Direct labor rate variance is one of the three basic analyses of labor cost variance. The other two are direct labor efficiency variance and idle time variance.
Direct labor rate variance is a key aspect of standard costing which helps to study the discrepancy between standard results and actual results.
What Is Direct Labor Rate Variance?
Direct labor rate variance (DLRV) refers to the difference between the standard direct labor rater per hour and the actual direct labor rate paid per hour for the total number of hours worked.
The above definition is built on the premise that you already understand direct labor, direct labor refers to the effort expended in the conversion of raw materials to finished forms.
Just like direct material price variance, DLRV can be established with a formula:
DLRV = (SR − AR) × AH
Where:
SR means the standard direct labor rate/hour
AR means the actual direct labor rate/hour
AH means the actual direct labor hours
TIP: From this mathematical formula, DLR variance would give a favorable or adverse (unfavorable) result. This depends on whether the standard rate is lower or higher than the actual rate. Below is an illustration to guide you on attempting questions related to direct labor rate variance.
Worked Example
Assuming the standard rate in a manufacturing outfit in Kano is $10 per hour while the actual labor rate is $15. Calculate the DLRV for 500 hours. And is the variance adverse or favorable?
From the formula above. DLRV = (SR – AR) x AH
Where SR = $10
AR = $15
AH = 500 hours.
Therefore, DLRV = $(10 -15 )X 500
= $2500 Adverse.
Since the manufacturing outfit spent more than their estimated cost, the variance shows an adverse result.
Reasons For Direct Labour Rate Variance.
- The management having to pay a higher wage than it already agreed.
- The management paying huge amounts for overtime or bonuses.
- Due to hiring inexperienced workers who spend more hours to get the job done, the management will have to pay a higher direct labor rate,
- Breakdown of machines means the management will still pay the workers for when they didn’t work.
However, you must also know that having a favorable direct labor rate variance does not automatically imply direct labor efficiency. This is because people who earn less would not be as efficient as those who earn higher pay.
Advantages Of Direct Labor Rate Variance
- It assists management in understanding how much labor cost is being incurred by the company.
- It helps in better planning the labor cost for future accounting years.
- Aids management in planning the quality of workers to employ.
- It shows the impact of unplanned overtime or bonuses paid on the entity’s finances.
Weaknesses Of Direct Labor Rate Variance
The disadvantages of this variance are not limited to the following:
- It gives an incomplete view of the effect of the variance is computed.
- It focuses on past events which usually does not affect future costs.
Idle Time Variance
The third aspect of labor cost variance is idle time variance. Idle time variance can be logically assumed to be due to inefficiency.
The formula for idle time variance is idle time x standard rate.
Idle time may be due to any of the following;
- Strike actions by the workforce
- Poor coordination between management and workers,
- Breakdown of equipment, and so on.
One of the cheapest means of improving direct labor efficiency variance is to eliminate or lower idle time to the barest level possible.