Computation of the Labor Rate Variance

Direct labor activity for the Bluechitos inspectors will be used to illustrate the computation of the labor
rate variance. We know that 360 hours were used for inspection during the first week in March. The
actual hourly wage paid for inspection was $7.35. From Exhibit 9-2, the standard wage rate is $7.00.
Thus, AH is 360, AR is $7.35, and SR is $7.00. The labor rate variance is computed as follows:

LRV = (AR - SR)AH

=($7.35 -$7.00)360
= $0.35 x 360
= $126 U
Percent of SR X AH = $126/$2,520 = 5%

Responsibility for the Labor Rate Variance

When labor rate variances do occur, they usually do so because an average wage rate is used for the
rate standard and because more skilled and more highly paid laborers are used for less skilled tasks.

Rather than selecting labor rate standards reflecting those different levels, an average wage rate is
often chosen. As the seniority mix changes,the average rate changes. This will give rise to a labor
rate variance;. However, the use of labor is controllable by the production manager. The use of more
skilled workers to perform less skilled tasks (or vice versa) is a decision that a production manager
consciously makes. For this reason, responsibility for the labor rate variance is generally assigned to
the individuals who decide how labor will be used.

Analysis of the Labor Rate Variance

The cause of the variance is found to be the use of more highly paid and skilled machine operators as
inspectors, which occurred because two inspectors quit without formal notice. The corrective action is
to hire and train two new inspectors.

Labor Efficiency Variance: Formula Approach

The labor efficiency variance (LEV) measures the difference between the labor hours that were
actually used and the labor hours that should have been used:
LEV = (AH X SR) - (SH X SR)
or, factoring, we have:
LEV = (AH - SH)SR
where
AH =The actual direct labor hours used
SH = The standard direct labor hours that should have been used
SR = The standard hourly wage rate

Computation of the Labor Efficiency Variance

The Bluechitos line used 360 direct labor hours for inspection while producing 48,500 bags of corn
chips. From Exhibit 9-2, the rate of 0.007 hour per bag of chips at a cost of $7 per hour should have
been used. The standard hours allowed for inspection are 339.5 (0.007 x 48,500). Thus, AH is 360,
SH is 339.5, and SR is $7. The labor efficiency variance is computed as follows:
LEV = (AH - SH)SR
= (360 - 339.5)$7
= 20.5 x $7
= $143.50 U
Percent of SH x SR = $143.50/$2,376.50 = 6%

Responsibility for the Labor Efficiency Variance

For example, frequent breakdowns of machinery may cause interruptions and nonproductive use of
labor. But the responsibility for these breakdowns may be faulty maintenance. If so, the maintenance
manager should be charged with the unfavorable labor efficiency variance. Production managers may
be tempted to engage in dysfunctional behavior if too much emphasis is placed on the labor efficiency
variance. For example, to avoid losing hours and prevent using additional hours because of possible
rework, a production manager could deliberately transfer defective units to finished goods.

Sum of LRV and LEV

From Exhibit 9-7, we know that the total labor variance is $269.50 unfavorable. This total variance is
the sum of the unfavorable labor rate variance and the unfavorable labor efficiency variance ($126.00
+ $143.50).

Variance Analysis: Overhead Costs

A. Variable Overhead Variances
To illustrate variable overhead variances, we will examine one week of activity for Blue-Corn Foods
(for the first week in March). The following data were gathered for this time period:
Variable overhead rate (standard) $3.85 per DLH
Actual variable overhead costs $1,600
Actual hours worked (machining and inspection) 400
Bags of chips produced 48,500
Hours allowed for production 378.3a
Applied variable overhead $1,456b
a0.0078 _ 48,500
b$3.85 _ 378.3 (rounded to nearest dollar; overhead is applied using hours allowed in a standard cost system)

Total Variable Overhead Variance

The total variable overhead variance is the difference between the actual and the applied variable
overhead. For our example, the total variable overhead variance is computed as follows:

Total variance = $1,600 - $1,456 = $144 U

This total variance can be divided into spending and efficiency variances. This computation is
illustrated using a three-pronged approach in Exhibit 9-8

Variable Overhead Spending Variance

The variable overhead spending variance measures the aggregate effect of differences between
the actual variable overhead rate (AVOR) and the standard variable overhead rate (SVOR). The
actual variable overhead rate is simply actual variable overhead divided by actual hours.
For our example, this rate is $4 per hour ($1,600/400 hours). The formula for computing the variable
overhead spending variance is:
Variable overhead spending variance = (AVOR - AH) x (SVOR - AH)
=(AVOR - SVOR)AH
= ($4.00 - $3.85)400
= $60 U

Comparison to the Price Variances of Materials and Labor

Variable overhead is not a homogeneous inputit is made up of a large number of individual items,
such as indirect materials, indirect labor, electricity, maintenance, and so on
Responsibility for the Variable Overhead Spending Variance

Many variable overhead items are affected by several responsibility centers. For example, utilities are
a joint cost.7 To the extent that consumption of variable overhead can be traced to a responsibility
center, responsibility can be assigned. Consumption of indirect materials is an example of a traceable
variable overhead cost. Accordingly, responsibility for the variable overhead spending variance is
generally assigned to production departments.
Analysis of the Variable Overhead Spending Variance

From Exhibit 9-9, it is clear that two of the three items present no control problems for the firm.
Electricity is the only item showing an unfavorable variance; in fact, it is the cause of the overall
variable overhead spending variance. If the variance is significant, an investigation may be warranted.
This investigation may reveal that the power company raised the price of electricity. If so, the cause of
the variance is beyond the control of the company. The correct response is to revise the budget
formula to reflect the increased cost of electricity

Variable Overhead Efficiency Variance

The variable overhead efficiency variance measures the change in variable overhead consumption
that occurs because of efficient (or inefficient) use of direct labor. The efficiency variance is computed
using the following formula:
Variable overhead efficiency variance = (AH - SH)SVOR
=(400 _ 378.3)$3.85
= $84 U (rounded)

Responsibility for the Variable Overhead Efficiency Variance

The variable overhead efficiency variance is directly related to the direct labor efficiency or usage
variance. The validity of the measure depends on how valid the relationship is between variable
overhead costs and direct labor hours
Analysis of the Variable Overhead Efficiency Variance

The reasons forthe unfavorable variable overhead efficiency variance are the same as those offered
for the unfavorable labor usage variance. More hours were used than the standard called for because
of excessive idle time for inspectors and because the machine operators used as substitute
inspectors were inexperienced in sorting. More information concerning the effect of labor usage on
variable overhead is available in a lineby- line analysis of individual variable overhead items. This can
be accomplished by comparing the budget allowance for the actual hours used with the budget
allowance for the standard hours allowed for each item. A performance report that makes this
comparison for all variable overhead costs