Variance analysis---the process of calculating and investigating variances---is a good management tool for controlling costs. It is most often used with standard costing because standard costs are good benchmarks on which to evaluate performance. The standard cost system must be continually reviewed and kept up to date in order to ensure that variances are meaningful.


This chapter covers direct labor variance analysis that enables managers to identify if a labor variance exist, and if so, is it caused by the rate paid to employees or the efficiency with which employees work. Identifying which labor variances need investigation and with whom the responsibility of the variance lies is also addressed. Because variance analysis compares actual amounts with standards, it is performed at the end of an accounting period at the earliest point that the actual costs are known.


Direct Labor Variance Analysis

A labor price standard is the amount that the company expects to pay per hour for direct labor. It is often called the labor rate standard. A labor quantity standard is the quantity of hours that management believes should be used to produce one unit of product, and is often referred to as the labor efficiency standard.


A matrix format to determine variances for direct labor makes the calculation of direct variances more efficiently and avoids memorization of formulas which is necessary without it. It was developed by the late Dr. Charles Horngren. First, a little insight on the syntax used in the matrix:

P = Price

Q = Quantity

A = Actual

S = Standard

The matrix that follows displays two rows on which the letters 'P' and 'Q' appear to the left side. Amounts in the first row will contain only price amounts of labor (labor rates). Amounts in the second row will contain only quantity amounts of labor (labor hours). The amount to be indicated for 'A' in the 'P' row will be the actual price (rate) of labor paid per hour. The amount to be placed in the space occupied by both 'S' letters on the 'P' row, is the standard price (wage rate) per hour. The second row is used to write the actual (A) quantity (Q) and standard (S) quantity (Q) of hours allowed for production.


The three columns that contain the amounts of the AA, SA, and SS labels are multiplied down to determine a total of each of the three columns. The total of the AA column is compared to the total of the SA column. The difference is labeled either labor price variance or labor rate variance. The total of the SA column is compared to the total of the SS column and the difference is labeled as labor quantity variance or labor efficiency variance.


The total labor variance is calculated by adding the labor rate variance to the labor efficiency variance. 



Determining if a Variance is Favorable and Unfavorable

Favorable variances occur when actual costs are less than expected. From a conceptual perspective, the following apply: 


Type of Variance Variance Occurs When
 Unfavorable labor rate variance   Actual labor rate per hour exceeds the standard labor rate per hour
 Favorable labor rate variance  Actual labor rate per hour is less than the standard rate per hour
 Unfavorable labor efficiency variance  Actual labor hours used exceed the standard hours allowed
 Favorable labor efficiency variance  Actual labor hours used is less than the standard hours allowed


From a mechanical perspective, when comparing the AA and SA column totals, if the left column total is greater than the right total, the variance is unfavorable. Likewise, when comparing the SA and SS column totals, if the left column total is greater than the right total, the variance is unfavorable. If the left column total is smaller than the right column, the variance is favorable.


Interpreting Variances

Interpreting variances is crucial to understanding what needs to be done to correct the variances. Assume a company has an unfavorable labor rate variance of $200. Paying employees more per hour than allowed in the budget caused an additional cost of $200 for labor. If the same variance was favorable, the company would have saved $200 by paying its employees less per hour than allowed in the budget. An unfavorable labor efficiency variance of $450 would indicate that an extra labor cost of $450 was incurred by using more hours in production than allowed. If the same variance was favorable, the company would have saved $450 by using less labor hour than allowed in the budget.


The standard labor rate established by a company is an average, usually pertaining to average quality workers. Newly hired workers will likely get paid less which often creates a favorable labor rate variance. New employees will also work more slowly (are less efficient) than more experienced workers creating an unfavorable labor efficiency variance. The opposite is true if a company employs highly skilled workers.


Responsibility for Labor Variances

Labor Rate Variance

Whose problem is it when a labor rate variance exists? The production supervisor hires production workers and assigns each a wage rate. He is able to give them raises and terminate them if necessary. For this reason, if a labor rate variance exists, upper-level managers inquire of the production supervisor to determine the variance cause.


Labor Efficiency Variance

Whose problem is it when a labor efficiency variance exists? The production supervisor oversees the production workers and monitors the efficiency with which each of these employees works. For this reason, if a labor efficiency exists, management should inquire of the production supervisor to try to determine the variance cause.


Walk Through Problem

Bateh Company produces hot sauce. It uses units as the cost driver for overhead. Bateh has a 2% materiality threshold. The following information was provided concerning its standard cost system for 2018:


Standard Data


Actual Data

Direct material

1/8 lb. @

$7.50 per lb.


Units of product produced


Direct labor

24 mins. @

$12 per hr.

Materials purchased

600 lbs. for $4,440

Budgeted fixed overhead


Materials used

556 pounds

Budgeted variable overhead

$4.50 per unit

Direct labor worked

1,610 hours totaling $19,481

Budgeted production in units


Overhead incurred

Fixed $20,000;

Variable $28,400


Calculate all three direct labor variances for Bateh Company. Determine which variances should be investigated and indicate who is responsible for each.


Step 1: Draw a matrix by writing the letters of each row across the page: P-A-S-S and Q-A-A-S.


Step 2: Write the actual price (rate) and standard price (rate) amounts on the first row--the P-A-S-S row. The standard (S) price per hour is $12.00. The actual price for direct labor must be calculated. You are given the total direct labor of $19,481, and the actual hours worked in the amount of 1,610. Because total wages are equal to hours worked times the rate per hour, you can work backwards to calculate the wage rate of $12.10 per hour as: $19,481 = 1,610 hrs x 'Rate'






















Step 3: Write the quantities (Q) of hours in the second row. The actual quantity for the first two columns is 1,610 hours. The last column is tricky. The total in this column represents the flexible budget amount and is the same amount that will appear on the company's flexible budget for direct labor. Recall that flexible budget considers the actual number of units produced. The standard quantity allowed is 24 minutes or 24/60 = 0.40 hours for each finished goods unit produced. Since 4,400 units were produced, multiply 4,400 times 0.40 hours to arrive at a total of 1,760 hours of direct labor allowed for the level of production achieved.

























Step 4: Multiply down and write the total below the underline for each of the three columns.

P A  S  S
 $12.10    $12.00    $12.00
Q  A    A    S 
      1,610         1,610        1,760
     19,481        19,320      21,120

Step 5: Determine the difference between the first and second columns totals to arrive at the labor rate variance as: $19,481 - $19,320 = $161. Since the left total (column 1) is greater than the right total (column 2), the variance is unfavorable. Determine the difference between the second and last columns to arrive at the labor efficiency variance as: $21,120 - $19,320 = $1,800. Because the left total (column 2) is less than the right total (column 3), the variance is favorable.


P A  S  S
 $12.10    $12.00    $ 12.00
Q  A    A    S 
       1,610          1,610         1,760
     19,481        19,320       21,120




  Total Labor Variance 

  $1,639 F


Step 6: The total labor variance is determined by combining the two labor variances together. Because the favorable variance of $1,800 is greater than the unfavorable variance of $161, subtract the amounts and the resulting total labor variance is favorable.


Step 7: Should these variances be investigated if the company has a 2% materiality threshold? First, determine the dollar amount of the threshold. The last column is the total flexible budget amount allowed and is used as the budget amount for this calculation:

            2% x $21,120 = $422.40

Step 8: Only the labor efficiency variance exceeds the $422.40 amount, and as such, it should be investigated. Keep in mind that because a variance is favorable, this does not mean it is a 'good' variance. Even favorable variances can be bad for a company. Who is responsible for the labor efficiency variance? The production supervisor is responsible because he has control of all aspects of employee performance.

This page was last edited on Friday March 27, 2015 05:39 PM
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