Learning Outcomes
After completing this article, you will be able to define, calculate, and explain the labour rate and labour efficiency variances. You will understand how these variances help assess labour costs and productivity in standard costing systems. You will also be able to discuss the causes of these variances and identify which factors are within a manager's control—skills required for the ACCA Performance Management exam.
ACCA Performance Management (PM) Syllabus
For ACCA Performance Management (PM), you are required to understand and apply basic variance analysis techniques, particularly for labour. This article focuses on:
- The calculation and interpretation of labour rate and labour efficiency variances
- The use of these variances in performance evaluation and cost control
- Recognising controllable and uncontrollable factors affecting labour variances
- Explaining the causes and significance of adverse and favourable variances
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.
- What does an adverse labour rate variance indicate about the cost of labour?
- A business planned for 400 labour hours at $15 per hour but actually used 410 hours at $16 per hour. Calculate the labour rate and efficiency variances.
- Which manager is normally responsible for a labour efficiency variance, and why?
- State the key difference between the labour rate variance and the labour efficiency variance.
Introduction
Variance analysis for labour costs is a fundamental tool in standard costing. It allows managers to investigate the difference between expected (standard) and actual labour costs, and to identify the causes of deviations. Two main variances are tracked: the labour rate variance (how much was paid per hour compared to the standard) and the labour efficiency variance (how many hours were used compared to hours expected for the output achieved). Together, these variances provide essential information for controlling costs and evaluating workforce efficiency.
Key Term: Labour rate variance
The difference between the actual labour rate paid and the standard rate, multiplied by the actual hours worked.Key Term: Labour efficiency variance
The difference between the actual hours worked and the standard hours allowed for actual production, valued at the standard hourly rate.
Labour Rate Variance
The labour rate variance measures whether a business paid more or less per hour for labour than planned. This may arise from overtime premiums, wage rate changes, or the use of different skill levels.
Formula: Labour rate variance = (Actual rate per hour – Standard rate per hour) × Actual hours worked
Worked Example 1.1
A factory planned for 500 hours of direct labour at a standard rate of $14 per hour. However, it actually paid workers $15 per hour for 480 hours. Calculate the labour rate variance.
Answer:
Labour rate variance = (Actual rate – Standard rate) × Actual hours = ($15 – $14) × 480 = $1 × 480 = $480 Adverse The adverse variance means labour was more expensive per hour than expected.
Labour Efficiency Variance
The labour efficiency variance reveals how well the workforce performed relative to expectations, in terms of the number of hours taken to produce the actual output.
Formula: Labour efficiency variance = (Standard hours for actual production – Actual hours worked) × Standard rate per hour
Standard hours for actual production is calculated by multiplying the actual output by the standard hours per unit.
Worked Example 1.2
A company produces 200 units in a period. The standard labour requirement is 2 hours per unit, and the standard rate is $12 per hour. Actual hours worked were 430. Calculate the labour efficiency variance.
Answer:
Standard hours for actual production = 200 units × 2 hours = 400 hours Labour efficiency variance = (Standard hours – Actual hours) × Standard rate = (400 – 430) × $12 = (–30) × $12 = $360 Adverse The adverse variance shows more hours were used than allowed, indicating inefficiency.
Analysing the Causes of Labour Variances
Understanding why variances have arisen is essential for effective control and fair staff appraisal.
Common causes of a labour rate variance include:
- Overtime premiums being paid
- Employment of higher or lower skilled workers than planned
- Errors in payroll processing
- Changes in basic wage rates due to negotiations, regulation, or market conditions
Common causes of a labour efficiency variance include:
- Workforce skill levels differing from standard assumptions
- Machine breakdowns or poor materials causing delays
- Staff motivation or morale issues
- Poor supervision or inadequate training
- Unexpected process changes or learning curve effects
Performance measurement should only hold managers accountable for those costs and variances within their control.
Worked Example 1.3
A company used 600 hours of labour at $18 per hour to achieve actual output for which the standard allowed 570 hours. The standard rate was $17 per hour. Calculate (a) the labour rate variance, and (b) the labour efficiency variance.
Answer:
(a) Labour rate variance = (Actual rate – Standard rate) × Actual hours = ($18 – $17) × 600 = $1 × 600 = $600 Adverse (b) Labour efficiency variance = (Standard hours – Actual hours) × Standard rate = (570 – 600) × $17 = –30 × $17 = $510 Adverse Both variances are adverse: higher wage rates and lower productivity than expected.
Controllability and Fair Appraisal
Managers should be appraised only on those costs they can influence. For example, the production manager may be responsible for labour efficiency (through supervision, training, or process control), but may not control wage rates or union-negotiated pay rises.
Key Term: Controllability
The principle that managers should only be held accountable for costs and variances they have significant influence over.
Summary
Labour rate and efficiency variances provide clear signals about wage costs and workforce productivity. Adverse variances indicate costs are higher or efficiency lower than planned; favourable variances indicate better-than-expected performance. These variances help to pinpoint reasons for cost overruns or efficiency problems, guiding corrective action and fair performance appraisal.
Key Point Checklist
This article has covered the following key knowledge points:
- Define and calculate the labour rate variance
- Define and calculate the labour efficiency variance
- Identify common causes of each variance
- Recognise the importance of controllability in variance analysis
- Understand which managers should be held responsible for labour variances
Key Terms and Concepts
- Labour rate variance
- Labour efficiency variance
- Controllability