"Direct labor" refers to the work done by those employees who actually make the product on the production line. ("Indirect labor" is work done by employees who work in the production area, but do not work on the production line. Examples include employees who set up or maintain the equipment.)

Unlike direct materials (which are obtained prior to being used) direct labor is obtained and used at the same time. This means that for any given good output, we can compute the direct labor rate variance, the direct labor efficiency variance, and the standard direct labor cost at the same time.

January 2010

Let's begin by determining the standard cost of direct labor for the good output produced in January 2010:

	Large Aprons	Small Aprons	Total
Actual aprons manufactured	100	60
Standard hours of direct labor per apron manufactured	0.3 hr.	0.2 hr.
Total standard hours of direct labor for actual aprons manufactured	30 hr.	12 hr.	42 hr.
Standard cost per direct labor hour incl. payroll taxes	$10	$10	$10
Standard cost of direct labor in the good output	$300	$120	$420

Assuming that the actual direct labor in January adds up to 50 hours and the actual hourly rate of pay (including payroll taxes) is $9 per hour, our analysis will look like this:

Direct Labor Variance Analysis for January 2010:

4. Credit Wages Payable for the actual direct labor cost.	5. Direct Labor Rate Variance Act Hr x (Std Rate - Act Rate)	2. Actual hours of direct labor used x the standard hourly pay rate	3. Direct Labor Efficiency Variance(Std Hr - Act Hr) x Std Cost	1. Debit Inventory-FG for the standard hours of direct labor that should have been used to make the good output x the standard hourly pay rate.
Act Hr x Act Rate	Difference	Act Hr x Std Rate	Difference	Std Hr x Std Rate
50 act hr x $9	50 hr x $1	50 act hr x $10	(8 hr) x $10	42 std hr x $10
$450		$500		$420
	$50Favorable		$80 Unfavorable

In January, the direct labor efficiency variance (#3 above) is unfavorable because the company actually used 50 hours of direct labor—this is 8 hours more than the standard quantity of 42 hours allowed for the good output. The additional 8 hours is multiplied by the standard rate of $10 to give us an unfavorable direct labor efficiency variance of $80. (The direct labor efficiency variance could be called the direct labor quantity variance or usage variance.)

Note that DenimWorks paid $9 per hour for labor when the standard rate is $10 per hour. This $1 difference—multiplied by the 50 actual hours—results in a $50 favorable direct labor rate variance. (The direct labor rate variance could be called the direct labor price variance.)

The journal entry for the direct labor portion of the January production is:

Date	Account Name		Debit	Credit
Jan. 31, 2010	Inventory-FG		420
	Direct Labor Efficiency Variance		80
		Direct Labor Rate Variance		50
		Wages Payable		450

February 2010

In February your company manufactures 200 large aprons and 100 small aprons. The standard cost of direct labor for the good output produced in February 2010 is computed here:

	Large Aprons	Small Aprons	Total
Actual aprons manufactured	200	100
Standard hours of direct labor per apron manufactured	0.3 hr.	0.2 hr.
Total standard hours of direct labor for actual aprons manufactured	60 hr.	20 hr.	80 hr.
Standard cost per direct labor hour incl. payroll taxes	$10	$10	$10
Standard cost of direct labor in the good output	$600	$200	$800

If we assume that the actual labor hours in February add up to 75 and the hourly rate of pay (including payroll taxes) is $11 per hour, the total equals $825. The analysis for February 2010 looks like this:

Direct Labor Variance Analysis for February 2010:

4. Credit Wages Payable for the actual direct labor cost.	5. Direct Labor Rate Variance Act Hr x (Std Rate - Act Rate)	2. Actual hours of direct labor used x the standard hourly pay rate	3. Direct Labor Efficiency Variance(Std Hr - Act Hr) x Std Cost	1. Debit Inventory-FG for the standard hours of direct labor that should have been used to make the good output x the standard hourly pay rate.
Act Hr x Act Rate	Difference	Act Hr x Std Rate	Difference	Std Hr x Std Rate
75 act hr x $11	75 hr x ($1)	75 act hr x $10	5 hr x $10	80 std hr x $10
$825		$750		$800
	$75 Unfavorable		$50 Favorable

Notice that for the good output in February, the total actual labor costs amounted to $825 and the total standard cost of direct labor amounted to $800. This unfavorable difference of $25 agrees to the sum of the two labor variances:

Direct labor efficiency variance	$50 Favorable
Direct labor rate variance	$75 Unfavorable
Total Direct Labor Variance	$25 Unfavorable

The journal entry for the direct labor portion of the February production is:

Date	Account Name		Debit	Credit
Feb. 28, 2010	Inventory-FG		800
	Direct Labor Rate Variance		75
		Direct Labor Efficiency Variance		50
		Wages Payable		825

Later in Part 5 we will discuss what to do with the balances in the direct labor variance accounts under the heading "What To Do With Variance Amounts".

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