The direct labor variance is the difference between the actual labor hours used for production and the standard labor hours allowed for production on the standard labor hour rate.
From the definition, you can easily derive the formula:
Direct Labor Efficiency Variance = (Actual Labor Hours – Budgeted Labor Hours)
Labor efficiency variance compares the actual direct labor and estimated direct labor for units produced during the period.
It is a very important tool for management as it provides the management with a very close look at the efficiency of labor work.
Example of direct labor efficiency variance
ABC Company produces crystal glass in a very high-tech company. Labor is used for packing the glass into cotton.
The company is recently implemented the standard costing system.
The management estimate that 2000 hours should be used for packing 1000 kinds of cotton or glass.
The actual results show that the packing department worked 2200 hours while 1000 kinds of cotton were packed.
The standard cost for a labor hour is $40.
Required: Calculate the efficiency variance
Solution:
Write down the formula
Direct labor efficiency variance = (actual labor hours – budgeted labor hours) × standard labor rate
Write down the important data from the question
Actual labor hours used in 2200
Standard labor hour allowed 2000
Standard rate 40/hour
Now put the amounts in the formula
Direct labor efficiency variance = (2,200 – 2,000) × 40
= (200) × 40
Direct labor efficiency variance = 8,000 unfavorable.
Example#2
MI is a leading manufacturing company in the field of making jeans. MI manufactured and sold 10,000 pairs during the period.
Following is information about the company’s direct labor and its cost.
| Actual Hours/unit | Standard hours/unit | Actual rate/hour | Standard rate/hour | |
| Direct Labor | 0.6 | 0.7 | $14 | $12 |
Labor variance can be calculated in the following 5 steps
1) Calculation of Actual Hours
Actual hours = 10,000 × 0.6 = 6,000 hours
2) Calculation of standard cost on actual hours
The standard cost of actual hours = Actual hours × estimated rate
= 6,000 × 12 = 72,000
Step 3 Calculation of standard hours
Standard hours will be = 10,000 × 0.7
= 7,000 hours
Step 4 Calculation of standard cost
Standard hour’s × standard rate
= 7,000 × 12 = 84,000
Step 5 Calculation of variance
Labor Efficiency variance = estimated/standard cost of actual hours – standard cost
= 72,000 – 84,000
= 12,000 favorable.
Explanation:
Measuring the efficiency of the labor department is as important as any other task. Because labor cost is one of the major components of any product.
If the company fails to control the efficiency of labor, then it becomes very difficult for the company to survive in the market.
Standard costing plays a very important role in controlling labor costs while maximizing the labor department’s efficiency.
The result of efficiency variance is either favorable or unfavorable.
Favorable variance means that the actual labor hours’ usage is less than the actual labor hour usage for a certain amount of production.
It also indicates that the laborers follow the management strategies. It is stated that there should be some motivation if you apply standard costing in your organization.
Unfavorable efficiency variance means that the actual labor hours are higher than expected for a certain amount of a unit’s production.
The unfavorable variance tells the management to look at the production process and identify where the loopholes are, and how to fix them.