# Comparison of Labor Price Variance vs. Labor Efficiency Variance

## Direct Labor Rate Variance Calculation

The difference between the actual quantity at standard price and the standard cost is the direct materials quantity variance. The total of both variances equals the total direct materials variance. Calculating a standard direct labor cost per unit rate lets you set a tolerance range of direct labor variance costs. You can use this information to identity and investigate why your actual costs are higher or lower than your standard direct labor per unit costs.

Because the company uses 30,000 pounds of paper rather than the 28,000-pound standard, it loses an additional \$20,700. Direct labor refers to those who produce goods, such as workers on an assembly line. Usually when dealing with direct labor, the actual rate is set by you. It is the amount you agree to pay each direct labor employee for direct labor hours worked.

Accountants usually examine direct labor costs, direct product costs and overhead costs when determining variances. If the actual costs are less than the expected costs, the business has a favorable variance. Accountants perform standard costing calculations periodically to help managers stay on budget, determine inventory costs and help management price products.

### What do you mean by Labour variance?

A labor variance arises when the actual expense associated with a labor activity varies (either better or worse) from the expected amount. The expected amount is typically a budgeted or standard amount. The labor variance concept is most commonly used in the production area, where it is called a direct labor variance.

Labor efficiency variance measures the difference between the number of direct labor hours you budgeted and the actual hours your employees work. Compare these two variances to determine how well your small business managed its direct labor costs during a period. 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. As stated earlier, variance analysis is the control phase of budgeting. This information gives the management a way to monitor and control production costs.

The labor rate variance focuses on the wages paid for labor and is defined as the difference between actual costs for direct labor and budgeted costs based on the standards. The labor efficiency variance focuses on the quantity of labor hours used in production. It is defined as the difference between the actual number of direct labor hours worked and budgeted direct labor hours that should have been worked based on the standards. 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).

## Labor rate variance

Standard costs are used to establish the flexible budget for direct labor. The flexible budget is compared to actual costs, and the difference is shown in the form of two variances.

Small business owners then use this amount to find the variance between the actual rate and the standard rate for the area to see whether they overpaid or underpaid for the direct labor. However, if you just paid a lump sum for the direct labor costs, you can find the actual direct labor rate by dividing the total amount paid by the actual hours worked. If the actual direct labor cost per unit is less than the direct labor standard rate, you have a favorable variance; it costs you less to produce the items than expected. If the actual direct labor cost per unit is more than the direct labor standard rate, you have an unfavorable variance; it costs you more to produce the items than expected.

## How to Measure Direct Labor

A labor variance that is a positive number is favorable and can result in profit that is higher than expected. A favorable variance occurs when your actual direct labor costs are less than your standard, or budgeted, costs. A labor variance that is a negative number is unfavorable and can result in profit that is lower than expected. An unfavorable variance occurs when actual direct labor costs are more than standard costs. The actual cost less the actual quantity at standard price equals the direct materials price variance.

As with direct materials, the price and quantity variances add up to the total direct labor variance. Labor efficiency variance equals the number of direct labor hours you budget for a period minus the actual hours your employees worked, times the standard hourly labor rate. For example, assume your small business budgets 410 labor hours for a month and that your employees work 400 actual labor hours.

• Standard costs are used to establish the flexible budget for direct labor.
• The flexible budget is compared to actual costs, and the difference is shown in the form of two variances.
• The labor rate variance focuses on the wages paid for labor and is defined as the difference between actual costs for direct labor and budgeted costs based on the standards.

The variance is obtained by calculating the difference between the direct labor standard cost per unit and the actual direct labor cost per unit. If the actual direct labor cost is lower, it means that it costs lower to produce one unit of a product than the standard direct labor rate, and therefore, favorable.

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. To estimate how the combination of wages and hours affects total costs, compute the total direct labor variance.

For example, assume your small business budgets a standard labor rate of \$20 per hour and pays your employees an actual rate of \$18 per hour. Also, assume your employees work 400 actual hours during the month.

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. 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 total of both variances equals the total direct labor variance. Labor price variance, or rate variance, measures the difference between the budgeted hourly rate and the actual rate you pay direct labor workers who directly manufacture your products.

## What Is Labor Variance?

Your labor price variance would be \$20 minus \$18, times 400, which equals a favorable \$800. United Airlines asked a bankruptcy court to allow a one-time 4 percent pay cut for pilots, flight attendants, mechanics, flight controllers, and ticket agents. The pay cut was proposed to last as long as the company remained in bankruptcy and was expected to provide savings of approximately \$620,000,000. How would this unforeseen pay cut affect United’s direct labor rate variance? Labor variance either results from efficiency or rate discrepancies.

Next, we calculate and analyze variable manufacturing overhead cost variances. As with direct materials variances, all positive variances are unfavorable, and all negative variances are favorable. The labor rate variance calculation presented previously shows the actual rate paid for labor was \$15 per hour and the standard rate was \$13. This results in an unfavorable variance since the actual rate was higher than the expected (budgeted) rate.

## What is Direct Labor?

Your labor efficiency variance would be 410 minus 400, times \$20, which equals a favorable \$200. Accountants perform standard costing by comparing expected costs with actual costs and analyzing the differences.

Knowing the direct labor cost per unit makes pricing and margin management much easier. Labor price variance equals the standard hourly rate you pay direct labor employees minus the actual hourly rate you pay them, times the actual hours they work during a certain period.