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? The

direct labor rate variance would likely be favorable, perhaps

totaling close to $620,000,000, depending on how much of these

savings management anticipated when the budget was first

established. However, they spend 5.71 hours per unit (200,000 hours /35,000 units) on the actual production.

If the balance is considered insignificant in relation to the size of the business, then it can simply be transferred to the cost of goods sold account. Harold Averkamp (CPA, MBA) has worked as a university accounting instructor, accountant, and consultant for more than 25 years. Kenneth W. Boyd has 30 years of experience in accounting and financial services. He is a four-time Dummies book author, a blogger, and a video host on accounting and finance topics.

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 per unit × 210,000 units produced. 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).

- Management needs to investigate and solve the issue by reducing the actual time spend or revising the standard cost.
- 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).
- He has worked as an accountant and consultant for more than 25 years and has built financial models for all types of industries.
- Figure 10.43 shows the connection between the direct labor rate variance and direct labor time variance to total direct labor variance.
- The variance is unfavorable since more hours than the standard number of hours were required to complete the period’s production.

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. 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.

## Direct Labor Efficiency Variance Calculation

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. 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.

If the direct labor cost is $6.00 per hour, the variance in dollars would be $0.90 (0.15 hours × $6.00). For proper financial measurement, the variance is normally expressed in dollars rather than hours. 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. This shows that our labor costs are over budget, but that our employees are working faster than we expected.

## Labor efficiency variance definition

Due to the unexpected increase in actual cost, the company’s profit will decrease. Management needs to investigate and solve the issue by reducing the actual time spend or revising the standard cost. Labor efficiency variance happens when the price per direct labor remains the same but the time spends to produce one unit different from standard costing. Management makes the wrong estimate of the time spent in production or the actual time increase due to various reasons.

## What is the Labor Efficiency 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. However, one particular indicator such as direct labor efficiency variance cannot determine the whole process of efficiency or productivity. 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. Such control measures can also motivate the direct labor to work on reducing idle labor hours, process wastes, and inaccuracies that can be a useful starting point in applying the total quality management approach.

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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. Let’s assume that the Direct Materials Usage Variance account has a debit balance of $2,000 at the end of the accounting year.

If the standard quantity allowed had exceeded the quantity actually used, the materials usage variance would have been favorable. (standard hours allowed for production – actual hours taken) × standard rate per direct labour hour. Doctors, for example, have a time allotment for a physical exam and base their fee on the expected time. Insurance companies pay doctors according to a set schedule, so they set the labor standard.

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Review this figure carefully before moving on to the

next section where these calculations are explained in detail. 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.