If it’s zero, it means no variance exists between the actual hours and standard hours for the specific activity level. Nonetheless, the interpretation of positive and negative results from the direct labour efficiency variance is below. The direct labour efficiency variance provides insights into the performance of direct labour employees. Similarly, it offers companies the opportunity to optimize their production processes, control costs, and enhance overall operational efficiency. Simply, it measures how efficiently a company utilizes its direct labour compared to the standard labour hours.
Actual labor costs may differ from budgeted costs due to differences in rate and efficiency. Note that both approaches—the direct labor efficiency variance
calculation and the alternative calculation—yield the same
result. The labor efficiency variance is also known as the direct labor efficiency variance, and may sometimes be called (though less accurately) the labor variance. Together with the price variance, the efficiency variance forms part of the total direct labor variance. The above formula for direct labour efficiency variance includes the following components.
Example Calculation of Direct Labor Efficiency Variance
The labor efficiency variance calculation presented previously
shows that 18,900 in actual hours worked is lower than the 21,000
budgeted hours. Clearly, this is favorable since the
actual hours worked was lower than the expected (budgeted)
hours. The standard hours (26,400) is computed by multiplying the number of units produced by the hours required to complete one unit, i.e. 9,600 units x 2.75 hours each. This means that if the standard time was followed, the company should have used 26,400 hours only. 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.
- 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.
- During the year, the company spends 200,000 hours producing 35,000 of output.
- 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.
- If the direct labour efficiency variance is positive, it suggests that the actual hours worked were fewer than the standard hours.
- However, it may also occur due to substandard or low quality direct materials which require more time to handle and process.
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. Typically, the hours of labor employed are more likely to be under management’s control than the rates that are paid. For this reason, labor efficiency variances are generally watched more closely than labor rate variances. Companies prepare budgets that plan how long it should take employees to produce a specific number of products. Therefore, companies must calculate variance to understand why differences exist.
Create a Free Account and Ask Any Financial Question
Calculate the labor rate variance, labor time variance, and total labor variance. There is a favorable direct labor efficiency variance when the actual hours used is less than the anticipated or standard hours. In some cases, this might be due to employing more skillful workers which results in unfavorable direct labor rate variance (higher wages paid). The purpose of calculating the direct labor efficiency variance is to measure the performance of the production department in utilizing the abilities of the workers. A positive value of direct labor efficiency variance is obtained when the standard direct labor hours allowed exceeds the actual direct labor hours used. A negative value of direct labor efficiency variance means that excess direct labor hours have been used in production, implying that the labor-force has under-performed.
Great! The Financial Professional Will Get Back To You Soon.
Insurance companies pay doctors according to a set schedule, so they set the labor standard. Let’s assume further that instead of the actual hours per unit of 0.4, Techno Blue manufactures was able to produce at 0.25 actual hours per unit. Later in Part 6 we will discuss what to do with the balances in the direct labor variance accounts under the heading What To Do With Variance Amounts. An unfavorable variance means that labor efficiency has worsened, and a favorable variance means that labor efficiency has increased. If this cannot be done, then the standard number of hours required to produce an item is increased to more closely reflect the actual level of efficiency.
Accounting Ratios
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. This awareness
helps managers make decisions that protect the financial health of
their companies. 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. If the total actual cost incurred is less than the total standard cost, the variance is favorable.
The actual time can be shorter or longer due to various reasons, so it will create a favorable and unfavorable variance. Where,
SH are the standard direct labor hours allowed,
AH are the actual direct labor hours used, and
SR is the standard direct labor rate per hour. The estate tax return is one of the main standard costing variances, and results from the difference between the standard quantity and the actual quantity of labor used by a business during production. Additionally the variance is sometimes referred to as the direct labor usage variance or the direct labor quantity variance. The unfavorable variance tells the management to look at the production process and identify where the loopholes are, and how to fix them. Any positive number is considered good in a labor efficiency variance because that means you have spent less than what was budgeted.
The actual results show that the packing department worked 2200 hours while 1000 kinds of cotton were packed. Chartered accountant Michael Brown is the founder and CEO of Double Entry Bookkeeping. He has worked as an accountant and consultant for more than 25 years and has built financial models for all types of industries.
Types of Labor Cost Variance
The combination of the two variances can produce one overall total direct labor cost variance. 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.