Calculation of Variances: Labour Variances (Rate and Efficiency)

In the previous section, we discussed the calculation of material variances, specifically the price and usage variances. In this section, we will focus on another important aspect of budget variances – labour variances. Labour variances help organisations understand the differences between the standard cost of labour and the actual cost incurred.

Labour Rate Variance

The labour rate variance compares the standard rate of pay per hour with the actual rate paid to the workers. It helps identify whether the organisation is paying more or less than the expected rate for labour.

The formula to calculate the labour rate variance is:

Labour Rate Variance = (Actual Rate – Standard Rate) x Actual Hours

If the labour rate variance is favourable, it means that the organisation is paying less than the standard rate for labour. On the other hand, if the variance is adverse, it indicates that the organisation is paying more than the standard rate.

For example, let’s say the standard rate of pay per hour is £15 and the actual rate paid is £16. If the actual hours worked are 100, the labour rate variance can be calculated as follows:

Labour Rate Variance = (£16 – £15) x 100 = £100

In this case, the labour rate variance is favourable, indicating that the organisation paid £100 less than the standard rate for labour.

Labour Efficiency Variance

The labour efficiency variance compares the actual hours taken to complete a task with the standard hours allowed for that task. It helps identify whether the workers are more or less efficient than expected.

The formula to calculate the labour efficiency variance is:

Labour Efficiency Variance = (Actual Hours – Standard Hours) x Standard Rate

If the labour efficiency variance is favourable, it means that the workers completed the task in fewer hours than expected. Conversely, if the variance is adverse, it indicates that the workers took more hours than the standard allowed.

Let’s consider an example to understand this better. Suppose the standard hours allowed for a task are 80 and the actual hours taken are 90. If the standard rate of pay per hour is £15, the labour efficiency variance can be calculated as follows:

Labour Efficiency Variance = (90 – 80) x £15 = £150

In this case, the labour efficiency variance is adverse, indicating that the workers took 10 hours more than the standard allowed, resulting in an additional cost of £150.

Interpreting Labour Variances

Labour variances provide valuable insights into the cost and efficiency of labour in an organisation. By analysing these variances, management can identify areas for improvement and take corrective actions.

If both the labour rate variance and the labour efficiency variance are favourable, it indicates that the organisation is paying less than the standard rate and the workers are completing tasks in fewer hours than expected. This can be seen as a positive outcome, as it results in cost savings.

However, if both variances are adverse, it suggests that the organisation is paying more than the standard rate and the workers are taking more hours than allowed. This can be a cause for concern, as it leads to increased costs.

It is also possible to have mixed variances, where one variance is favourable and the other is adverse. In such cases, management needs to analyse the variances in more detail to understand the underlying causes and take appropriate actions.

Overall, labour variances play a crucial role in budget analysis and help organisations monitor and control their labour costs effectively.

Conclusion

In this section, we discussed the calculation of labour variances, specifically the labour rate variance and the labour efficiency variance. These variances provide insights into the cost and efficiency of labour in an organisation. By analysing these variances, management can identify areas for improvement and take corrective actions to control labour costs effectively.

In the next section, we will explore another important aspect of budget variances – the total fixed overhead variance. Stay tuned!