Direct labor efficiency variance

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.

Advantages of Direct labor efficiency variance

The advantages of direct labor efficiency variance are varied, and include the following:

• It allows for the comparison of actual labor performance to the standard set for labor performance, providing a measure of efficiency. This allows managers to take corrective action when needed and to reward employees who have achieved higher levels of efficiency.
• It helps to identify areas where the standard labor performance is not being achieved, allowing the manager to determine the cause and take corrective action.
• It provides an easy way to track labor performance over time, allowing managers to compare performance from one period to the next.
• It can be used to help set future labor performance standards based on past performance.
• It provides an incentive for employees to strive for higher levels of efficiency, as their performance will be tracked and rewarded.

Limitations of Direct labor efficiency variance

Direct labor efficiency variance is an important tool for analyzing labor costs and measuring performance, but it does have some limitations. The following are some of the limitations of direct labor efficiency variance:

• It does not take into account any changes in labor rates, which can have a significant effect on labor costs.
• It does not consider any non-labor related costs, such as materials or overhead costs, which can have a major impact on overall costs.
• It does not consider any changes in the production process that may affect labor efficiency, such as new technology or improved methods.
• It does not take into account any changes in labor availability, such as shifts in labor demand or changes in the labor pool.
• It also does not take into account any changes in the quality of labor, which can have major implications for efficiency.

Other approaches related to Direct labor efficiency variance

Introduction Aside from direct labor efficiency variance, there are several other approaches to financial management. These include:

• Budgetary control: This approach emphasizes setting up a budget and then comparing actual performance to the budget, to allow for corrective action when necessary.
• Cash flow management: This approach focuses on managing cash flows to optimize the use of short-term resources and ensure long-term sustainability.
• Risk management: This approach involves assessing and managing the financial risks associated with a business to minimize the potential impact of loss.
• Investment management: This approach involves making decisions about the optimal use of resources to maximize the return on investment.
• Cost control: This approach seeks to minimize costs by controlling expenses and increasing efficiency.

In summary, aside from direct labor efficiency variance, there are several other approaches to financial management, such as budgetary control, cash flow management, risk management, investment management, and cost control.

Footnotes

Direct labor efficiency variance — recommended articles

Hidden cost — Hidden factory — Variable overhead efficiency variance — Allocated cost — Differential costing — Overall equipment effectiveness — Productivity report — Production reserve — Differential cost

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