Direct labor efficiency variance

Direct labor efficiency variance
See also
Work cycle Overall equipment effectiveness Time study Time card Step cost Job simplification Peak demand Lieu days Departmental planning

The direct labor efficiency variance (also known as labor efficiency variance, direct labor quantity or usage variance) is a tool used in financial management which allows to measure the difference between the labor hours that were actually worked and the labor hours that should have been used.

Calculating the direct labor efficiency variance

The following formula is used to calculate this variance:

$LEV=(SH\cdot SR)-(AH\cdot SR)=SR\cdot (SH-AH)$ where

$LEV$ - the labor efficiency variance,

$SR$ - the standard labour rate,

$SH$ - the standard hours allowed (the standard hour is an achievable amount of work for one hour considering standard efficiency levels),

$AH$ - the actual direct labor hours worked .

Example of computing the direct labor efficiency variance

To illustrate how to use this variance, let's assume that a manufacturer called Cambria Company produces leather bags to carry the Watch Dog robots. At Cambria Company, each bag requires: 2.4 standard direct labor hours and $8.50 standard direct labor rate per hour.

In August, 450 direct labor hours were used to produce 180 bags at an average pay rate of $9.20 per hour. Depending on these numbers, the direct labor efficiency variance is computed as follows:

1. Standard hours allowed = amount of bags produced in August $\cdot$ standard direct labor hours per bag, $SH=180\cdot 2,4=432$,
2. Actual hours worked $AH=450$,
3. Standard rate $SR=8,5$,
4. Direct Labor Efficiency Variance $LEV=SR\cdot (SH-AH)=8,5\cdot (432-450)=153(U)$; U=unfavorable.

Because of the fact that Cambria Company's direct labor efficiency variance were unfavorable, its managers decided to investigate the causes of this deviation. An analysis of employee time cards showed that the assembly worker who was ill was replaced with a machine operator from the different department. New machine operator made $9.20 per hour, whereas the primal worker earned the standard $8.50 per hour rate. What is more, the assembly supervisor identified two possible cocauses of the unfavorable efficiency variance: firstly, new machine operator had to learn another skills on the job what resulted in longer assembly time and secondly, he emphasized some setbacks of materials handling people who delivered parts late for five times. For the reason that machine operator replacement was a temporary state of affairs, Cambria's managers decided not to take any corrective action, but they decided to keep an eye on the materials handling function .

Possible causes of the Labor Efficiency Variance

There are a lot of reasons of unfavorable direct labor efficiency variance. Some common reasons are as follows:

• lack of proper supervision,
• weak working conditions,
• delays caused by waiting for materials, tools, instructions, etc. if not treated as idle time,
• flawed machines, tools and other equipments,
• new machines requiring more time than established, till such time standard is not revised,
• basic inefficiency of workers caused by low morale, faulty instructions, insufficient training, incorrect scheduling, etc.,
• operating with non-standard material which require more or less operation time,
• inadequate standards,
• bad selection of workers,
• wrong recording of performances, i.e., time or output.

References

• Chea A. C. (2011), Activity-based costing system in the service sector: A strategic approach for enhancing managerial decision making and competitiveness, "International Journal of Business and Management", Vol. 6, Nr 11.
• Cost and management accountancy: Intermediate (2013), Study Note 4 : Standard Costing , The Institute of Cost Accountants of India, Kolkata.
• Guvenen F. (2009), An empirical investigation of labor income processes, "Review of Economic dynamics", Vol. 12, Nr 1.
• Hansen D. R., M. Mowen M.M. (2013), Managerial Accounting 8th Edition, Thomson South-Western, Mason.
• Needles B. E., Powers M., Crosson S. V. (2011), Financial and Managerial Accounting,(9th) Edition, Thomson South-Western, Mason.
• Stuebs M.,Sun L. (2010), Business reputation and labor efficiency, productivity, and cost, "Journal of Business Ethics", Vol. 96, Nr 2.
• Weetman P. (2013), Financial And Management Accounting: An Introduction, 5th Edition, Dorling Kindesley Pearson Education, Essex.

Author: Anna Kasprzyk