# Interrelationship Of Variances

The fixed overhead volume variance is solely a result of the difference in budgeted production and actual production. There is no efficiency variance for fixed manufacturing overhead because, by definition, fixed costs do not change with changes in the activity base. Actual wages were paid at the rates of Rs 1.20, Rs 0.85 and Rs 0.65 respectively. Two hours per week were lost due to abnormal idle time and 960 units of output were produced. This is a variance in labour cost which arises due to substitution of labour when one grade of labour is substituted by another.

Old equipment breaking down caused workers to waste time waiting for repairs. After filing for Chapter 11 bankruptcy in December 2002, United cut close to \$5,000,000,000 in annual expenditures. As a result of these cost cuts, United was able to emerge from bankruptcy in 2006.

## How To Calculate Labor Rate Variance?

If, however, the actual rate of pay per hour is greater than the standard rate of pay per hour, the variance will be unfavorable. If the total actual cost is higher than the total standard cost, the variance is unfavorable since the company paid more than what it expected to pay. Note that both approaches—the direct labor efficiency variance calculation and the alternative calculation—yield the same result. Note that both approaches—direct labor rate variance calculation and the alternative calculation—yield the same result.

• Jerry , Tom , Lynn , and Michelle were at the meeting described at the opening of this chapter.
• The labor efficiency in hours is the difference between the total actual hours and standard hours.
• Often, by analyzing these variances, companies are able to use the information to identify a problem so that it can be fixed or simply to improve overall company performance.
• This results in an unfavorable variance since the actual rate was higher than the expected rate.
• The materials price variance, defined as the difference between what is paid for a quantity of materials and what should have been paid according to the standard, is \$21 favorable.

Connie’s Candy paid \$1.50 per hour more for labor than expected and used 0.10 hours more than expected to make one box of candy. The same calculation is shown as follows using the outcomes of the direct labor rate and time variances. In this case, the actual rate per hour is \$7.50, the standard rate per hour is \$8.00, and the actual hour worked is 0.10 hours per box. This is a favorable outcome because the actual rate of pay was less than the standard rate of pay. The labor efficiency variance calculation presented previously shows that 18,900 in actual hours worked is lower than the 21,000 budgeted hours. Clearly, this is favorable since the actual hours worked was lower than the expected hours.

## Causes Of Labor Rate Variance

In contrast, an adverse or unfavorable variance shows the inefficiency or low productivity of the labor used in the production. Whereas the labor rate variance is the difference between standard labor cost and the actual labor cost for the production. In this article, we will focus more on the direct labor efficiency variance while the labor rate variance will be covered in another article. In this illustration, AH is the actual hours worked, AR is the actual labor rate per hour, SR is the standard labor rate per hour, and SH is the standard hours for the output achieved.

• Now, the rate variance is \$4,000, though because the value is negative, it indicates that the company is spending \$4,000 under what they expected to pay for labor.
• Adding the budget variance and volume variance, we get a total unfavorable variance of \$1,600.
• As a result, the techniques for factory overhead evaluation vary considerably from company to company.
• An example is when a highly paid worker performs a low-level task, which influences labor efficiency variance.
• This is the variance that happens due to a difference in the actual number of hours worked Vs. the standard number of hours estimated.

Figure 10.6 “Direct Labor Variance Analysis for Jerry’s Ice Cream” shows how to calculate the labor rate and efficiency variances given the actual results and standards information. Review this figure carefully before moving on to the next section where these calculations are explained in detail. Standard costs per unit for direct materials, direct labor, and variable manufacturing overhead can be used to compute activity and spending variances as described in the previous chapter. To estimate how the combination of wages and hours affects total costs, compute the total direct labor variance. As with direct materials, the price and quantity variances add up to the total direct labor variance.

The materials price variance is the difference between actual costs for materials purchased and budgeted costs based on the standards. One must consider the circumstances under which the variances resulted and the materiality of amounts involved.

## Variance Analysis For Variable Manufacturing Overhead

The following illustration is intended to demonstrate the very basic relationship between actual cost and standard cost. SQ and SP refer to the “standard” quantity and price that was anticipated. Variance analysis can be conducted for material, labor, and overhead. We find the labor rate variance by multiplying the actual labor hours worked times the difference between the actual rate per labor hour and the standard rate per labor hour.

• Another way to keep employees busy during this type of slump in sales may be to build up inventory.
• As with direct materials, the price and quantity variances add up to the total direct labor variance.
• Actual labor costs may differ from budgeted costs due to differences in rate and efficiency.
• Was this the reason for the unfavorable outcomes in efficiency and volume?
• Inappropriately high setting of the standard cost of direct labor which may, in the hindsight, be attributed to inaccurate planning.

The first is a comparison of the standard rate per unit of labor with the actual rate per unit of labor, which results in the determination of the labor rate variance. 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 difference in hours is multiplied by the standard price per hour, showing a \$1,000 unfavorable direct labor time variance. This is offset by a larger favorable direct labor rate variance of \$2,550. The net direct labor cost variance is still \$1,550 , but this additional analysis shows how the time and rate differences contributed to the overall variance.

The quantity variance is labeled unfavorable because the actual quantity exceeds the standard quantity allowed by 10 kilograms. The quantity standard for variable manufacturing overhead is expressed in either direct labor hours or machine hours depending on which is used as the allocation base in the predetermined overhead rate. The processing of a product requires a standard of 0.8 direct labor hours per unit for Operation at a standard wage rate of \$6.75 per hour.

## Formula:

An unfavorable variance occurs when actual direct labor costs are more than standard costs. For example, a company is looking to hire more staff to meet the expected cost of labor in a production facility. Hiring new staff means that they will also be able to push out more total hours worked, resulting in more product.

There are two components to a labor variance, the direct labor rate variance and the direct labor time variance. The labor rate variance is unfavorable because the actual rate paid to workers is more than the standard rate. It is that portion of labour cost variance which is due to the abnormal idle time of workers. This variance is shown separately to show the effect of abnormal causes affecting production like power failure, breakdown of machinery, shortage of materials etc. While calculating labour efficiency variance, abnormal idle time is deducted from actual time expended to ascertain the real efficiency of the workers. We find the actual labor rate by dividing the \$18,910 total labor cost by 1,550 direct labor hours actually worked. The materials variances are not always entirely controllable by one person or department.

Labor Cost Variance can be very helpful to a company in making its production efficiency. The calculation and analysis of this variance could provide management with in-depth information on the cause of the variance. They can then take appropriate corrective actions to eliminate or at least minimize the LCV.

## Who Is Responsible For The Labor Rate Variance?

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. Quantity standards indicate how much labor (i.e., in hours) or materials (i.e., in kilograms) should be used in manufacturing a unit of a product. In contrast, cost standards indicate what the actual cost of the labor hour or material should be. Standards, in essence, are estimated prices or quantities that a company will incur.

• By so doing, the full \$719,000 actually spent is fully accounted for in the records of Blue Rail.
• The actual price of \$4.90 per kilogram is computed by dividing the actual cost of the material by the actual number of kilograms purchased.
• So Hupana had some ups and downs with the transition to hiring Jake and getting their systems back in place.
• The standard cost of the three types of labor is \$40, \$30, and \$20, respectively.
• Fixed factory overhead might include rent, depreciation, insurance, maintenance, and so forth.

First, other costs usually comprise by far the largest part of manufacturing expenses, rendering labor immaterial. With either of these formulas, the actual hours worked refers to the actual number of hours used at the actual production output. The standard rate per hour https://accountingcoaching.online/ is the expected hourly rate paid to workers. The standard hours are the expected number of hours used at the actual production output. If there is no difference between the actual hours worked and the standard hours, the outcome will be zero, and no variance exists.

This is a favorable outcome because the actual hours worked were less than the standard hours expected. As a result of this favorable outcome information, the company may consider continuing operations as they exist, or could change future budget projections to reflect higher profit margins, among other things. Measures how efficiently the company uses labor as well as how effective it is at pricing labor.

Also, just as you did with the material variance questions, try to answer each question before advancing to the solution. They allow for normal machine downtime and employee rest periods and can be attained through reasonable, highly efficient efforts of the average worker. Practical standards can also be used for forecasting cash flows and in planning inventory. Fast-food outlets such as McDonald’s have exacting standards for the quantity of meat going into a sandwich. As the standards are always set in accordance with the best practices of the industry.

When less is spent than applied, the balance represents the favorable overall variances. Favorable overhead variances are also known as “overapplied overhead” since more cost is applied to production than was actually incurred. An example is when a highly paid worker performs a low-level task, which influences labor efficiency variance. Hence, variance arises due to the difference between actual time worked and the total hours that should have been worked.

If the actual hours worked are less than the standard hours at the actual production output level, the variance will be a favorable variance. A favorable outcome means you used fewer hours than anticipated to make the actual number of production units. If, however, the actual hours worked are greater than the standard hours at the actual production output level, the variance will be unfavorable. An unfavorable outcome means you used more hours than anticipated to make the actual number of production units.

## Labour Efficiency Variance

For example, the production manager may schedule production in such a way that it requires express delivery of raw materials resulting in an unfavorable materials price variance. The purchasing manager may purchase lower quality raw materials resulting in an unfavorable materials quantity variance for the production manager. The standard rate per hour for direct labor includes not only wages earned but also fringe benefits and other labor costs. Direct Labor Variance Analysis Many companies prepare a single rate for all employees within a department that reflects the “mix” of wage rates earned. Comparing labor price variance to labor efficiency variance helps you pinpoint areas of strength and weakness in your small business’s labor management. For example, if your labor price variance is a favorable \$500, but your labor efficiency variance is an unfavorable \$700, the unfavorable amount offsets the favorable amount.