Direct labor efficiency variance

By: Rashid Javed | Updated on: September 26th, 2022

The difference between actual time incurred to manufacture a certain number of units and the time allowed by standards to manufacture that number of units multiplied by standard direct labor rate is called direct labor efficiency variance or direct labor quantity variance. 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.

Favorable and unfavorable variance

Like direct labor rate variance, this variance may be favorable or unfavorable. If workers manufacture a certain number of units in an amount of time that is less than the amount of time allowed by standards for that number of units, the variance is known as favorable direct labor efficiency variance. On the other hand, if workers take an amount of time that is more than the amount of time allowed by standards, the variance is known as unfavorable direct labor efficiency variance.

The direct labor efficiency variance may be computed either in hours or in dollars. Suppose, for example, the standard time to manufacture a product is one hour but the product is completed in 1.15 hours, the variance in hours would be 0.15 hours – unfavorable. If the direct labor cost is $6.00 per hour, the variance in dollars would be $0.90 (0.15 hours × $6.00). For proper financial measurement, the variance is normally expressed in dollars rather than hours.

Formula

The following formula is used to calculate this variance:

Direct labor efficiency variance = (Actual hours worked × Standard rate) – (Standard hours allowed × Standard rate)

Or

Standard rate × (Actual hours worked – Standard hours allowed)

Example 1

During the second quarter of 2022, the direct labor workers at Purple Fly Inc. worked for 3,780 hours to complete its scheduled output of 1,200 units of product TK-9. The direct labor standards set by the Inc. reveal that the standard time allowed to produce a single unit of TK-9 is 3.20 hours and the standard direct labor rate is $3.65 per hour. Purple Fly actually incurred a direct labor cost of $14,000 during the quarter. What would be the direct labor efficiency variance for the second quarter?

Solution

= (3,780 hours x $3.65) – (*3,840 hours x $3.65)
= $13,797 – $14,016
= $219 Favorable

or

= $3.65 x (3,780 hours – *3,840 hours)
= $3.65 x $60
= $219 Favorable

*Standard hours allowed to manufacture 1,200 units:
= 1,200 units × 3.20 hours
= 3,840 hours

The Purple Fly has experienced a favorable direct labor efficiency variance of $219 during the second quarter of operations because its workers were able to finish 1,200 units in fewer hours (3,780) than the hours allowed by standards (3,840).

Example 2

Nice Furniture Manufacturing Company presents the following data for the month of March 2022:

Standard direct labor rate per hour: $6.50
Actual direct labor rate per hour: $6.75
Standard time to produce one unit of product: 3 hours
Production during the month of March 2022: 600 units
Hours worked during the month of March: 1,850 hours

Required:

  1. Compute direct labor efficiency variance.
  2. Indicate whether the variance is favorable or unfavorable.

Solution

= (1,850 hours × $6.50) – (*1,800 hours × $6.50)
= $12,025 – $11,700
= $325 Unfavorable

Or

= $6.50 × (1,850 hours – *1,800 hours)
= $6.50 × 50 hours
= $325 Unfavorable

*Standard hours allowed to manufacture 600 units:
= 600 units × 3 hours
= 1,800 hours

In this question, the company has experienced an unfavorable direct labor efficiency variance of $325 during March because its workers took more hours (1,850) than the hours allowed by standards (1,800) to complete 600 units.

Causes of direct labor efficiency variance

There are a lot of reasons of unfavorable direct labor efficiency variance. Some common reasons are as follows:

  1. Inexperienced workers
  2. Poorly motivated workers
  3. Use of old, outdated or faulty equipment which takes excessive time to process the raw materials
  4. Purchase of low quality, substandard or unsuitable direct materials which is difficult to process
  5. Poor supervision by production supervisors and foremen
  6. Insufficient demand for company’s product(s)
  7. Frequent breakdowns and strikes
  8. Load shedding and interception in supply of electricity, gas and water etc.
  9. Shortage of raw materials
  10. Practicing just in time (JIT) manufacturing system
  11. Using inaccurate data while establishing direct labor time standards
  12. Change in processing technology

Who is responsible for the variance?

At first glance, the responsibility of any unfavorable direct labor efficiency variance lies with the production supervisors and/or foremen because they are generally the persons in charge of using direct labor force. However, it may also occur due to substandard or low quality direct materials which require more time to handle and process. If direct materials is the cause of adverse variance, then purchase manager should bear the responsibility for his negligence in acquiring the right materials for his factory.

If customer orders for a product are not enough to keep the workers busy, the production managers will have to either build up excessive inventories or accept an unfavorable labor efficiency variance. The first option is not in line with just in time (JIT) principle which focuses on minimizing all types of inventories. Excessive inventories, particularly those that are still in process, are considered evil as they generally cause additional storage cost, high defect rates and spoil workers’ efficiency. Due to these reasons, managers need to be cautious in using this variance, particularly when the workers’ team is fixed in short run. In such situations, a better idea may be to dispense with direct labor efficiency variance – at least for the sake of workers’ motivation at factory floor.

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