Definition
The Direct Labour Rate of Pay Variance measures the difference between the actual rate paid to direct labour and the standard rate of pay allotted for an activity, considering the actual hours worked. This variance can be either adverse or favourable, impacting the budgeted profit. This component is part of the total direct labour cost variance.
Formula
The formula for calculating the Direct Labour Rate of Pay Variance is:
\[ \text{Direct Labour Rate of Pay Variance} = (\text{Actual Rate} - \text{Standard Rate}) \times \text{Actual Hours Worked} \]
Alternatively: \[ \text{Direct Labour Rate of Pay Variance} = \text{Actual Direct Labor Cost} - (\text{Standard Rate} \times \text{Actual Hours Worked}) \]
Examples
Example 1
A manufacturing company pays its workers an actual rate of $25 per hour whereas the standard rate is set at $22 per hour. If the workers worked for 1,000 hours in a specific period, the calculation would be:
\[ \text{Direct Labour Rate of Pay Variance} = ($25 - $22) \times 1,000 = $3,000 , (Adverse) \]
Here, the $3,000 adverse variance indicates the company paid more than expected for labour, negatively affecting profit.
Example 2
Another company pays an actual rate of $18 per hour, when the standard rate is $20 per hour, for 800 hours worked:
\[ \text{Direct Labour Rate of Pay Variance} = ($18 - $20) \times 800 = -$1,600 , (Favourable) \]
This $1,600 favourable variance signifies the company saved on labour costs, positively affecting profit.
Frequently Asked Questions (FAQs)
What is the standard rate of pay?
The standard rate of pay represents the expected cost per hour of direct labour, as established by a company’s budgeting and costing systems.
What causes labour rate variance?
Labour rate variance can occur due to several factors, such as wage rate changes, different skill levels of workers, or changes in labor agreements.
How can a business manage an adverse labour rate variance?
Businesses can manage adverse labour rate variances through renegotiating labour contracts, improving workforce efficiency, and better aligning payroll with budgeting expectations.
What does a favourable labour rate variance indicate?
A favourable labour rate variance indicates that the company paid less for direct labour than anticipated, resulting in cost savings.
Is labour rate variance always a direct indicator of good or poor performance?
No, while a favourable variance suggests cost savings, it may not always indicate good performance. For instance, lower wage rates might correlate with lower-skilled, less efficient labour.
How does direct labour rate variance affect a company’s financial statements?
Direct labour rate variance impacts the cost of goods sold (COGS) and operating expenses, ultimately affecting gross profit and net income in the financial statements.
Related Terms
Standard Costing
A method used to estimate the expected cost of production, incorporating standard costs for direct materials, direct labour, and overheads.
Variance Analysis
The process of evaluating the differences between actual financial performance and budgeted or expected performance.
Direct Labour
Labour costs that can be directly attributed to a specific production process or job.
Total Direct Labour Cost Variance
This combines the direct labour rate of pay variance and the direct labour efficiency variance to measure overall labour cost performance against standard costs.
Online References
- Investopedia on Standard Costing
- AccountingTools on Variance Analysis
- The Balance on Cost Accounting
Suggested Books for Further Studies
- “Cost Accounting: A Managerial Emphasis” by Charles T. Horngren, Srikant M. Datar, and Madhav V. Rajan
- “Management and Cost Accounting” by Colin Drury
- “Principles of Cost Accounting” by Edward J. Vanderbeck and Maria R. Mitchell
Accounting Basics: Direct Labour Rate of Pay Variance Fundamentals Quiz
Thank you for exploring the Direct Labour Rate of Pay Variance. Understanding these financial nuances is key to excelling in management accounting!
