How is direct labor rate variance computed? What are the reasons of unfavorable labor rate variance?
Direct labor rate variance is equal to the difference between actual hourly rate and standard hourly rate multiplied by actual hours worked. This variance is also known as direct labor price variance.
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)
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.
= (600 hours × $7.95) – (600 hours × $7.80)
= $4,770 – $4,680
= $90 Unfavorable
= $600 × ($7.95 – $7.80)
= $600 × $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 standard hourly rate ($7.80).
Reasons of unfavorable labor rate variance:
Usually, labor rate variance does not occur due to change in labor rates because they are normally predictable. The common reason of an unfavorable labor rate variance is inappropriate use of labor by production supervisors.
All tasks do not require equally skilled workers. Some tasks are more complicated and require more experienced workers than others. It should be kept in mind when tasks are assigned to workers. If the tasks that are not so complicated are assigned to very experienced workers, unfavorable labor rate variance may be the result. Because highly experienced workers are paid high wages. On the other hand, if poorly trained workers are assigned tasks that require high level of expertise, favorable labor rate variance may be the result. Because such workers are usually paid low wages. But inexperienced workers may not be as efficient.