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When Purchases Differ From Usage

The discussion and illustration for direct material variances presumed that all of the raw material purchases were put into production. If this were not a valid assumption, then the preceding illustration would need to be modified to reflect price variances based on the amount purchased and quantity variances based on output. Be aware that the ripple effect of this modification would potentially upset the relationships between the "red, green, and blue balls" used in this chapter to illustrate the basic principles of variance calculations. Further discussion of this topic issue is deferred to more advanced managerial accounting courses.

Variances Relating to Direct Labor

The intrinsic logic for direct labor variances is very similar to that of direct material. The total variance for direct labor is found by comparing actual direct labor cost to standard direct labor cost. The overall labor variance could result from any combination of having paid laborers at rates equal to, above, or below standard rates, and using more or less direct labor hours than anticipated. In this illustration, AH is the actual hours worked, AR is the actual labor rate per hour, SR is the standard labor rate per hour, and SH is the standard hours for the output achieved.

Variances Relating to Direct Labor

The Total Direct Labor Variance can be separated into the:

• Labor Rate Variance: A variance that reveals the difference between the standard rate and actual rate for the actual labor hours worked [(standard rate - actual rate) x actual hours].

• Labor Efficiency Variance: A variance that compares the standard hours of direct labor that should have been used to the actual hours worked. The efficiency variance is measured at the standard rate per hour [(standard hours - actual hours) x standard rate].

If you carefully study the illustration, you will see there are several ways to perform the intrinsic labor variance calculations. You can very simply compute the values for the red, blue, and green balls; noting the differences. Or, you can perform the noted algebraic calculations for the rate and efficiency variances; adding them together gives you the total variance. In performing the math operations, be very careful to note that unfavorable variances (negative numbers) offset favorable (positive numbers) variances.

An Illustration of Direct Labor Variance Calculations

Let's continue with our illustration for Blue Rail Manufacturing. Recall that each section of railing requires that individual pieces of pipe be custom cut, welded, sanded, and painted. Welding is a slow and labor intensive process, and the company has adopted a standard of 3 labor hours for each section of rail. Skilled labor is anticipated to cost $18 per hour. During August, remember that Blue Rail produced 3,400 sections of railing. Therefore, the standard labor cost for August is calculated as:

Output Number of rail sections


Standard hours per rail section

X 3.00

Standard hours to achieve output


Standard rate per hour of labor

X $18

Standard cost of direct labor

$ 183,600

The monthly performance report revealed actual labor cost of $175,000. A closer examination of the actual cost of labor revealed the following:

Actual hours of labor


Actual rate per hour

X $14

Actual cost of direct labor

$ 175 000

The total direct labor variance was favorable $8,600 ($183,600 vs. $175,000). This variance was driven by favorable wage rates:

LABOR RATE VARIANCE = (SR - AR) x AH = ($18 - $14) x 12,500 = $50,000

The hourly wage rate was lower because of a shortage of highly skilled welders. The less experienced welders were paid less per hour but they also worked slower. This inefficiency shows up in the unfavorable labor efficiency variance:

LABOR EFFICIENCY VARIANCE = (SH - AH) x SR = (10,200 - 12,500) x $18 =<$41,400>

These two variances net ($50,000 + <$41,400>) to produce the total $8,600 favorable outcome:

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