Direct Labor Efficiency Variance

Learning Objective of the article:

1. Define and explain "direct labor efficiency | usage variance" .
2. How direct labor efficiency or usage variance is calculated?
3. What are the reasons / causes of unfavorable or favorable labor efficiency variance?

1. Definition and explanation
2. Formula of direct labor efficiency variance
3. Example
4. Who is responsible for direct labor efficiency variance?
5. Exercises

Definition and Explanation:

The quantity variance for direct labor  is generally called direct labor efficiency variance or direct labor usage variance. This variance measures the productivity of labor time. No variance is more closely watched by management, since it is widely believed that increasing the productivity of direct labor time is vital to reducing costs. The formula for the labor efficiency variance is expressed as follows:

Formula of labor efficiency variance:

[Labor efficiency variance = (Actual hours worked × Standard rate) − (Standard hours allowed × Standard rate)]

Example:

A company produces 2000 units of finished products using 5,400 hours. Standard time allowed for a unit of finished product is 2.5 hours. Standard rate that is paid to workers is $14.00 per direct labor hour.

Calculate direct labor efficiency variance or direct labor quantity variance.

Calculation of direct labor efficiency or quantity or usage variance.

Labor efficiency variance = (Actual hours worked × Standard rate) − (Standard hours allowed × Standard rate)

= (5,400 × $14.00 ) − (5,000* × $14.00)

= $75,600 − $70,000

= $5,600 Unfavorable

 5,000* = 2,000 actual production × 2.50 standard hour allowed per unit

Processing of 2000 units required more time than what was allowed by standards. The result is an unfavorable labor efficiency variance. A favorable labor efficiency variance occurs when actual processing time is less than the time allowed by standards.

Who is Responsible for Labor Efficiency Variance?

The manager in charge of production is generally considered responsible for labor efficiency variance. However, purchase manager could be held responsible if the acquisition of poor materials resulted in excessive labor processing time. Possible causes / reasons of an unfavorable efficiency variance include poorly trained workers, poor quality materials, faulty equipment, and poor supervision. Another important cause / reason of an unfavorable labor efficiency variance may be insufficient demand for company's products.

If customers orders are insufficient to keep the workers busy, the work center manager has two options, either accept an unfavorable labor efficiency variance or build up inventories. The second option is opposite to the basic principle of just in time (JIT). Inventories with no immediate prospect of sale is a bad idea according to just in time approach. Inventories, particularly work in process inventory leads to high defect rate, obsolete goods, and generally inefficient operations.  As a consequence, when the work force is basically fixed in the short term, managers must be cautious about how labor efficiency variances are used. Some managers advocate dispensing with labor efficiency variance entirely in such situations―at least for the purpose of motivating and controlling workers on the shop floor.

Exercises:

Exercise 1: Labor Variance Analysis
The processing of a product requires a standard of 0.8 direct labor hours per unit for Operation 4-802 at a standard wage rate of $6.75 per hour. The 2,000 units actually required 1,580 direct labor hours at a cost of $6.90 per hour.

Required: Calculate labor efficiency variance or Labor usage variance.

Solution:

 

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