The difference between the actual direct rate and standard labor rate is called direct labor rate variance.
Direct labor variance is a management tool to compare the budgeted rate set for direct labor at the start of production with the actual labor rate applicable during the production period.
Management can revise their budgeted rate if there is something extra ordinary happens in the normal course of business.
Standard should be real and based on the past experience, as the unreal standards may affect adversely.
How to Calculate Direct Labor Rate Variance:
The formula for direct labor may be derived as
(Standard rate × actual hours used) – (Actual rate × Actual Hours used)
So Actual Hours Used (Actual Rate – Standard Rate) = Direct Labor Rate Variance
The following example will help you to understand further
The Coporal Company is a larger manufacturer of handmade furniture. Management decides to apply standard costing in the labor department to analyze and control the labor cost.
Corporal Company manufactures and sold 10,000 units of furniture during the period.
Direct labor cost are as follows:
|Item||Actual Hours/Unit||Standard Hours/Unit||Actual Rate/Hour||Standard Rate/Hour|
Calculation of Labor Rate Variance
First we have to calculate actual labor hours used:
Actual Hours = Actual Units Manufactured × Actual Price
= 10,000 × 0.6
= 6,000 hours
Now calculate the actual cost
Actual Labor Cost = Actual Hours × Actual Rate
= 6,000 × 13
Now calculate the standard amount of actual number of hours
Standard cost of actual hours = Standard rate × Actual hours
= 6000 × 11
Now you have calculate all the components of formula
Direct material rate variance = Actual Cost – Standard cost of actual hours
=78,000 – 66,000
= 12,000 Adverse
A favorable variance may arise due to one of the following reasons:
- The phenomena of supply and demand also applies on the labor rate. Like if the availability of labor is more in the market while the demand is not really high. Then it is possible that labor decrease their rate to get some work. This decrease in rate also benefits the organization and gets a favorable variance at the end of period.
- If the company due to some reasons go for relatively unskilled or semi-skilled labor. Then they have to pay on less rate as compare to highly skilled labors.
- There may be wrong estimations taken by the management about the labor rate. They may sets very high rates as compared to actual labor rates. It will give you favorable variance, at the end when you compare the two.
Causes for unfavorable variance:
- If there is a boom in the labor rate throughout the market. Then organization have to increase their wage rate to retain their skilled labor.
- Due to some reasons HR did not work efficiently and hired labor on much higher rate than expected.
- If the labor union is strong enough to approve their demands.
- Company may hire some highly skilled labor as compared to their needs.
Labor rate variance is widely used in almost all manufacturing companies. Management are always want to find some new ways to control their product’s price.
And direct labor is one the essential part of cost of goods sold. So every company want to set some high standards in order to achieve the desired rates.
But as we discussed there are certain things, which are not in the control of management and there may arise some unfavorable variance.