Standard Cost Variance Calculations And Analysis

Total actual and standard direct labor costs are calculated by multiplying number of hours by rate, and the results are shown in the last row of the first two columns. ABC Company has an annual production budget of 120,000 units and an annual DL budget of $3,840,000. Four hours are needed to complete a finished product and the company has established a standard rate of $8 per hour. The Direct Labor Variance Analysis company used 39,500 direct labor hours and paid a total of $325,875. During March, your shoe-making company incurred actual direct labor costs of $58,872 for 6,690 hours of direct labor in the production of 2,150 pairs of shoes. If required, round the actual cost of labor per hour to the nearest cent. However, a positive value of direct labor rate variance may not always be good.

• The actual price of $4.20 per hour is computed by dividing the actual total cost for variable manufacturing overhead by the actual number of hours worked.
• For example, if the actual cost is lower than the standard cost for raw materials, assuming the same volume of materials, it would lead to a favorable price variance (i.e., cost savings).
• They can then take appropriate corrective actions to eliminate or at least minimize the LCV.
• Actual wages were paid at the rates of Rs 1.20, Rs 0.85 and Rs 0.65 respectively.

How would this unforeseen pay cut affect United’s direct labor rate variance? The direct labor rate variance would likely be favorable, perhaps totaling close to $620,000,000, depending on how much of these savings management anticipated when the budget was first established. For example, a material price variance may be favorable because of a bargain purchase opportunity or because of a combination of available resources designed to save overall costs.

Direct Material Variance

To compute the direct labor quantity variance, subtract the standard cost of direct labor ($48,000) from the actual hours of direct labor at standard rate ($43,200). This math results in a favorable variance of $4,800, indicating that the company saves $4,800 in expenses because its employees work 400 fewer hours than expected. The difference between the standard cost of direct labor and the actual hours of direct labor at standard rate equals the direct labor quantity variance.

One should also understand that not all unfavorable variances are bad. For example, buying raw materials of superior quality may be offset by reduction in waste and spoilage. Blue Rail’s very favorable labor rate variance resulted from using inexperienced, less expensive labor. Was this the reason for the unfavorable outcomes in efficiency and volume? The challenge for a good manager is to take the variance information, examine the root causes, and take necessary corrective measures to fine tune business operations.

Direct Labor Rate Variance:

Skill workers with high hourly rates of pay may be given duties that require little skill and call for low hourly rates of pay. This will result in an unfavorable labor rate variance, since the actual hourly rate of pay will exceed the standard rate specified for the particular task. In contrast, a favorable rate variance would result when workers who are paid at a rate lower than specified in the standard are assigned to the task.

• Because Band made 1,000 cases of books this year, employees should have worked 4,000 hours .
• Some of that variance is due to the rate being $0.30 too much and some of that variance is due to the direct labor using too many hours—not being efficient.
• The direct materials standard calls for 1.5 pounds per Zippy at $4.00 per pound.
• The labor efficiency variance is the difference between the actual number of direct labor hours worked and budgeted direct labor hours that should have been worked based on the standards.
• As stated earlier, variance analysis is the control phase of budgeting.
• Standards that are viewed as reasonable by employees can serve as benchmarks that promote economy and efficiency.
• Managers can better address this situation if they have a breakdown of the variances between quantity and rate.

In this case, the actual rate per hour is $9.50, the standard rate per hour is $8.00, and the actual hours worked per box are 0.10 hours. This is an unfavorable outcome because the actual rate per hour was more than the standard rate per hour. As a result of this unfavorable outcome information, the company may consider using cheaper labor, changing the production process to be more efficient, or increasing prices to cover labor costs. As with direct materials variances, all positive variances are unfavorable, and all negative variances are favorable. The labor rate variance calculation presented previously shows the actual rate paid for labor was $15 per hour and the standard rate was $13. This results in an unfavorable variance since the actual rate was higher than the expected rate. We find the labor efficiency variance by multiplying the standard rate for one hour of labor times the difference between the actual hours of labor and the standard hours of labor.

Budgeting Basics And Beyond By Jae K Shim, Joel G Siegel

We might have the same number of hours at a different hourly rate, or more hours at the same rate, or some combination of these factors. Let’s first look at the standard cost variance analysis chart for labor variances. No headers Actual and standard quantities and rates for direct labor for the production of 1,000 units are given in the following table.

• Although quantity and price variances are known by different names, they are computed exactly the same way for direct materials, direct labor, and variable manufacturing overhead.
• Factored equations can also be used to compute the rate and efficiency variances.
• This is denoted by difference between the actual hours at standard rate of standard worker and the actual hours at standard rate of actual worker.
• Manufacturing companies often have highly developed standard costing systems that establish quantity and price standards for each separate product’s material, labor, and overhead inputs.
• Manufacturing companies are required to assign fixed manufacturing overhead costs to products for financial reporting purposes .

The 2,000 units actually required 1,580 direct labor hours at a cost of $6.90 per hour. It is common for companies to apply fixed manufacturing overhead costs to products based on direct labor hours, machine hours, or some other activity. The materials quantity variance is the difference between the actual quantity of materials used in production and budgeted materials that should have been used in production based on the standards.

Possible Causes Of Direct Labor Variances

The standard quantity represents the standard quantity allowed for the actual output of the period. This is the variance that happens due to a difference in the actual number of hours worked Vs. the standard number of hours estimated. If we see in the above example, at all stages, the actual number of hours worked is more (480, 1000 & 440) as against the standard hours estimated initially (384, 768 & 288). Therefore, the cost varying to the extent of the excess number of hours worked is the Labor Hours Variance. We may also call it Labor Quantity Variance or Labor Efficiency Variance. For this, we need to multiply the standard labor hours by the ratio of Actual output and standard output. 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.

The $600 unfavorable labor efficiency variance results because Hanson’s employees worked 50 hours more than standard to make 1,000 Zippies, and each hour of labor has a standard rate of $12.00. Like direct labor rate variance, this variance may be favorable or unfavorable.

Labor Rate Variance Concept & Formula

If actual cost exceeds standard cost, the resulting variances are unfavorable and vice versa. The overall labor variance could result from any combination of having paid laborers at rates equal to, above, or below standard rates, and using more or less direct labor hours than anticipated. Standard costs are used to establish the flexible budget for direct labor. The flexible budget is compared to actual costs, and the difference is shown in the form https://accountingcoaching.online/ of two variances. The labor rate variance focuses on the wages paid for labor and is defined as the difference between actual costs for direct labor and budgeted costs based on the standards. The labor efficiency variance focuses on the quantity of labor hours used in production. It is defined as the difference between the actual number of direct labor hours worked and budgeted direct labor hours that should have been worked based on the standards.

There are many things that can contribute to labor variances, and figuring out first the “why” and then the “how do we fix this? But when a long-time employee leaves, it can ripple throughout the company. Let’s look at some ways Mary, and the rest of the management staff at Hupana, can work to keep labor variances to a minimum. First, we need to calculate the total actual labor hours as well as the standard labor hours. Further investigation of detailed costs is necessary to determine the exact cause of the fixed overhead spending variance. Variable manufacturing overhead variance analysis involves two separate variances. Inappropriately high setting of the standard cost of direct labor which may, in the hindsight, be attributed to inaccurate planning.

In this simple example, this variance shows ADVERSE variance, because the labor took more hours per unit and cost more per unit than the standard or budgeted targets. Companies using a standard cost system ultimately credit favorable variances and debit unfavorable variances to income statement accounts.

Labor price variance equals the standard hourly rate you pay direct labor employees minus the actual hourly rate you pay them, times the actual hours they work during a certain period. The availability of direct labor hours is often scarce in bulk production so utilizing the labor hours to maximize the profits is important for sales and production targets too. The variable overhead efficiency variance can be confusing as it may reflect efficiencies or inefficiencies experienced with the base used to apply overhead. For Blue Rail, remember that the total number of hours was “high” because of inexperienced labor. These welders may have used more welding rods and had sloppier welds requiring more grinding. While the overall variance calculations provide signals about these issues, a manager would actually need to drill down into individual cost components to truly find areas for improvement. In this case, two elements are contributing to the unfavorable outcome.

Specifically, knowing the amount and direction of the difference for each can help them take targeted measures forimprovement. Blue Rail produces handrails, banisters, and similar welded products. This pipe is custom cut and welded into rails like that shown in the accompanying picture. In addition, the final stages of production require grinding and sanding operations, along with a final coating of paint . The articles and research support materials available on this site are educational and are not intended to be investment or tax advice. All such information is provided solely for convenience purposes only and all users thereof should be guided accordingly. Decrease in the overall wage rates in the market due to an increase in the supply of labor which may be caused, for example, due to the influx of immigrants as a result of the relaxation of immigration policy.

Labour Efficiency Variance

The standard hours per unit reflects the labor hours required to complete one unit of product. Standards can be determined by using available references that estimate the time needed to perform a given task, or by relying on time and motion studies. The standard price per unit for direct materials should reflect the final, delivered cost of the materials, net of any discounts taken.

It means that the performance of labor will be matched with the best workers and identify the problems if there is an unfavorable variance. Due to best standards implemented the production of company increase without paying extra to the workers. Many organizations also analyze fixed manufacturing overhead variances. Variances are used to analyze the difference between actual direct material costs and standard direct material costs. Following is an illustration showing the flow of fixed costs into the Factory Overhead account, and on to Work in Process and the related variances. But, a closer look reveals that overhead spending was quite favorable, while overhead efficiency was not so good. An overview of these two types of labor efficiency variance is given below.