Direct Labor Rate Variance: Definition, Formula, Explanation, Analysis, And Example

Definition:

Direct Labor rate variance indicates the actual cost of any change from the standard labor rate of remuneration. In simple words, it measures the difference between the actual and expected cost of labor.

Direct labor rate variance is also called direct labor price variance or spending variance or wage rate variance. In terms of calculation, it is very much similar to direct material price variance.

Formula:

Direct Labor Rate Variance

                                = Actual Hours (Actual Rate – Standard Rate) or

                                = Actual Cost – Standard cost of actual labor hours

Explanation:

Direct labor rate variance recognizes and explains the performance of the human resource department in negotiating lower wage rates with employees and labor unions.

It is because the labor rate standards are defined by labor union contracts and company personnel policies.

Standard labor rates are influenced by the amount of overtime, new hiring at various paying rates, promotions of labor, and the outcome of contract negotiations with any unions representing the production staff.

The information obtained from direct labor variance can be used to plan ahead in the development of budgets for future purposes as well as a feedback loop to those employees responsible for the direct labor component of the business.

Analysis:

Favorable rate variance is attained when the standard labor hours rate exceeds the actual direct labor hours rate. Consequently, favorable labor rate variance cannot always be good.

When laborers are hired at lower rates owing to their skills, the direct labor rate variance will be positive, however, these laborers ought to generate poor output and result in adverse efficiency variance. The reasons for favorable labor variance include:

  • The hiring of lowly skilled laborers than required. It needs to be studied with labor efficiency variance.
  • The general decline in wages rate in the market
  • Over ambitious setting of the standard cost of labor hours
  • General increment in wages rate in the market.
  • Inefficient hiring by the HR department
  • Effective negotiations by labor unions
See also  Importance and limitation of Direct Labor Rate Variance

Adverse labor rate variance indicates higher labor costs when compared with standard costs. The reasons for adverse labor rate variance are as follows:

Example:

Sinra Inc estimates that the average labor hour rate for the upcoming project will be $20 per hour. The number of hours estimated to be worked was 400 hours.

As it turned out, the actual number of hours turned out to be 412 hours and the rate per hour was $21 per hour.

Here, we have,

Standard hours SH = 400 hrs

Standard rate SR = $20 per hour

Actual hours AH = 412 hours

Actual rate AR = $21 per hour

Direct Labor rate variance = AH (AR – SR)

     = 412 (21-20)

                                          = $ 412 Adverse