Additionally full details of the journal entry required to post the variance, standard cost and actual cost can be found in our direct labor variance journal tutorial. Direct labour efficiency variance measures the difference between actual and standard hours worked for a specific activity level. The formula for direct labour efficiency variance considers three components. Once they are available, companies can calculate this variance for any activity level.

We should allocate this $2,000 to wherever those direct materials are physically located. However, if $2,000 is an insignificant amount, the materiality guideline allows for the entire $2,000 to be deducted from the cost of goods sold on the income statement. Assume your company’s standard cost for denim is $3 per yard, but you buy some denim at a bargain price of $2.50 per yard.

- The standard hours (26,400) is computed by multiplying the number of units produced by the hours required to complete one unit, i.e. 9,600 units x 2.75 hours each.
- If, however, the actual hours worked are greater than the standard hours at the actual production output level, the variance will be unfavorable.
- Direct labor efficiency variance pertain to the difference arising from employing more labor hours than planned.
- Management needs to investigate and solve the issue by reducing the actual time spend or revising the standard cost.

Direct labor efficiency variance is a measure of how well a company uses its actual labor hours compared to the budgeted or standard labor hours for a given level of output. It is one of the components of the total direct labor variance, along with the direct labor rate variance. Calculating the direct labor efficiency variance can help managers identify and correct any problems related to labor productivity, scheduling, or quality. The direct labor efficiency variance is usually reported as part of the variance analysis report, which compares the actual and standard costs and revenues for a period. The variance analysis report can be prepared at different levels of detail and frequency, depending on the needs and preferences of the managers and stakeholders. The direct labor efficiency variance can be shown as a separate line item, or as a subcomponent of the total direct labor variance, which also includes the direct labor rate variance.

## How can you calculate the direct labor efficiency variance?

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. Actual labor costs may differ from budgeted costs due to differences in rate and efficiency. An adverse labor efficiency variance suggests lower productivity of direct labor during a period compared with the standard.

What we have done is to isolate the cost savings from our employees working swiftly from the effects of paying them more or less than expected. If the direct labour efficiency variance is negative, it implies the actual hours worked are higher than the standard hours. An unfavourable variance can lead to increased labour costs and prompts management to investigate the reasons behind the inefficiency.

In other words, when actual number of hours worked differ from the standard number of hours allowed to manufacture a certain number of units, labor efficiency variance occurs. 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.

As a result of these cost cuts, United was able to emerge from bankruptcy in 2006. Like in any other variance, if the standard is obsolete and not applicable to the current situation, it should be updated. After filing for Chapter 11 bankruptcy in

December 2002, United cut close to $5,000,000,000

in annual expenditures.

## Question Submitted

Labor rate variance arises when labor is paid at a rate that differs from the standard wage rate. 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. If we compute for the actual rate per hour used (which will be useful for further analysis later), we would get $8.25; i.e. $325,875 divided by 39,500 hours. However, during the production of 1,000 units, the actual time taken by the direct labour employees was 2.2 hours per item, and the actual labour rate was $14 per hour.

He has worked as an accountant and consultant for more than 25 years and has built financial models for all types of industries. He has been the CFO or controller of both small and medium sized companies and has run small businesses of his own. He has been a manager and an auditor with Deloitte, a big 4 accountancy firm, and holds a degree from Loughborough University. If the balance is considered insignificant in relation to the size of the business, then it can simply be transferred to the cost of goods sold account. Harold Averkamp (CPA, MBA) has worked as a university accounting instructor, accountant, and consultant for more than 25 years. Kenneth W. Boyd has 30 years of experience in accounting and financial services.

## Direct Labor Variances

As a result of this unfavorable outcome information, the company may consider retraining its workers, changing the production process to be more efficient, or increasing prices to cover labor costs. 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. The direct labor efficiency variance can be either favorable or unfavorable. A favorable variance indicates that the actual labor hours are less than the standard labor hours, suggesting that the workers are more efficient than anticipated.

For example, the number of units of direct material could assume the absence of scrap, when in fact a standard amount of scrap is normally realized, causing a continuing negative efficiency variance. This would be a theoretical standard, that can only be met if the circumstances are optimal. Or, a realistic standard could be used that incorporates reasonable inefficiency levels, and which comes close to actual results.

## Direct Labor Efficiency Variance: Definition, Formula, Calculation, Example

For example, if the variance is due to low-quality of materials, then the purchasing department is accountable. Doctors, for example, have a time allotment for a physical exam and base their fee on the expected time. Insurance companies pay doctors according to a set schedule, so they set the labor standard.

For each yard of denim purchased, DenimWorks reports a favorable direct materials price variance of $0.50. A direct labor variance is caused by differences in either wage rates or hours worked. As with direct materials understanding what your startups burn rate really means variances, you can use either formulas or a diagram to compute direct labor variances. We may think that only unfavorable variance is required to solve as it impacts the profit at the end of the year.

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. Tracking this variance is only useful for operations that are conducted on a repetitive basis; there is little point in tracking it in situations where goods are only being produced a small number of times, or at long intervals. Chartered accountant Michael Brown is the founder and CEO of Double Entry Bookkeeping.

## Get Your Questions Answered and Book a Free Call if Necessary

The direct labour efficiency variance is a critical component of variance analysis within cost accounting. Variance analysis involves comparing actual to expected or standard performance to understand the reasons behind deviations and take appropriate actions. The direct labour efficiency variance measures the difference between the actual hours of direct labour used in production and the standard hours based on the production level achieved.

To arrive at the total cost per unit, we need to multiply the unit of material and labor with the standard rate. It is the estimated price of material and labor that a company need to pay to supplier and workers. Note that both approaches—the direct labor efficiency variance calculation and the alternative calculation—yield the same result. The standard hours (26,400) is computed by multiplying the number of units produced by the hours required to complete one unit, i.e. 9,600 units x 2.75 hours each. This means that if the standard time was followed, the company should have used 26,400 hours only.

Because of the cost principle, the financial statements for DenimWorks report the company’s actual cost. If none of the direct materials purchased in this journal entry was used in production (all of the direct materials remain in the direct materials inventory), the company’s balance sheet must report the direct materials inventory at $13,500. In other words, the balance sheet will report the standard cost of $10,000 plus the price variance of $3,500. If the direct labor is not efficient when producing the good output, there will be an unfavorable labor efficiency variance. That inefficiency will likely cause additional variable manufacturing overhead which will result in an unfavorable variable manufacturing overhead efficiency variance.