Question

In the standard cost system, what is the appropriate treatment of a change in wage rates (per new labor union contract) that dominate the cost of labor?

Answer 1

The standard labor cost of any product is equal to the standard quantity of labor time allowed multiplied by the wage rate that should be paid for this time. It follows that the actual labor cost may differ from standard labor cost because of the wages paid for labor, the quantity of labor used, or both. Thus, two labor variances exist—a rate variance and an efficiency variance.

Labor rate variance The labor rate variance occurs when the average rate of pay is higher or lower than the standard cost to produce a product or complete a process. The labor rate variance is similar to the materials price variance.

To compute the labor rate variance, we use the actual direct labor-hour rate paid (AR), the standard direct labor-hour rate allowed (SR) and the actual hours of direct labor services worked (AH). It can also be calculated in either of the following ways:

Labor rate variance= (Actual rate – Standard rate) x Actual hours worked

OR

Labor rate variance = (Actual rate x actual hours worked) – (Standard rate x actual hours worked)

Example:- Assume that the direct labor payroll of the company consisted of 22,200 hours at a total cost of $ 233,100 (an average actual hourly rate of $ 10.50). Because management has set a standard direct labor-hour rate of $ 10 per hour, the labor rate variance is:

Labor rate variance = (Actual rate – Standard rate) x Actual hours worked

= ($10.50 actual rate – $10 per hour standard) x 22,200 actual hours

= $ 0.50 x 22,200

= $ 11,100 or $11,100 unfavorable variance

OR

Labor rate variance = (Actual rate x actual hours worked) – (Standard rate x actual hours worked)

= ($10.50 actual rate x 22,200 hours) – ($10 per hour standard x 22,200 actual hours)

= $ 233,100 – $ 222,000

= $ 11,100 or $11,100 unfavorable variance

The variance is positive and unfavorable because the actual rate paid exceeded the standard rate allowed. If the reverse were true, the variance would be favorable.