Direct Labor: Standard Cost, Rate Variance, Efficiency Variance
"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.
Let's begin by determining the standard cost of direct labor for the good output produced in January 2020:
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 2020:
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:
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 2020 is computed here:
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 2020 looks like this:
Direct Labor Variance Analysis for February 2020:
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:
The journal entry for the direct labor portion of the February production is:
Later in Part 6 we will discuss what to do with the balances in the direct labor variance accounts under the heading "What To Do With Variance Amounts".