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What is Labor Rate Variance?
Labor Rate Variance [LRV] is otherwise called as labor Price Variance, labor Rate of Pay Variance and labor Wage Rate Variance. It is a part of direct labor cost variance.
Definition of LRV
According to ICMA, London,
“Labor Rate Variance is that portion of labor [Wages] variance which is due to the difference between the standard rate of pay specified and actual rate paid”.
Formula to calculate LRV
The following formula is used to calculate labor rate variance.
Labor rate variance = Actual Hours Booked or Actual Hours Taken x [Standard Rate – Actual Rate]
If the standard rate is more than the actual rate, the variance will be favorable, and on the other hand, if the standard rate is less than actual rate, the variance will be unfavorable or adverse.
Causes for labor Rate Variance
1. Employment of more efficient and skilled labor force demanding higher rate of wages.
2. Sometimes, there may be non-availability of labor force but they are demanding higher rate of wages.
3. There may be more availability of labor force and there is a chance of being payment of low rate of wages.
4. Employment of unskilled workers at lower rates might have caused less payment for wages.
5. The workers are allowed to work in over time. Since the overtime allowance is more than the normal time rate, more wages will be paid to workers.
6. Extra shift allowance may be paid to workers.
7. More bonus may be paid to workers.
8. Higher piece rate might have been paid for quality production.
9. Method of wage payment may be changed.
10. Some incentives or bonus schemes might have been introduced or withdrawn.
11. Grades of workers might have been revised.
12. Increase rate of wages based on the agreement made with trade union or according to the policy of Government.
13. Higher rate of wages may be paid during seasonal or emergency operations.
Generally, the wage rate is determined on the basis of demand and supply conditions of labor in the labor market. Hence, labor rate variance is uncontrollable. If the workers are selected wrongfully or employment of low grade or high grades of labors in the place of high grade or low grade of labors respectively, the production foreman will be responsible.
Labor price variance, or direct labor rate variance, measures the difference between the budgeted hourly rate and the actual rate you pay direct labor workers who directly manufacture your products. Labor efficiency variance measures the difference between the number of direct labor hours you budgeted and the actual hours your employees work. Compare these two variances to determine how well your small business managed its direct labor costs during a period.
Direct Labor Usage Variance
A labor variance that is a positive number is favorable and can result in profit that is higher than expected. A favorable variance occurs when your actual direct labor costs are less than your standard, or budgeted, costs, reports Accounting Coach.
A labor variance that is a negative number , on the other hand, is unfavorable and can result in profit that is lower than expected. An unfavorable variance occurs when actual direct labor costs are more than standard costs.
Labor Price Variance Calculation
Labor price variance equals the standard hourly rate you pay direct labor employees minus the actual hourly rate you pay them, times the actual hours they work during a certain period.
For example, assume your small business budgets a standard labor rate of $20 per hour and pays your employees an actual rate of $18 per hour. Also, assume your employees work 400 actual hours during the month. Your labor price variance would be $20 minus $18, times 400, which equals a favorable $800.
Labor Efficiency Variance Formula
Labor efficiency variance equals the number of direct labor hours you budget for a period minus the actual hours your employees worked, times the standard hourly labor rate.
For example, assume your small business budgets 410 labor hours for a month and that your employees work 400 actual labor hours. Also, assume your standard labor rate is $20 per hour. Your labor efficiency variance would be 410 minus 400, times $20, which equals a favorable $200.
Labor Variance Factors
Labor price variance and labor efficiency variance might be favorable or unfavorable for various reasons. For example, you might use newer workers who receive lower pay than usual, which would create a favorable labor price variance and could increase your expected profit. These workers might have insufficient training and might require more hours to complete a job. More labor hours would create an unfavorable labor efficiency variance, which could decrease your expected profit.
Comparing Variances
Comparing labor price variance to labor efficiency variance helps you pinpoint areas of strength and weakness in your small business’s labor management. For example, if your labor price variance is a favorable $500, but your labor efficiency variance is an unfavorable $700, the unfavorable amount offsets the favorable amount.
Consult with the manager in charge of your direct labor employees to determine the underlying cause of your variances and determine what you need to improve for the next period. Various factors may influence the labor expense for the part of the business, reports Accounting Verse. These include shift premiums, overtime payments and production down times, labor union influences, overstaffing and understaffing.