Variances are calculated to Analyze Company’s planning with actual results. The difference between the actual number of hours per unit and the budgeted number of hours per unit, valued at a specific wage rate is called direct labor efficiency variance.
The labor efficiency variance calculates and measures the ability to utilize labor according to expectations.
The variances are important tools to highlight all the areas of production processes that are consuming more labor hours than expected.
The positive results are termed favorable while bad results are known as an unfavorable variance.
The Formula for Direct Labor Efficiency Variance:
The formula for direct labor efficiency can be expressed as:
(Actual hours – standards hours) × Standard rate = labor efficiency variance.
The favorable results will show you that the company’s labor has worked efficiently and according to the plan of management.
While the unfavorable efficiency variance shows that the company’s labor does not achieve the standards needed to complete one unit.
Importance of direct labor efficiency variance:
The available labor hours are always important for companies as they are considered of scarce resources.
Efficient use of labor hours is very beneficial for the company.
And that’s why companies make special attention to this segment. Because in today’s cut-throat competition selling price is really matters and labor efficiency can play a major part in lowering the cost of any product.
Helps in Decision Making:
The direct labor efficiency variance plays an important role in decision-making, providing useful information about the company’s actual labor efficiency.
Most manufacturing companies nowadays use standard costing to enhance direct labor efficiency as they motivate their labor to achieve the best standards in the industry.
Due to the best standards implemented the production of the company increase without paying extra to the workers.
This results in a lower cost of goods sold, and the company can get high benefits is sales by lowering their sales price in the market.
Helps in Cost Control:
The best practices of the industry always set the standards.
It means that the labor performance will be matched with the best workers and identify the problems if there is an unfavorable variance.
Implementing high standards in labor departments will enhance the company’s production capacity, which is the ultimate result of controlling the cost of the company’s products.
Act as Motivational Factor:
The achievement of the goal always has a very positive impact on human life. The standards set by the company for labor should be achievable to act as a motivational factor for the labor.
Limitations of Direct Labor Efficiency Variance:
The companies can achieve the standards by announcing extra benefits to the labor so everyone will try to achieve the standards.
So in this way, the unfavorable variance can be changed to favorable.
The direct labor variance has some limitations which may affect the results. There are some controllable and non-controllable factors associated with labor efficiency.
Managers should be aware of all these factors and update their planning accordingly.
If there is a dramatic technological change comes in the industry, the labor will take time to get used to it. In this way, the efficiency variance of the company will go down.
Because the direct labor efficiency variance formula does not consider these accounts, the managers should revise their budget to motivate the laborers.