Direct Labor Cost Variance

Learning Outcomes

  • Compute the direct labor cost variance

Person sawing woodLabor costs can be a significant expense in a manufacturing company. The Human Resources and Accounting departments will set a standard cost for labor, and the budget will be built on that. A direct labor cost variance occurs when a company pays a higher or lower price than the standard price set.

The direct labor cost variance is the difference between actual cost (AC) and standard cost allowed (SC) multiplied by the actual number of hours worked (AQ). Just like the direct materials cost variance, the direct labor cost variance can be done in two ways:

Direct labor cost variance = (Actual Cost – Standard Cost) x Actual Quantity

OR

(Actual Cost x Actual Quantity) – (Standard Cost x Actual Quantity)

Boulevard Blanks has set the standard cost for labor at $18 per hour.

Let’s look again at Boulevard Blanks’ partial income statement that compares budget to actual for the month of July:

Boulevard Blanks
Partial Income Statement
For the month ended July 31, 20XX
Actual Budget
Sales revenue $        178,200.00 $        178,200.00
Subcategory, Variable manufacturing costs Single Line Single Line
      Direct materials           38,080.00           38,880.00
      Direct Labor           46,500.00           43,740.00
      Allocated overhead             1,395.00             1,944.00
Subcategory, Fixed manufacturing costs
      Allocated overhead           13,485.00           13,365.00
Cost of Goods Manufactured and sold Single Line          99,460.00 Single Line          97,929.00
Gross Profit Single Line$        78,740.00Double line Single Line$        80,271.00Double line

For Boulevard Blanks, we see that the actual total direct labor cost was $46,500. That means we came in over budget for that line item by $2,760. We call that an unfavorable budget variance because it decreased our bottom line. Was that unfavorable variance due to higher than expected wages and benefits, or did our employees waste time?

Let’s say our accounting records show that the line workers put in a total of 2,325 hours during the month.

The actual hourly cost of labor was $46,500 / 2,325 = $20.00.

Let’s compute the direct labor cost variance:

  • Actual cost (AC) per unit was $20.00
  • Standard cost (SQ) was $18.00
  • Actual quantity (AQ) of labor hours was 2,325.

(AC – SC) * AQ = ($20.00 – $18.00) * 2,325 = (-$2.00) * 2,325 = $4,650.00

The direct labor cost variance was a positive $4,650.00.

Alternatively:

(AC * AQ) – (SC * AQ) = ($20 * 2,325) – ($18 * 2,325) = $46,500 – $41,850= $4,650

We actually paid $46,500 for labor for which we expected to pay $41,850. Since we’re basing this calculation on actual quantity, this isolates the effect of high wages from the effect of employees working faster or slower than our expectations (that is calculated using the direct labor efficiency variance).

Reporting the absolute value of the number (without regard to the negative sign) and an Unfavorable label makes this easier for management to read. We can also see that this is an unfavorable variance just based on the fact that we paid $20 per hour instead of the $18 that we used when building our budget.

Before we take a look at the direct labor efficiency variance, let’s check your understanding of the cost variance.

Practice Question