Direct Labor Variance Analysis

Now let’s talk about direct labor variances. There are two elements that make up our direct labor costs: One is the number of direct labor hours it takes to manufacture a product. Two is the cost per direct labor hour. Let’s say for example, that you are manufacturing laptops and each laptop takes five direct labor hours, and each direct labor hour costs you $20. Therefore, your total direct labor cost is $100. 

If there are two factors making up our direct labor cost, that means that there are also two types of variance analysis, one variance analysis for each of the factors.

For the price per hour, we have the price variance analysis. This variance asks, “Did we spend more or less per direct labor hour than expected?” For the number of direct labor hours per unit, we have the efficiency variance analysis, which asks, “Did we use more direct labor hours per unit or fewer than we expected?” If we used fewer direct labor hours per unit than we expected, then we were more efficient, which would be favorable. If we used more direct labor hours per unit than we expected, then we were less efficient, which would be unfavorable.

• Direct Labor Price Variance = (Actual Price Per Labor Hour – Standard Price Per Labor Hour) X Actual Hours Per Unit X Total Units Produced

• Direct Labor Efficiency Variance = (Actual Labor Hours Per Unit – Standard Labor Hours Per Unit) X Standard Price Per Labor Hour X Total Units Produced

Direct Labor Variance Analysis – Example

Now we’re going to go through an example to begin dissecting the two types of direct labor

variance analysis. Let’s look at the following numbers for a home manufacturer:

Standard Amounts:

Build 50 Homes

Each Home Requires 400 Labor Hours

Each Labor Hour Costs $20

Actual Amounts:

Built 35 Homes

Each Home Required 400 Labor Hours

Each Labor Hour costs $20

Before we started the year, we thought that we would build 50 homes. We estimated that each home would require 400 direct labor hours and each direct labor hour would cost $20. These are our standard numbers (i.e., our estimated numbers). 

We ended up building far fewer homes than we expected. Instead of building 50 homes as we expected, we only built 35. When performing variance analysis, the number of units we expected to make is irrelevant. The fact that we expected to build 50 homes is irrelevant to this problem. We’re only focused on the 35 homes that we actually built.

Price Variance Formula

First, let’s calculate the price variance, which asks, “Did we spend more or less per direct

labor hour than we expected?” 

Direct Labor Price Variance = (Actual Price Per Labor Hour – Standard Price Per Labor Hour) X Actual Hours Per Unit X Total Units Produced

We estimated that we would spend $20 per labor hour, yet we actually spent $21 per labor hour. We spent $1 more per hour than we thought. We need to multiply this $1 by the total number of labor hours we used. We used 375 labor hours per home and built 35 homes, which totals 13,125 labor hours. We multiply these 13,125 total labor hours by our $1 difference per hour, and our price variance is $13,125.

What does this mean? It means that we spent $13,125 more on labor than we expected. We spent more than we thought, making this an unfavorable variance. Because we spent $1 more per direct labor hour, and then we had a total of 13,125 direct labor hours.

Efficiency Variance Formula

Now let’s find the direct labor efficiency variance, which focuses on the number of labor hours per home. It’s going to figure out whether we are more efficient with our labor hours or less efficient than we expected. We expected to use 400 direct labor hours per home. We actually used 375 direct labor hours. We used 25 fewer hours per home than we expected.

This is a favorable variance because we are saving money

Is it enough to say we are 25 hours more efficient per home? No, because we need to multiply that difference by how many homes we produced and we need to represent the number in terms of dollars.

Study Tip 😀 

We always multiply by the actual number of labor hours per unit for the direct labor price variance. 

Direct Labor Efficiency Variance Formula

(Actual Labor Hours Per Unit – Standard Labor Hours Per Unit) X Standard Price Per Labor Hour X Total Units Produced

First, we need to multiply the 25-hour difference by the 35 homes we produced, resulting in 875 hours. This means that since we were 25 hours more efficient and we made 35 homes, we saved a total number of 875 hours. Now we have to quantify that amount by multiplying it by the standard price per hour. Our standard rate is $20 per hour.

Study Tip 😀

We always multiply by the standard price per labor hour for the direct labor efficiency variance.

We multiply the 875 hours by $20 per hour for an efficiency variance of $17,500. This

means that because we were more efficient with our workers, we spent $17,500 less than

we expected.