Direct labor rate variance

By: Rashid Javed | Updated on: September 18th, 2022

Direct labor rate variance is equal to the difference between actual hourly rate and standard hourly rate multiplied by the actual hours worked during the period. This variance is also known as direct labor price variance. The variance would be favorable if the actual direct labor cost is less than the standard direct labor cost allowed for actual hours worked by direct labor workers during the period concerned. Conversely, it would be unfavorable if the actual direct labor cost is more than the standard direct labor cost allowed for actual hours worked.

The other two variances that are generally computed for direct labor cost are the direct labor efficiency variance and direct labor yield variance.

Formula

To understand the computation of this variance, see the following formula:

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

Or

Actual hours worked x (Actual rate – Standard rate)

Example 1

Hitech manufacturing company is highly labor intensive and uses standard costing system. The standard time to manufacture a product at Hitech is 2.5 direct labor hours. The standard wage rate is $7.80 per hour. Last month, 600 hours were worked to manufacture 1,700 units. Workers were paid @ $7.95 per direct labor hour. Calculate direct labor rate variance of Hitech.

Solution

= (600 hours × $7.95) – (600 hours × $7.80)
= $4,770 – $4,680
= $90 Unfavorable

Or

= 600 hours × ($7.95 – $7.80)
= 600 hours × $0.15
= $90 Unfavorable

In this example, the Hitech company has an unfavorable labor rate variance of $90 because it has paid a higher hourly rate ($7.95) than the standard hourly rate ($7.80).

Example 2

During June 2022, Bright Company’s workers worked for 450 hours to manufacture 180 units of finished product. The standard direct labor rate was set at $5.60 per hour but the direct labor workers were actually paid at a rate of $5.40 per hour. Find the direct labor rate variance of Bright Company for the month of June.

Solution

= (450 hours × $5.40) – (450 hours × $5.50)
= $2,430 – $2,475
= $45 Favorable

Or

= 450 hours × ($5.40 – $5.50)
= 450 hours × $0.10
= $45 Unfavorable

In this question, the Bright Company has experienced a favorable labor rate variance of $45 because it has paid a lower hourly rate ($5.40) than the standard hourly rate ($5.50).

Causes of direct labor rate variance

Usually, direct labor rate variance does not occur due to change in labor rates because they are normally pretty easy to predict. A common reason of unfavorable labor rate variance is an inappropriate/inefficient use of direct labor workers by production supervisors.

All tasks do not require equally skilled workers; some tasks are more complicated and require more experienced workers than others. This general fact should be kept in mind while assigning tasks to available work force. If the tasks that are not so complicated are assigned to very experienced workers, an unfavorable labor rate variance may be the result. The reason is that the highly experienced workers can generally be hired only at expensive wage rates. If, on the other hand, less experienced workers are assigned the complex tasks that require higher level of expertise, a favorable labor rate variance may occur. However, these workers may cause the quality issues due to lack of expertise and inflate the firm’s internal failure costs. In order to keep the overall direct labor cost inline with standards while maintaining the output quality, it is much important to assign right tasks to right workers.

Who is responsible for direct labor rate variance?

The responsibility of unfavorable direct labor rate variance partially lies on production managers, like production supervisors and foremen, because they are the persons who are generally authorized for assigning tasks to direct labor workers.

Other reasons of labor rate variance include the payment of overtime premium to workers in case of rush orders with aggressive delivery dates and relying on inaccurate or incomplete data at the time of setting direct labor standards.

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