Direct Labor Variance Analysis

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
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