretical standard, that can only be met if the circumstances are optimal. Or, a realistic standard could be used that incorporates reasonable inefficiency levels, and which comes close to actual results. Generally, the latter approach is preferable, if only to avoid a depressing series of negative efficiency variances. The labor efficiency in hours is the difference between the total actual hours and standard hours. The total labor actual and standard hours were calculated as per step 1 and step 2 above. The variance is positive and unfavorable because the actual rate paid exceeded the standard rate allowed.