In variance analysis, the total direct labor variance may be split into two: rate variance and efficiency variance. The direct labor efficiency variance refers to the variance that arises due to the difference between the standard and actual time used to produce finished products.
The formula for direct labor efficiency variance is:
DL efficiency variance = (AH - SH) x SR
where: AH = actual hours, SH = standard hours, and SR = standard rate.
Example: XYZ Company has budgeted its direct labor at a rate of $8 per hour. Each unit of its product requires 2.75 direct labor hours to complete. Last month, XYZ produced 9,600 units. The company employed 29,000 direct labor hours for which it paid a total of $217,500. Compute for the direct labor efficiency variance.
|DL efficiency variance||=||(AH - SH) x SR|
|=||(29,000 - 26,400) x $8|
|DL efficiency variance||=||$20,800 unfavorable|
The standard hours (26,400) is computed by multiplying the number of units produced by the hours required to complete one unit, i.e. 9,600 units x 2.75 hours each. This means that if the standard time was followed, the company should have used 26,400 hours only.
The variance is unfavorable since the company used more time than expected.
There is a favorable direct labor efficiency variance when the actual hours used is less than the anticipated or standard hours. This means that the company was efficient in terms of labor. In some cases, this might be due to employing more skillful workers which results in unfavorable direct labor rate variance (higher wages paid).
An unfavorable direct labor efficiency variance happens when the actual hours worked is greater than the expected or standard hours. The company used more time in producing its products than anticipated.
The use of excessive hours could be due to employing under-qualified workers (may be evidence by cheaper wages, hence a favorable direct labor rate variance), or due to poor quality of raw materials (favorable direct materials price variance). These factors should be considered in evaluating an unfavorable DL efficiency variance.
Like in any other variance, if the standard is obsolete and not applicable to the current situation, it should be updated.
Generally, the production department is responsible for direct labor efficiency variance. However, the variance may be influenced by other factors. For example, if the variance is due to low-quality of materials, then the purchasing department is accountable.