Direct Labor Rate Variance
Direct Labor Rate Variance is the measure of difference between the actual cost of direct labor and the standard cost of direct labor utilized during a period.
Direct Labor Rate Variance:
= Actual Quantity x Actual Rate - Actual Quantity x Standard Rate
= Actual Cost - Standard Cost of Actual Hours
DM is a denim brand specializing in the manufacture and sale of hand-stitched jeans trousers.
DM manufactured and sold 10,000 pairs of jeans during a period.
Information relating to the direct labor cost and production time per unit is as follows:
Labor rate variance shall be calculated as follows:
Step 1: Calculate Actual hours
Actual Hours = 10,000 units x Actual Price
= 5,000 hours.
Step 2: Calculate the actual cost
Actual Cost = Actual Hours x Actual Rate
= 5,000 hours (Step 1) x $12 per hour
Step 3: Calculate the standard cost of actual number of hours
Standard Cost of actual hours = Actual Hours x Standard Rate
= 5,000 hours (Step 1) x $10 per hour
Step 4: Calculate the variance
Labor Rate Variance = Actual Cost - Standard Cost of the Actual Hours
= $60,000 (Step 2) - $50,000 (Step 3)
= $10,000 Adverse.
A favorable labor rate variance suggests cost efficient employment of direct labor by the organization.
Reasons for a favorable labor rate variance may include:
- Hiring of more un-skilled or semi-skilled labor (this may adversely impact labor efficiency variance)
- Decrease in the overall wage rates in the market due to an increase in the supply of labor which may be caused, for example, due to the influx of immigrants as a result of the relaxation of immigration policy
- Inappropriately high setting of the standard cost of direct labor which may, in the hindsight, be attributed to inaccurate planning
An adverse labor rate variance indicates higher labor costs incurred during a period compared with the standard.
Causes for adverse labor rate variance may include:
- Increase in the national minimum wage rate
- Hiring of more skilled labor than anticipated in the standard (this should be reflected in a favorable labor efficiency variance)
- Inefficient hiring by the HR department
- Effective negotiations by labor unions