In variance analysis, the total direct labor variance may be split into: rate variance and efficiency variance. The direct labor rate variance refers to the variance that arises due to the difference between the standard and actual wage paid per hour of direct labor.
The formula for direct labor rate variance is:
DL rate variance = (AR - SR) x AH
where: AR = actual rate, SR = standard rate, and AH = actual hours.
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 rate variance.
|DL rate variance||=||(AR - SR) x AH|
|=||($7.50 - $8.00) x 29,000 hours|
|DL rate variance||=||$14,500 favorable|
The actual rate of $7.50 is computed by dividing the total actual cost of labor by the actual hours ($217,500 divided by 29,000 hours).
If the actual rate is higher than the standard rate, the variance is unfavorable since the company paid more than what it expected. If actual rate is lower than standard rate, the variance is favorable.
A favorable DL rate variance occurs when the actual rate paid is less than the estimated standard rate. It usually occurs when less-skilled laborers are employed (hence, cheaper wage rate). However, the use of under-qualified laborers may result to excessive time in performing tasks (resulting in an unfavorable direct labor efficiency variance), excessive raw materials used (unfavorable direct materials quantity variance), and/or poor product quality.
The DL rate variance is unfavorable if the actual rate per hour is higher than the standard rate. The company paid more per hour of labor than what it has estimated. This could be due to employing more skillful workers. Though unfavorable, the variance may have a positive effect on the efficiency of production (favorable direct labor efficiency variance) or in the quality of the finished products.
In addition, the difference between the actual and standard rates sometimes simply means that there has been a change in the general wage rates in the industry. In such case, the standard rate needs to be updated.