Accounting: The Language of Business - Vol. 1 (Part 137)

The prudent heir takes careful inventory of his legacies and gives a faithful accounting to those whom he owes an obligation of trust.
John F. Kennedy

Performance Evaluation Using Variances from Standard Costs (Part D) 

by

Charles Lamson

Direct Labor Variances

Western Rider Inc.'s direct labor cost variance can be separated into two parts. Recall that the direct labor standards from Exhibit 1 (from part 136 and reintroduced below) are as follows:

Rate standard: $8 per hour

 Time standard: 0.80 hour per pair of XL jeans]

The actual production (5,000 pairs) is multiplied by the time standard (0.80) hour per pair to determine the number of standard direct labor hours budgeted. The standard direct labor hours are then multiplied by the standard rate per hour ($9) to determine the standard direct labor cost at actual volumes. These calculations are shown below.

EXHIBIT 2 Budget Performance Report

Assume that the actual total cost for direct labor during June 2023 was as follows: 

Recall from part 135 that unfavorable variance is an accounting term that describes instances where actual costs are greater than the standard (estimates of the actual costs in a company's production process), or projected costs (estimated costs based on the previous period's sales and expenses). An unfavorable variance can alert management that the company's profit will be less than expected.

Bearing this in mind, the total unfavorable cost variance $2,500 ($38,500 - $36,000) results from an excess rate of $1 per direct labor hour and using 150 fewer direct labor hours. These two reasons can be reported as two separate variances, as we discuss next.

Direct Labor Rate Variance

The direct labor rate variance is the difference between the actual rate ( the full amount paid for direct labor divided by the full amount for direct labor hours) per hour ($10) and the standard rate (rate of hourly pay) per hour ($9), multiplied by the actual hours worked (3,850 hours). The variance is favorable. If the actual rate per hour exceeds the standard rate per hour, the variance is unfavorable, as shown below for Western Rider Inc. 

Direct Labor Time Variance

The direct labor time variance is the difference between the actual hours worked (3,850 hours) and the standard hours (the amount of work achievable, at the expected level of efficiency, in an hour) at actual production (4,000 hours), multiplied by the standard rate per hour ($9). If the actual hours worked exceed the standard hours, the variance is unfavorable. If the actual hours worked are less than the standard hours, the variance is favorable, as shown below for Western Rider Inc.

Direct Labor Variance Relationships

The direct labor variances can be illustrated by making the 3 calculations shown in Exhibit 4.

EXHIBIT 4 Direct Labor Variance Relationships

Reporting Direct Labor Variances

Controlling direct labor cost is normally the responsibility of the production supervisors. To aid them, reports analyzing the cause of any direct labor variance may be prepared. Differences between standard direct labor hours and actual direct labor hours can be investigated. For example, the time variance may be incurred because of the shortage of skilled workers. Such variances may be uncontrollable unless they are related to high turnover rates among employees, in which case the cause of the high turnover should be investigated.

Likewise, differences between the rates paid for direct labor and the standard rates can be investigated. For example, unfavorable rate variances may be caused by the improper scheduling and use of workers. In such cases, skilled, highly paid workers may be used in jobs that are normally performed by unskilled, lower-paid workers. In this case, the unfavorable rate variance should be reported for corrective action to the managers who schedule work assignments. 

*WARREN, REEVE, & FESS, 2005, ACCOUNTING, 21ST ED., PP. 923-925*

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