# Direct Labor Variance Analysis

United Airlines asked a bankruptcy court to allow a one-time 4 percent pay cut for pilots, flight attendants, mechanics, flight controllers, and ticket agents. The pay cut was proposed to last as long as the company remained in bankruptcy and was expected to provide savings of approximately \$620,000,000. How would this unforeseen pay cut affect United’s direct labor rate variance? The direct labor rate variance would likely be favorable, perhaps totaling close to \$620,000,000, depending on how much of these savings management anticipated when the budget was first established. The labor variance is particularly suspect when the budget or standard upon which it is based has no resemblance to actual costs being incurred. The use of the labor variance is questionable in a production environment, for two reasons.

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## How to Calculate the Average Hourly Rate for Employees

First, other costs usually comprise by far the largest part of manufacturing expenses, rendering labor immaterial. 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 (budgeted) hours. Additionally, mistakes in setting or applying the standard hours allowed can also lead to an efficiency variance. Doctors, for example, have a time allotment for a physical exam and base their fee on the expected time.

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. As with direct materials variances, all positive variances are unfavorable, and all negative variances are favorable.

## Sweet and Fresh Shampoo Labor

Thus the 21,000 standard hours (SH) is 0.10 hours per unit × 210,000 units produced. 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. In February DenimWorks manufactured 200 large aprons and 100 small aprons.

The actual hours worked are the actual number of hours worked to create one unit of product. If there is no difference between the standard rate and the actual rate, the outcome will be zero, and no variance exists. The direct labor variance measures how efficiently the company uses labor as well as how effective it is at pricing labor. There are two components to a labor variance, the direct labor rate variance and the direct labor time variance. Recall from Figure 10.1 “Standard Costs at Jerry’s Ice Cream” that the standard rate for Jerry’s is \$13 per direct labor hour and the standard direct labor hours is 0.10 per unit. 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.

## Time of Production

Jerry (president and owner), Tom (sales manager), Lynn (production manager), and Michelle (treasurer and controller) were at the meeting described at the opening of this chapter. Michelle was asked to find out why direct labor and direct materials costs were higher than budgeted, even after factoring in the 5 percent increase in sales over the initial budget. Lynn was surprised to learn that direct labor and direct materials costs were so high, particularly since actual materials used and actual direct labor hours worked were below budget.

• The combination of the two variances can produce one overall total direct labor cost variance.
• The actual hours worked are the actual number of hours worked to create one unit of product.
• United Airlines asked a bankruptcy court to allow a one-time 4 percent pay cut for pilots, flight attendants, mechanics, flight controllers, and ticket agents.

Standard cost variances are the differences between the actual costs and the budgeted costs of a product or service. They are used to measure the efficiency and performance of a business in managing its resources and processes. In this article, we will focus on the common causes and effects of direct labor variances, which are one of the main components of standard cost variances.

Another situation that may lead to an unfavorable labor variance in the short run, is a lack of market for a company’s products. Would it be wise to let go of employees, or might it be favorable in the long run to keep employees busy on other tasks, to keep up company morale? This can be a tough question, and one that companies need to address. Another way to keep employees busy during this type of slump in sales may be to build up inventory. The rate variance can be caused by a variety of factors, such as changes in the market wage rate due to supply and demand, inflation, or legislation. Additionally, changes in the skill mix or quality of the labor force can also affect the rate variance, as can alterations to incentive schemes or bonuses that influence workers’ motivation and productivity.

## Follow-Up Meeting at Jerry’s Ice Cream

Finally, errors in setting or applying the standard wage rate can also lead to a rate variance. The combination of the two variances can produce one overall total direct labor cost variance. So Hupana had some ups and downs with the transition to hiring Jake and getting their systems back in place.

## Introduction to Labor Variances

Note that both approaches—the direct labor efficiency variance calculation and the alternative calculation—yield the same result. The labor rate variance measures the difference between the actual and expected cost per hour, multiplied by the actual hours incurred. The labor efficiency variance measures the difference between actual and expected hours worked, multiplied by the standard hourly rate.

Analyze each part of your production or service delivery process to determine which parts can be handled by lower-wage employees. You should also do an analysis of when it’s most cost effective to use contract help and when you should bring work in-house. The first step you should take when facing labor cost overruns due to staff productivity issues is to meet with your supervisors to get their input. Next, ask your employees about the most difficult part of their jobs and what you can do to get them to become more productive and efficient. Understanding why labor variances occur will help you determine which of your project estimates are the most likely to vary, and how to deal with variances when they happen. Are you paying your employees too much for the production of a particular product or delivery of a particular service?