## **Learning Outcomes**

After reading this article, you will be able to explain the purpose of variance analysis for labour, distinguish between labour rate and labour efficiency variances, perform calculations for each, and interpret their implications for organisational performance. You will also be able to identify common causes for these variances and recommend appropriate management responses in line with the ACCA exam requirements.

## **ACCA Management Accounting (MA) Syllabus**

For ACCA Management Accounting (MA), you are required to understand the concept and calculation of standard costing variances, particularly those relating to direct labour. This article is specifically relevant to the exam topics below:

- Calculate and interpret labour total, rate, and efficiency variances
- Explain the significance and causes of labour variances
- Identify appropriate management action in response to variances
- Prepare operating statements including analysis of labour variances
- Recognise how labour variances relate to performance measurement and responsibility accounting

## **Test Your Knowledge**

_Attempt these questions before reading this article. If you find some difficult or cannot remember the answers, remember to look more closely at that area during your revision._

1. What does the labour rate variance measure, and how is it calculated?
2. When is a labour efficiency variance considered favourable?
3. A department has a standard direct labour cost of £15 per hour. During the period, 4,000 hours were worked at a total cost of £62,800. The standard hours allowed for actual production were 3,900. Calculate the labour efficiency variance.
4. List two possible causes of an adverse labour rate variance.

## **Introduction**

Variance analysis allows organisations to understand why actual results differ from those planned or standard. Labour variances focus on the difference between what labour should have cost and what was actually paid, as well as how efficiently employees used their time during production.

The two main variances for labour are the rate variance and the efficiency variance. Their calculation, causes, and impact provide key information for management control and decision making.

> **Key Term: Labour rate variance**
> The difference between actual direct labour cost incurred and what that labour should have cost at the standard rate, for the actual hours worked.
>
> **Key Term: Labour efficiency variance**
> The difference between the standard hours allowed for actual output and the actual hours worked, valued at the standard labour rate.

## Labour Cost Variance Structure

The analysis of direct labour variances follows this structure:

1. Labour total variance: Overall difference between actual labour cost and the standard cost for actual output.
2. Labour rate variance: Highlights whether workers were paid at a higher or lower rate than standard.
3. Labour efficiency variance: Measures whether workers took more or fewer hours than the standard allows for actual output.

These variances are used both for control and for motivating improvement.

## Calculating Labour Rate and Efficiency Variances

The formulae you are expected to use are:

- **Labour Total Variance**
  = Actual hours × Actual rate – Standard hours × Standard rate

- **Labour Rate Variance**
  = Actual hours × (Actual rate – Standard rate)

- **Labour Efficiency Variance**
  = Standard rate × (Standard hours – Actual hours worked)

The standard hours used in efficiency variance is the time that should have been worked for the level of actual output achieved, not the budgeted hours.

### **Worked Example 1.1**

A company has a standard labour rate of £12 per hour. Each unit has a standard labour time of 2 hours. In the last week, 160 units were produced, the staff worked 350 hours, and were paid £4,340 in total.

**Required:** Calculate the labour rate and efficiency variances.

> **Answer:**
>
> - Standard hours for actual output: 160 units × 2 = 320 hours
> - Labour Rate Variance: 350 × (Actual rate – Standard rate)
> - Actual rate = £4,340 / 350 = £12.40
> - Labour Rate Variance = 350 × (£12.40 – £12.00) = 350 × £0.40 = £140 Adverse
> - Labour Efficiency Variance = £12 × (320 – 350) = £12 × (–30) = £360 Adverse

## Interpreting Labour Rate and Efficiency Variances

- A **favourable rate variance** means employees were paid less per hour than the standard; an **adverse rate variance** signals higher pay per hour than planned.
- A **favourable efficiency variance** means production was completed in fewer hours than allowed; an **adverse efficiency variance** shows more hours than standard.

### **Worked Example 1.2**

Company B expects to pay £8 per hour. Manufacturing 200 units is expected to require 400 hours. Actual hours worked were 420 at a total cost of £3,570.

**Required:** Calculate the labour rate and efficiency variances.

> **Answer:**
>
> - Standard hours allowed = 200 × (400/200) = 400 hours
> - Actual rate = £3,570 / 420 = £8.50
> - Labour Rate Variance = 420 × (£8.50 – £8.00) = 420 × £0.50 = £210 Adverse
> - Labour Efficiency Variance = £8 × (400 – 420) = £8 × (–20) = £160 Adverse

## Causes of Labour Rate Variance

- Overtime worked at premium rates increases costs.
- Use of a more skilled (and thus higher paid) workforce than the standard presumes.
- Wage increases or bonuses not anticipated in the standard.
- Employing temporary or agency staff at higher rates.

> **Key Term: Overtime premium**
> The extra amount paid above the basic pay rate for hours worked beyond contracted hours, usually treated as part of indirect labour cost unless worked at a customer's request.

## Causes of Labour Efficiency Variance

- Poor production planning, resulting in idle time.
- Lower-skilled workers used, reducing average efficiency.
- Machine breakdowns or material shortages causing staff inactivity.
- Improved production methods, training, or motivation (which might make the variance favourable).

### **Revision Tip**

Identify which manager controls each cause. Rate variances are commonly controllable by HR or payroll; efficiency variances are often due to production management.

## Management Action in Response to Variances

- Investigate significant adverse variances promptly.
- For rate variances, review wage structures, overtime policies, and staff utilisation.
- For efficiency variances, assess production workflows, training needs, and adequacy of equipment.

### **Exam Warning**

Be precise: efficiency variance is based on **standard hours allowed for actual output**, not the original budget or planned hours.

## Relationship Between Rate and Efficiency Variances

These variances can be related. For example, paying more for highly skilled labour may increase costs (adverse rate variance) but deliver quicker output (favourable efficiency variance).

### **Worked Example 1.3**

A skilled worker is paid £2 per hour above the standard rate but completes units in less time than expected.

**Question:** Could an adverse rate variance be offset by a favourable efficiency variance?

> **Answer:** Yes. Higher hourly pay costs are offset if total hours worked are significantly lower, but overall cost impact depends on the size of both variances.

## Application: Operating Statement

Labour variances are included in operating statements, which reconcile total standard cost with actual cost. Their analysis supports responsibility accounting, highlighting performance at department or cost centre level.

## **Key Point Checklist**

_This article has covered the following key knowledge points:_

- Calculating labour rate and efficiency variances using standard formulae
- Understanding the meaning of favourable and adverse variances
- Identifying common causes of rate and efficiency variances
- Interpreting variances for management control
- Relating variances to operational responsibility
- Recognising how variances can offset or combine

## **Key Terms and Concepts**

- Labour rate variance
- Labour efficiency variance
- Overtime premium


Sales, material, and labour variances - Labour rate and efficiency variances