Labor Efficiency Variance

What do we mean by Labor Efficiency Variance?

Variance is a measurement term of statistics that tells us the difference between individual numbers in a data set from the mean of that set. It helps us measure how volatile a data set is by studying the individual participants. In production processes, we usually have a set standard number of hours for each individual activity or phase, which is a measure of the efficiency of labor. Labour efficiency variance measures the variance or difference of the actual number of hours taken for completing an activity from the standard number of hours labor should take for that activity. Then this difference we multiply by the standard rate of direct labor. The variance calculation can be done for any particular activity or for a set number of units of that product.

We usually calculate labor efficiency variance in monetary terms. This helps us to gauge the financial impact of variation in labor efficiency. Also, concrete numbers are useful for comparison purposes between workers, processes, or even various manufacturers in the industry.

The variance can be favorable or unfavorable. Favorable labor efficiency variance is favorable or positive in nature. It means that the actual number of hours taken to complete a work is less than the standard number of hours set for that work or process. Unfavorable labor efficiency variance is the opposite of the above case. It is the case of labor taking more hours to finish the work or process than the standard number of hours set for that work.

Example

Let us understand the concept of labor efficiency variance with the help of an example. Suppose the standard number of hours for making one unit of a product in the company ABC Pvt. Ltd. is ten hours. The labor actually took eleven hours to make that product. The standard rate of direct labor is $ 5 per hour.

The variance in the above case will be: ( 11-10) x $5= $5. This is the case of unfavorable labor efficiency variance. This is a loss for the company, and we can say that labor is inefficient.

Now suppose in the same example, the labor finishes the work in 9.5 hours. The variance, in this case, will be:

(9.5 -10) x $5= $2.5.

The point to note is that this is a favorable labor efficiency variance. The labor is efficient, and his services are beneficial for the organization.

Types of Labor Efficiency Variance

There are many sub-types of Labour efficiency variance. Some of them are as follows:

Labour Mix Variance

There are primarily three categories of laborers in any factory. They are skilled, semi-skilled, and unskilled laborers. A company may set up a standard production schedule by creating a mix of “x” number of skilled laborers and “y” number of semi-skilled laborers. But the actual mix of workers may be different with varying numbers of any of the three categories of laborers. Hence there will be a variance in actual production numbers. We measure such variance by using Labour mix variance.

Let us understand this concept with the help of a simple example. Suppose Company A has a standard mix of 100 skilled laborers @ $20 per hour and 200 semi-skilled laborers @ $15 per hour. Suddenly there was a shortage of skilled laborers, and the company had to engage unskilled laborers as well @ $10 per hour. The actual mix of workers stood at 50 skilled laborers, 300 semi-skilled laborers, and 50 unskilled laborers. Both the composition of laborers gives the same level of production.

In order to calculate the variance, let us first calculate the standard cost of the standard mix of laborers.

(100 x 20)+ (200×15)= $ 5000.

Now, let us calculate the standard cost of the actual mix of laborers.

(50 x20)+ (300×15) +(50 x10)= $6000.

Therefore, the variance in the above example is $1000 ($6000- $5000) and this is unfavorable.

Labor Sub-Efficiency Variance

We also call it the labor yield variance. We calculate it by subtracting the standard cost of actual input of materials and labor from the standard cost of actual output. Every manufacturing unit suffers from differences in yield from operations on a regular basis. Hence, it is common for manufacturers to wrongly estimate the quantity of material to use to produce a specific quantity of goods. This results in a yield variance.

If a company faces unfavorable yield variance on a regular basis, it should look at ways to improve its efficiency. This will result in higher production levels while using the same quantity of inputs. Hence, the profits of the business will increase. Also, it may alter its set standard yield according to the current situation if it feels that the processes are already efficient enough.

For example, suppose that labor makes 10 pieces of a shirt in a day as a standard. One day he could make only 8 shirts in a day. The standard cost of each shirt is $ 10. Therefore, we calculate the unfavourable variance as: $10 x (10 – 8 pieces)= $20.

Any company can suffer huge losses due to labor inefficiency and lower yield when this happens persistently and with many laborers. Hence, companies should check their production levels and immediately rectify any process that leads to inefficiencies within the organization. 

Labor Idle Time Variance

Companies budget a specific number of hours that laborers must put in production as a standard. But often, the laborers put in lesser working hours and waste time by sitting idle or doing non-productive work during their shift. Also, there might be wastage of time due to machinery breakdown, power outages, disputes, etc. This idle time is a part of the paid hours for a company and hence, a loss for them.

We calculate the Labour idle time variance by multiplication of the number of hours spent idly by the standard pay per hour to laborers. For example, let us take the case of a bicycle manufacturing unit. It has a standard of putting in 4000 production hours every month and pays $5 per hour to its laborers. At the end of the month, the manager calculates the idle time over the month to be 100 hours due to labor inefficiency and an instance of a machine failure.

We simply calculate the labor idle time variance in this case as 100 hours x $5 per hour= $500.

A point to be noted here is that we need to have enough data to differentiate and calculate Labor Idle Time Variance, apart from when the variance is causing due to machine breakdown, as it can be confused with Labor Yield Variance.

Visit Labor Cost Variance for more details on other types of labor cost variances.

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