Definition
Labor rate variance measures the difference between the actual hourly rate paid to employees and the standard hourly rate that an organization had planned to pay them.
The standard hourly rate is usually calculated by considering factors such as employee skill level, experience, and local labor market conditions.
The formula for calculating labor rate variance is as follows:
Labor Rate Variance = (Actual Hourly Rate – Standard Hourly Rate) x Actual Hours Worked
If the actual hourly rate paid to employees is higher than the standard hourly rate, the labor rate variance will be unfavorable. Conversely, if the actual hourly rate paid to employees is lower than the standard hourly rate, the labor rate variance will be favorable.
Steps for Calculating Direct Labor Rate Variance
Here are the THREE simple steps for calculating Direct Labour Rate Variance:
- Determine the Actual Direct Labor Rate
- Determine the Standard Direct Labor Rate
- Calculate the Direct Labor Rate Variance
Here is how to calculate the direct labor rate variance:
Step 1: Determine the Actual Direct Labor Rate
To calculate the actual direct labor rate, you need to determine the average hourly rate that was paid to your employees during a given period.
Also Read: How to Calculate Activity Level
This can be done by taking the total cost of direct labor for the period and dividing it by the total number of direct labor hours worked. The formula for this step is:
Actual Direct Labor Rate = Total Direct Labor Cost / Total Direct Labor Hours
Example: Suppose a company paid $10,000 in direct labor costs for the month of January and the employees worked a total of 2,000 direct labor hours during the same period. Then, the actual direct labor rate can be calculated as follows:
Actual Direct Labor Rate = $10,000 / 2,000 hours = $5 per hour
| Total Direct Labor Cost | Total Direct Labor Hours | Actual Direct Labor Rate |
|---|---|---|
| $10,000 | 2,000 | $5 per hour |
Step 2: Determine the Standard Direct Labor Rate
The standard direct labor rate is the hourly rate that was budgeted or predetermined for the work that was performed during the same period.
This rate should take into account factors such as wage rates, employee benefits, and payroll taxes. The formula for this step is:
Standard Direct Labor Rate = Total Standard Direct Labor Cost / Total Standard Direct Labor Hours
Suppose the standard direct labor rate was budgeted to be $4.50 per hour based on expected wage rates, employee benefits, and payroll taxes for the month of January.
Additionally, the company budgeted a total of $9,000 for direct labor costs and 2,000 direct labor hours. Then, the standard direct labor rate can be calculated as follows:
Standard Direct Labor Rate = $9,000 / 2,000 hours = $4.50 per hour
| Total Standard Direct Labor Cost | Total Standard Direct Labor Hours | Standard Direct Labor Rate |
|---|---|---|
| $9,000 | 2,000 | $4.50 per hour |
Step 3: Calculate the Direct Labor Rate Variance
The direct labor rate variance measures the difference between the actual direct labor rate and the standard direct labor rate. A positive variance indicates that the actual rate was higher than the standard rate, while a negative variance indicates that the actual rate was lower than the standard rate. The formula for this step is:
Direct Labor Rate Variance = (Actual Direct Labor Rate - Standard Direct Labor Rate) x Actual Direct Labor Hours
Using the information from Steps 1 and 2, we can calculate the direct labor rate variance for the month of January as follows:
Direct Labor Rate Variance = ($5 per hour – $4.50 per hour) x 2,000 hours = $1,000
| Actual Direct Labor Rate | Standard Direct Labor Rate | Actual Direct Labor Hours | Direct Labor Rate Variance |
|---|---|---|---|
| $5 per hour | $4.50 per hour | 2,000 hours | $1,000 (favorable variance) |
Therefore, the company had a favorable direct labor rate variance of $1,000 for the month of January, meaning that they paid their employees at a lower rate than they had budgeted.
Benefits of Calculating Labor Rate Variance
Calculating labor rate variance provides several benefits to organizations. Firstly, it helps businesses identify how much they are spending on labor costs compared to their planned budget.
Secondly, it helps organizations identify whether they pay their employees a fair wage.
Finally, it can help organizations identify whether they are overstaffed or understaffed in certain areas, allowing them to make necessary adjustments.
Factors That Influence Labor Rate Variance
Several factors can influence labor rate variance.
- The local labor market conditions can significantly impact the standard hourly rate. If the labor market is competitive, employees may demand higher wages, leading to an unfavorable labor rate variance.
- Employee turnover can impact labor rate variance. If an organization experiences high employee turnover, it may have to pay a premium to attract new employees, leading to an unfavorable labor rate variance.
Other factors that can influence labor rate variance include changes in employee skill level, employee experience, and employee performance.
How to Improve Labor Rate Variance
Improving labor rate variance requires a multi-faceted approach. You should carefully consider the local labor market conditions when setting your standard hourly rate.
Moreover, you should invest in employee training and development programs to improve employee skill levels and experience. In addition, you can also implement employee retention programs to reduce employee turnover.
Finally, regularly review and adjust your compensation policies to ensure you’re paying a fair wage to your employees.
