Labor hours used directly upon raw materials to transform them into finished products is known as direct labor. This includes work performed by factory workers and machine operators that are directly related to the conversion of raw materials into finished products.
Direct labor refer to the manual work in producing a product.
Actual labor costs may differ from budgeted costs due to differences in rate and efficiency.
Direct labor rate variance arise from the difference in actual pay rate of laborers versus what is budgeted.
Direct labor efficiency variance pertain to the difference arising from employing more labor hours than the planned.
Note that in contrast to direct labor, indirect labor consists of work 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.
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.
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||$325,875|
|Less: Total standard cost||320,000|
|Direct labor variance||$ 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.
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|