Calculating variances gives management an good tool for controlling costs. But the system must be continually reviewed and kept up to date.
A standard cost system lends itself well to performing standard cost variance analysis in production. In this chapter, we will break the direct labor standards and direct labor variance into two components so that we can identify the cause of the variance more accurately. Sometimes a favorable variance in one component might cause an unfavorable variance elsewhere.
Price and Quantity Standards
A labor price standard is the amount that should be paid per hour for direct labor. It is often called the labor rate standard. A labor quantity standard is the amount of hours that should be sued for production, often referred to as the labor efficiency standard. A matrix developed by Dr. Charles Horngren appears below. We will use this matrix format to determine variances for direct labor. First, a little insight on what the letters mean:
P = Price
Q = Quantity
A = Actual
S = Standard
Note that there are two rows on which the letters P and Q appear to the left side. The first row will contain only Price amounts of labor. In the space occupied by A in the P row, we write down the Actual Price of labor, in the space occupied by the S on the P row, we write the Standard Price of direct labor. The second row is used to write the Actual Quantity and Standard Quantity of hours allowed for production.
The three columns that contain the amounts for AA, SA, and SS are multiplied down to give a total under each of the three columns. The total of the AA column is compared to the total of the SA column. The difference is labeled 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 Efficiency Variance.
Favorable and Unfavorable
If actual labor rate per hour exceeds allowed labor rate per hour, the variance = unfavorable labor rate variance
If actual labor rate per hour is less than allowed labor rate per hour, the variance = favorable labor rate variance
If actual labor hours used is less than allowed labor hours, the variance = favorable labor quantity/efficiency variance
If actual labor hours used exceeds allowed labor hours, the variance = unfavorable labor quantity/efficiency variance
The descriptions below tell you what information is provided by the amounts calculated. In each comparison, if the left total exceeds the right total, the variance will be unfavorable. If the left total is less than the right total, the variance will be favorable. Don't confuse favorable and unfavorable with good and bad.
To determine the total labor variance, combine the labor rate variance with the labor efficiency variance.
Causes of Labor Variances
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 creates a favorable labor rate variance. They will also work more slowly 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
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 exists, we inquire with the production supervisor to try to determine the variance cause.
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 workers works. For this reason, if a labor efficiency exists, we inquire with the production supervisor to try to determine the variance cause.
Bateh Company produces hot sauce. It uses units as the cost driver for overhead. The following information was provided concerning its standard cost system for 2012:
1/8 lb. @ $7.50 per lb.
24 mins. @ $12 per hr.
600 lbs. for $4,440
Budgeted fixed overhead
Budgeted variable overhead
$4.50 per unit
1,610 hours totaling $19,481
Fixed $20,000; Variable $28,400
Set up the matrix and write the actual price and standard price amounts on the first line. The problem gives you the standard (S) price per hour of $12.00. The actual price for direct labor must be determined. You are given the total direct labor of $19,481, and the actual hours worked in the amount of 1,610. Because total hours worked time the rate per hour equals total wages, you can work backwards to get $12.10 per hour.
Now write in the quantities in the second row. You are given the actual quantity for the first two columns. The last column is often referred to as the flexible budget column because the amount you will write in will calculate the amount on a flexible budget. Recall that flexible budget means the actual units produced are considered. The standard quantity allowed is 24 minutes or 24/60 = 0.40 hours for each finished goods unit produced. Since 4,400 were produced, you get 4,400 times 0.40 = 1,760 hours of direct labor allowed.
Now we need to multiply down and write the total below the underline for each of he three columns.
Take the difference between the first and second columns to get the labor price/rate variance. Since the left total is greater than the right total, the variance is unfavorable. Take the difference between the second and last columns to get the labor quantity/efficiency variance. Since the left total is less than the right total, the variance is favorable.
|Total Labor Variance|
The total 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, the total labor variance is favorable.
Should these variances be investigated if the company has a 2% materiality threshold? You first need to determine how much this is. 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
Because only the labor efficiency variance exceeds the $422.40 amount, it should be investigated. Note that favorable does not mean good. Even favorable variances can be bad.
Who is responsible for these variances? The production supervisor because he has control of all aspects of employee performance.