Labor cost variance scenario: One type of DL

Scenario 1: One type of direct labor

Each formula below is written as standard − actual: a negative result means actual cost exceeded standard - unfavorable, which lowers operating income - while a positive result is favorable. The actual rate (AR) and actual hours (AH) used below pair with the standard rate (SR) and standard hours (SH) from the prior lesson.

The following information was available for the month of August:

• Standard units planned in the master budget: 1,000 units
• Total standard direct labor hours to produce standard units: 3,000 hours
• Standard cost of direct labor in the master budget: $450,000
• Actual production of Product A for the month of August: 1,200 units
• Actual direct labor: 3,400 hours (AH) @ $160 per hour (AR)

Calculate the direct labor variances:

1. Labor rate variance
2. Labor efficiency variance
3. Labor cost variance

Comparing actual cost ($544,000) to the master budget ($450,000) gives $94,000 U, but $90,000 of that is the volume effect of producing 1,200 units instead of 1,000 (flexible budget $540,000 − $450,000). Only the remaining $4,000 U, measured against the flexible budget, reflects labor performance.

Step 1: Derive the missing inputs

Before computing the variances, we still need the standard rate ($\text{SR}$) of direct labor and the standard hours ($\text{SH}$) allowed for actual production, which we can derive from the given data:

$$\text{Standard DL per unit}=(3,000\text{ hours}÷1,000\text{ units})=3\text{ hours per unit}$$

$$\text{Standard DL rate per hour (SR)}=\$450,000÷3,000\text{ hours}=\$150$$

$$\text{Standard DL hours for actual production (SH)}=3\text{ hours}\times 1,200\text{ units}=3,600\text{ hours}$$

Scenario 1.1. Labor rate variance

$$\begin{array}{rl}\text{Labor rate variance}& =(\text{SR}\times \text{AH})-(\text{AR}\times \text{AH})\\ & =(150\times 3,400)-(160\times 3,400)\\ & =510,000-544,000\\ & =-\$34,000(\text{U})\end{array}$$

The variance is unfavorable because the actual rate per hour of direct labor ($160) is higher than standard rate ($150).

Scenario 1.2. Labor efficiency variance

$$\begin{array}{rl}\text{Labor efficiency variance}& =(\text{SR}\times \text{SH})-(\text{SR}\times \text{AH})\\ & =(150\times 3,600)-(150\times 3,400)\\ & =540,000-510,000\\ & =\$30,000(\text{F})\end{array}$$

The variance is favorable because the actual hours of direct labor used by production (3,400 hours) are lower than the standard hours (3,600 hours).

Scenario 1.3. Labor cost variance

$$\begin{array}{rl}\text{Labor cost variance}& =(\text{SR}\times \text{SH})-(\text{AR}\times \text{AH})\\ & =(150\times 3,600)-(160\times 3,400)\\ & =540,000-544,000\\ & =-\$4,000(\text{U})\end{array}$$

The labor cost variance can also be a summation of the rate and efficiency variances:

$$\begin{array}{rl}\text{Labor cost variance}& =\text{Labor rate variance}+\text{Labor efficiency variance}\\ & =-\$34,000(\text{U})+\$30,000(\text{F})\\ & =-\$4,000(\text{U})\end{array}$$

The variance is unfavorable because the actual cost is higher than the standard cost.

The $160 actual rate may reflect more skilled, higher-paid labor that also worked faster than the standard - explaining both the unfavorable rate variance and the favorable efficiency variance. With a net $4,000 U, management should judge whether that skill mix was worth it: HR/hiring typically controls the rate variance, while the production supervisor controls efficiency.