Labor expended directly upon raw materials to transform them into finished goods is known as *direct labor*.

It includes work performed by laborers and machine operators that are directly related to the conversion of raw materials into finished products.

Note that in contrast, *indirect labor* consists of labor that is **not** directly related to transforming the materials into finished goods. Examples include salaries of supervisors, janitors, and security guards. Indirect labor is included as part of *factory overhead*.

## Computing Direct Labor Variance

The direct labor (DL) variance is the difference between the total actual direct labor cost and the total standard cost.

*Direct labor variance = Total actual DL cost - Total standard DL cost*

The **total actual direct labor cost** and **total standard direct labor cost** may be computed as follows:

*Total actual DL cost = Actual hours used x Actual rate per hour*

*Total standard DL cost = Standard hours for actual production x Standard rate per hour*

If the total actual cost incurred is less than the total standard cost, the variance is **favorable**.

If the total actual cost is higher than the total standard cost, the variance is **unfavorable** since the company paid more than what it expected to pay.

## Example

ABC Company has an annual production budget of 120,000 units and an annual DL budget of $3,840,000. Four hours are needed to complete a finished product and the company has established a standard rate of $8 per hour. Last month, the company produced 10,000 units. The company used 39,500 direct labor hours and paid a total of $325,875.

The direct labor variance of the month's production is computed as:

Total actual cost | $325,875 | |

Less: Total standard cost | 320,000 | |

Variance - DL | $ 5,875 | unfavorable |

**Total actual cost.** The company paid a total of $325,875 for direct labor. If we compute for the actual rate per hour used (which will be useful for further analysis later), we would get $8.25; i.e. $325,875 divided by 39,500 hours.

**Total standard cost.** $320,000 is computed as: 40,000 standard DL hours for the actual production (4 x 10,000), multiplied by $8.00 – the standard rate per hour.

## Rate Variance and Efficiency Variance

For further analysis, the direct labor variance may be split into: **direct labor rate variance** and **direct labor efficiency variance**. The *rate variance* is due to the difference between the actual and standard labor rate, while the *labor efficiency variance* arises from the difference in the actual number of hours worked and number of hours that should have been used.

*DL rate variance = (Actual rate - Standard rate) x Actual hours
DL efficiency variance = (Actual hours - Standard hours) x Standard rate*

Labor rate variance ($8.25 - $8.00) x 39,500 | $9,875 | unfavorable |

Labor efficiency variance (39,500 - 40,000) x $8 | 4,000 | favorable |

Total DL variance | $5,875 | unfavorable |