labor Rate and Efficiency Variances Accounting Help

Brice incurred actual direct labor costs of $14,040 in March. The standard labor cost allowed for manufacturing 600 beams is only $10,800 (600 units X 1.5 hours per unit X $12 per hour).

Thus the company is faced with an unfavorable labor variance of $3.240 ($10,800 – $14,040). We can gain additional insight regarding the reasons for this overrun by separating the total variance amount into two elements-a labor rate variance and a labor efficiency variance.

Actual labor costs are a function of: (1) the wage rate paid to direct labor workers and (2) the number of direct labor hours worked.

A labor rate variance shows the extent to which hourly wage rates contributed to deviations from standard costs. The labor efficiency variance indicates the extent to which the number of labor hours worked during the period contributed to deviations from standard costs.

The labor rate variance is equal to the actual number of hours worked multiplied by the difference between the standard wage rate and the actual wage rate. Time cards show that I,080 direct labor hours were used in March. The average wage rate for the month
was $13 per hour.

Thus He labor rate variance for Brice is computed as follows:An favorable labor rate variance can result from using highly paid employees to perform lower-pay-scale jobs, poor scheduling, or incurring excessive overtime costs. Since the production manager is usually responsible for assigning employees to production activities, he or she normally is responsible for labor rate variances. (But, as we will see in our example, this is not always the case.An alternative is to record the materials price variance at the time the materials are purchased.

Such alternatives are discussed in cost accounting courses. 21 f the standard level of production requires overtime even with efficient scheduling. the overtime wage rate should be reflected in the standard cost.

An favorable labor rate variance can result from using highly paid employees to perform lower- pay scale jobs, poor scheduling, or incurring excessive overtime costs.Since the production manager is usually responsible for assigning employees to production activities, he or she normally is responsible for labor rate variances. (But, as we will see in our example, this is not always the case.

An alternative is to record the materials price variance at the time the materials are purchased. Such alternatives are discussed in cost accounting courses. 21 f the standard level of production requires overtime even with efficient scheduling. the overtime wage rate should be reflected in the standard cost.

The labor efficiency variance (also called the labor usage variance) is a measure of worker productivity.

This variance is favorable when workers are able to complete the scheduled production in fewer hours than allowed by the standard. It is unfavorable when wasted time or low productivity causes actual hours to exceed the standard.

The labor efficiency variance is computed by multiplying the standard hourly wage rate by the difference between the standard hours allowed and actual hours used. Brice allows 900 direct labor hours to produce 600 beams (600 units X 1.5 hours per unit). Given that 1,080 hours were actually required, the company’s unfavorable labor efficiency variance for March is computed as follows:

The unfavorable labor efficiency variance indicates that direct labor workers were unable to manufacture the 600 beams in the standard time allowed. Once again, the production manager is responsible for worker productivity and usually is held accountable for the labor variance. The labor efficiency variance and the labor rate variance are closely related. For instance, excessive direct labor hours may cause both the labor efficiency variance and the . labor rate variance to be unfavorable if, due to the excess hours, workers must be paid at overtime rates. . The two labor cost variances may be summarized as follows:

In similar fashion to the way direct material costs were charged to production, the Work in Process Inventory account is debited for the standard labor cost allowed, and the Direct Labor account is credited for the actual labor cost incurred. The unfavorable labor rate and efficiency variances are recorded by debit entries, because they both represent costs in excess of the budgeted standards.

Manufacturing Overhead Variances

The difference between actual manufacturing overhead costs incurred and the standard overhead costs charged to production is called the overhead variance. Whereas direct materials and direct labor are variable costs, manufacturing overhead is comprised of
both variable and fixed cost components. Therefore, the analysis of the overhead cost variance differs somewhat from the analysis of materials and labor variances. We willnow examine two elements of the overhead cost variance-the spending variance and
the volume variance?

The Overflead Spending Variance The most important element of the overhead cost variance is the spending variance. This variance is the-difference between the standard overhead allowed for a given level of output and the actual overhead costs incurred during the period; The overhead spending variance for Brice Mills in March may be computed as follows:

The spending variance is typically the responsibility of the production manager. In many cases, much of the spending variance involves controllable overhead costs. For this reason, it sometimes is called the ‘controllable variance. At Brice, the Production manager has kept variable overhead costs very close to standard and has kept fixed costs well.below the $5,600 amount budgeted.

The Overhead Volume Variance The volume variance represents the difference between the overhead applied to work in process (at standard cost) and the overhead expected at the actual, level of production. We will see that the volume variance is caused simply by the difference between the normal volume of output (700 units per month) and the actual volume of output (600 units in March). In a standard cost system, overhead is charged to work in process using standard unit costs.

On page 972, we determined that Brice’s standard manufacturing overhead cost  was $14 per unit. Thus its Work in Process Inventory account was debited with $14 in overhead costs for each unit produced ‘during the month. The more units produced during the month, the more overhead costs are charged to production. In .essence a standard cost system treats’ all overhead as a variable cost. In reality, however, manufacturing overhead includes many fixed costs. Treating manufacturing overhead as a variable cost automatically causes a cost variance whenever the level of production varies from the norm . To illustrate the variances-that result from applying overhead to production in a standard cost system, let us compare the overhead costs that Brice would apply to production at three different levels of monthly output of its 20-foot beams:

Notice that at an actual level of production of 700 beams per month, the normal level of output, there is no volume variance. This is because our $14 standard cost figure ‘assumes that 700 units will actually be produced each month. As shown on page 972, the $14 unit cost includes $8 per unit in fixed costs ($5,600 of budgeted fixed overhead + 700 units).

Whenever actual production is less than 700 units, less than $5,600 in fixed overhead costs will be applied to production. In March, for example, only 600 beams were actually produced. Thus use of a standard cost that includes $8 in fixed costs applies only $4,800 in fixed overhead costs to production.

The remaining $800 in fixed overhead is recorded as an unfavorable volume variance. It is viewed as an’ unfavorable variance because fixed overhead has been under applied, which means that additional overhead costs must be charged to the units
produced. The situation reverses whenever actual production exceeds the normal level. Had Brice’s actual output in March been 800 units, the application of overhead using a standard rate of $14 per unit would have applied more than $5,600 in fixed overhead costs to production ($8 of fixed cost per unit X 800 units = $6,400). Here, the $800 volume variance is viewed as favorable. It is favorable because the cost standard has charged production with too much fixed overhead, making the actual costs look low by comparison The key point.

is that volume variances occur automatically whenever actual output differs from the level of output .assumed i.n computing the standard overhead cost per unit. Over time. average production levels should equal the normal level used in developing the standard cost. Thus the favorable and unfavorable volume variances should balance out during the year. As long as the production department is producing the desired number of units, volume variances do not indicate either efficient or inefficient performance. Volume varianccs are simply ‘the natural result or fluctuations in the level of production from month :0 month. These Valuations often occur because of seasonal sales demand, efforts to increase or decrease inventory levels, holidays and vacations, etc. Thus, unless the production department fails to
produce a scheduled number of units, no manager should be considered responsible , . for a volume variance.

Posted on November 24, 2015 in Standard Cost Systems

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