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Managerial Accounting/Benchmarking/Direct Labor Variance

Benchmarking

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Direct Labor Variance

Direct labor is a significant cost for many businesses, which means accountants calculate the variance between standard and actual amounts.

Much like the direct materials variance, the direct labor variance is calculated from actual and standard amounts that give the rate variance and the quantity variance. One significant difference is that the accountant or manager calculates the direct labor variance from the hours needed times the rate per hour. This is determined by creating three labor categories: actual at actual, actual at standard, and standard at standard. Standard hours per unit is amount of labor time that should be required to complete a single unit of output.

Assume that a furniture manufacturer has the following labor data to make 15,000 units of furniture:

Direct Labor Hours and Rates

Standard Hours per Unit Actual Hours per Unit Standard Rate per Hour Actual Rate per Hour
Direct Labor 2.20 2.75 14.50 12.00

Direct labor variance calculations require standard and actual hours and rates.

Direct Labor Variance Calculations

Actual at Actual Actual at Standard Standard at Standard
Units Actual Hours per Unit Actual Rate Total Units Actual Hours per Unit Standard Rate Total Units Standard Hours per Unit Standard Rate Total
15,000 2.75 $12.00 $495,000 15,000 2.75 $14.50 $598,125 15,000 2.20 $14.50 $478,500

Direct labor variance calculations include price and quantity variances.

The accountant uses this information to figure out the labor rate variance for direct labor, which is the difference between the standard cost of labor for a process or project and the actual cost paid for the actual number of hours.
Direct Labor Rate Variance=(Actual Hours at Actual Price)−(Actual Hours at Standard Price)=$495,000−$598,125=−$103,125FavorableVariance\begin{aligned}{\text{Direct Labor Rate Variance}}&=(\text{Actual Hours at Actual Price})-(\text{Actual Hours at Standard Price})\\&=\$495{,}000-\$598{,}125\;\\&=-\$103{,}125\;{\text{Favorable}}\;{\text{Variance}}\end{aligned}
This shows that the actual price that is used is better than the standard price by $103,125. The accountant calculates the labor efficiency variance for direct labor, which is the difference between a company's actual time used for production and the standard or projected time.
Direct Labor Efficiency Variance=(Actual Hours at Standard Price)−(Standard Hours at Standard Price)=$598,125−$478,500=−$119,625Unfavorable Variance\begin{aligned}{\text{Direct Labor Efficiency Variance}}&=({\text{Actual Hours at Standard Price}})-({\text{Standard Hours at Standard Price}})\\&=\$598{,}125-\$478{,}500\\&=-\$119{,}625\;{\text{Unfavorable Variance}}\end{aligned}
The total labor variance can now be calculated.
$16,500Unfavorable=$119,625−$103,125\$\rm{16{,}500}\;{\text{Unfavorable}}=\${\rm{119{,}625}}-\${\rm{103{,}125}}
This calculation is the difference between the actual hours at actual price and standard hours at standard price, or $495,000−$478,500\$495{,}000-\$478{,}500.

Though the calculations are similar to the direct material variance, the direct labor variance analysis is more profound. In this example, the total variance is unfavorable. This is due to the larger unfavorable direct labor efficiency variance.

The direct labor variance helps managers understand the efficiency of the workers within the manufacturing process. It can be used as a performance measure. In this case, the loss in efficiency or performance may be because Mary's Manufacturing is paying its workers less than standard scale. Based on these calculations, managers will review hiring practices and try to figure out a solution to the unfavorable variance. There is the possibility that the lower pay is attracting less-qualified employees, which is negatively affecting the quality of work. If so, training programs may lessen or remove the variance.

It would also make sense to compare the labor efficiency to the direct materials quantity variance, which is also an efficiency indicator. If the quantity has not declined but the labor efficiency has, then the issue is most likely with the workers. If the quantity also declined, then it may be a problem with materials or with the manufacturing process.

<Direct Materials Variance>Variable Overhead and Efficiency Variances