# 8 5 Describe How Companies Use Variance Analysis Principles of Accounting, Volume 2: Managerial Accounting

The actual hours worked are the total hours worked by the employees. The formula calculates the differences between rates, given the number of hours worked. Primarily, it reviews the differences between the expected costs of labor and the actual costs of labor. It can also aid the planning and development of new budgets and serve as a means of gaining information on company performance. This information can be used to set new hourly rates for employees. Favorable when the actual labor cost per hour is lower than standard rate.

## Standard Costing Advantages Explained

To compute the direct labor price variance, subtract the actual hours of direct labor at standard rate ($43,200) from the actual cost of direct labor ($46,800) to get a $3,600 unfavorable variance. This result means the company incurs an additional $3,600 in expense by paying its employees an average of $13 per hour rather than $12. The total direct labor variance is also found by combining the direct labor rate variance and the direct labor time variance. By showing the total direct labor variance as the sum of the two components, management can better analyze the two variances and enhance decision-making.

- Management may overestimate the material price, labor rate, material quantity, or labor hours per unit, for example.
- In the short term, it might be more economical to repair the outdated equipment, but in the long term, purchasing more efficient equipment would help the organization reach its goal of eco-friendly manufacturing.
- An overview of these two types of labor efficiency variance is given below.
- Labor efficiency variance arises when the actual hours worked vary from standard, resulting in a higher or lower standard time recorded for a given output.

## Labor Rate Variance Formula

The variance is positive and unfavorable because the actual rate paid exceeded the standard rate allowed. If the reverse were true, the variance would be favorable. If we use more hours at the same rate of pay, it would be called a labor efficiency variance. If the outcome is unfavorable, the actual costs related to labor were more than the expected (standard) costs. If the outcome is favorable, the actual costs related to labor are less than the expected (standard) costs.

## What is the difference between labor yield and mix variances?

So as we discussed, we can analyze the variance for labor efficiency by using the standard cost variance analysis chart on 10.3. Labor yield variance arises when there is a variation in actual output from standard. Since this measures the performance of workers, it may be caused by worker deficiencies or by poor production methods. Labor mix variance is the difference between the actual mix of labor and standard mix, caused by hiring or training costs. Watch this video presenting an instructor walking through the steps involved in calculating direct labor variances to learn more.

## Learning Outcomes

Labor efficiency variance Usually, the company’s engineering department sets the standard amount of direct labor-hours needed to complete a product. Engineers may base the direct labor-hours standard on time and motion studies or on bargaining with the employees’ union. The labor efficiency variance occurs when employees use more or less than the standard amount of direct labor-hours to produce a product or complete a process. The labor efficiency variance is similar to the materials usage variance. The labor rate variance measures the difference between the actual and expected cost of labor. An unfavorable variance means that the cost of labor was more expensive than anticipated, while a favorable variance indicates that the cost of labor was less expensive than planned.

As with direct materials variances, you can use either formulas or a diagram to compute direct labor variances. The following is a summary of all direct materials variances (Figure 8.6), direct labor variances (Figure 8.7), and overhead variances (Figure 8.8) presented as both formulas and tree diagrams. Note that for some of the formulas, there are two presentations of the same formula, for example, there are two presentations of the direct materials price variance. While both arrive at the same answer, students usually prefer one formula structure over the other. The amount by which actual cost differs from standard cost is called a variance.

## Related AccountingTools Course

This information gives the management a way tomonitor and control production costs. Next, we calculate andanalyze variable manufacturing overhead cost variances. Biglow Company makes a hair shampoo called Sweet and Fresh. Each bottle has a standard labor cost of 1.5 hours at ? Calculate the labor rate variance, labor time variance, and total labor variance. Labor rate variance The labor rate variance occurs when the average rate of pay is higher or lower than the standard cost to produce a product or complete a process.

Both favorable and unfavorable must be investigated and solved. The unfavorable will hit our bottom line which reduces the profit or cause the surprise loss for company. The favorable will increase profit for company, but we may lose some customers due to high selling price which cause by overestimating the labor standard rate.

This method of overestimation, sometimes called budget slack, is built into the standards so management can still look good even if costs are higher than planned. In either case, managers potentially can help other managers and the company overall by noticing particular problem areas or by sharing knowledge that can improve variances. If the actual rate of pay per hour is less than the standard rate of pay per hour, the variance will be a favorable variance. A favorable outcome means you paid workers less than anticipated.

Lynn was surprised tolearn that direct labor and direct materials costs were so high,particularly since actual materials used and actual direct laborhours worked were below budget. An adverse labor rate variance indicates higher labor costs incurred during a period compared with the standard. A favorable labor rate variance occurred because the rate paid per hour was less than the rate expected to be paid (standard) per hour.

When low skilled workers are recruited at a lower wage rate, the direct labor rate variance will be favorable however, such workers will likely be inefficient and will generate a poor direct labor efficiency variance. Direct labor rate variance must be analyzed in combination with direct labor efficiency variance. Labor rate variance is the difference between actual cost of direct labor and its standard cost. The difference due to actual amount paid and the standard rate per hour while the time spends during production remains the same. A direct labor variance is caused by differences in either wage rates or hours worked.

Determine whether a variance is favorable or unfavorable by reliance on reason or logic. If more materials were used than the standard quantity, or if a price greater than the standard price was paid, the variance is unfavorable. At Hupana Running Company, our budget allows for .5 hours net revenue and operating income of direct labor per pair of shoes produced. The most common causes of labor variances are changes in employee skills, supervision, production methods capabilities and tools. An example is when a highly paid worker performs a low-level task, which influences labor efficiency variance.

In this case, the actual hours worked per box are \(0.20\), the standard hours per box are \(0.10\), and the standard rate per hour is \(\$8.00\). 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 https://www.business-accounting.net/ 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.