The total labour variance comprises of labour rate variance and labour efficiency variance. Labour rate variance occurs when there is a difference between the price (wages) paid out and the standard wages, which should have been paid. It measures the deviation, if any, from the standard of the average wages paid to direct labour hours. Labour efficiency occurs when there is a difference between the actual number of hours taken and the standard hours that would have been taken to complete and assignment. It measures the productivity of labour time.

**Labour Rate Variance (LRV)**

Labour rate variance measures the deviation from the standard of the average wages paid to direct labour hours. It is calculated by comparing the standard price per hour with the actual price paid per hour and multiplying the difference with actual hours taken.

In many organizations, LRV tends to be nonexistent since most of the rates paid to workers are set by union contracts. This means that the actual wage rate paid equals the standard wage rate paid. However, there are instances in which wage rate variance may arise. This, in most cases, depends on the way labour is used. For instance, highly skilled workers are more expensive to hire and if it demands that they be hired to take up an assignment, which was initially to be taken up by semi-skilled workers, then the wage rate paid to them shall be higher than the standard set initially. This will automatically translate to an adverse labour rate variance. The officers in charge of effective utilization of labour time are held responsible in ensuring that labor rate variances are kept under control.

Labor rate variance is calculated using the following formula;

Labor rate variance = Actual rate x Actual hours – Standard rate x Actual hours

= AR•AH – SR•AH

= (AR – SR) x AH

>>> Illustration V (LRV)

**>>> Illustration VI (LRV)**

A company operating a standard costing system has the following direct labour standards per

unit for one product AB611.

4 hours at Shs.12•50 per hour

In the period just ended, when 2,195 units of the product were manufactured, the actual direct

labour cost for the 9,200 hours worked was Shs.110,750.

Required: Calculate labour rate variance for the period

**Solution**

Labour rate variance = Actual rate x Actual hours–Standard rate x Actual hours

= Shs.110,750 – Shs.12.50 x 9200

= Shs.4,250 (F)

**Possible causes of Labour Rate Variance**

Negotiation of wages where the employee may demand a higher rate than the standard, this may be considered as uncontrollable as the employer has very little, if any, control on the wage rate. Higher wages than planned may be paid.

Unexpected overtime, which has an element of premium and bonus may also cause this variance

Misallocation of workforce, allocating semi-skilled workers

**Labor Efficiency variance (LEV)**

Labour efficiency variance measures the productivity of labour. It is equivalent to material usage variance. This variance is closely watched by management as increasing the productivity of labour is the vital key to minimizing unit cost of production.

Labor efficiency variance is calculated as follows:

Labor efficiency variance = Standard hours x Standard rate – Actual hours x Standard rate

= SH•SR – AH•SR

= (SH – AH) x SR

**>>> Illustration VII (LEV)**

There was no idle time.

Required: calculate the labour efficiency variance?

**Solution**

Labour efficiency variance = Standard hours x Standard rate – Actual hours x Standard rate

= 5500 units x 3hrs x Shs.10 per hr – 14,000 hrs x Shs.10 per hr

= Shs.165,000 – Shs.140,000

= Shs.25,000 (F)

**Causes of labour efficiency variance**

Labour efficiency variance may be caused by various factors including

Use of poor quality materials and poorly trained workers or incorrect grade of workers

and poor supervision of workers, requiring more labour time in processing.

Use of incorrect materials or experiencing machine problems

Use of higher or better quality materials

Use of faulty equipment causing breakdowns and work interruptions.

**Total Labor Variance**

Total labor variance, like total material variance, comprises two elements; labour rate variance

and labour efficiency variance:

Total labor variance = labour rate variance + labour efficiency variance

= AH(SR – AR) + SR(SH – AH)

= AH•SR – AH•AR + SR•SH – AH•SR

= SR•SH – AH•AR

>>> Illustration

There was no idle time.

Required: Calculate total labour variance

**Overhead variances**

Direct materials and direct labour vary directly with the output. However, total overheads do not. This is because they can further be classified into variable and fixed components. The variable overheads, which vary directly with output can be analyzed and controlled using the variance formulas used to analyze direct materials and direct labour variances.

**Variable Overhead Variances (VOV)**

Variable overhead variance comprises two elements; variable overhead expenditure variance and variable overhead Efficiency variance.

**Variable Overhead Expenditure Variance (VOXV)**

Variable Overhead Expenditure variance (equivalent to material price variance or labour rate variance) measures the deviation from the standard in amount spent for overhead input. It measures the difference between the budgeted flexed variable overheads for the actual units of the absorption base and the actual variable overhead costs incurred. The reason why we use the same multiplier (the actual units of the absorption base) is to remove any element of inefficiency; meaning that any difference arising is purely due to a difference in actual variable overhead spending and standard variable overhead spending.

The formula for the variable overhead Expenditure variance can be expressed as:

VOXV = Standard rate x Actual hours – Actual rate x Actual hours

= SR•AH –AR •AH

= (SR – AR) x AH

Possible causes of variable overhead expenditure variance

These include all factors that can cause a change in the standard overhead absorption rate; this may include a change in the overheads to be absorbed or a decrease in the activity level which is more than or less than proportionate increase in the overheads.

**Variable Overhead Efficiency Variance (VOEV)**

Variable overhead efficiency variance measures the difference between the actual activity of a period and the standard activity allowed, multiplied by the variable part of predetermined overhead rate. It is the difference between the allowed variable overheads and the absorbed variable overheads.

Variable overhead efficiency variance formula can be expressed as;

Possible causes of Variable Overhead Efficiency Variance

Variable overhead expenditure variance can be caused by any factor that causes a deviation of actual hours of production from the standard hours of production. This may include inefficiencies caused by use of faulty equipment thus increasing repair and maintenance and unskilled indirect laborers.

In general, all factors that may cause labor efficiency variance can cause variable overhead efficiency variance.

**Fixed Overhead Variances (FOV)**

Where marginal costing systems are in place, only variable overheads are absorbed into production costs and thus only variances relating to variable overheads arise. However, where full costing system is used, fixed overhead variances may arise. Fixed overheads are assumed to remain unchanged in the short term in response to changes in the level of activity, but they may change in response to changes in other factors.

Fixed overhead variances fall into two categories; fixed overhead expenditure variance and fixed overhead volume variance. Fixed overhead volume variance comprises of fixed overhead efficiency variance and fixed overhead capacity variance.

A diagrammatical illustration of fixed overhead variances

**Fixed Overhead Expenditure Variance (FOEV)**

Fixed overhead expenditure variance explains the difference between the budgeted fixed overheads and the actual fixed overheads. It is the difference between the budgeted fixed overheads and actual fixed overheads.

Fixed overhead expenditure variance = budgeted fixed overheads – Actual fixed overheads

**>>> Illustration**

A company operates a standard marginal costing system. Last month, its actual fixed overhead expenditure was 10% above budget resulting in a fixed overhead expenditure variance of Shs.36,000. What was the actual expenditure on fixed overheads last month?

**Solution**

Fixed overhead expenditure variance = budgeted fixed overheads – Actual fixed overheads

Let the budgeted fixed overheads be x

(36,000) = x – 1.1x

Since the actual overheads were more, then make the variance figure a negative. Alternatively,

it can be expressed as

Fixed overhead expenditure variance = Actual fixed overheads – budgeted fixed overheads

The budgeted fixed expenditure on fixed overheads was Shs. 360,000 and, therefore, the actual was Shs.396,000

**Fixed Overheads Volume Variance (FOVV)**

This is the difference between the standard cost absorbed in the production achieved and the budget cost allowed for the period. It arises due to the actual production volume differing from the planned: this is in turn caused by volume differing form the planned, labour efficiency variance and or capacity variance (hours of working being less or more than planned). The fixed overhead volume variance has a portion of fixed overheads capacity variance and fixed overheads efficiency variance:

**Fixed overheads capacity variance**

This is the portion of the fixed overhead volume variance, which is the difference between the standard cost absorbed in the production achieved whether completed or not, and the actual labour hours worked. (Valued at the standard hourly absorption rate).

**Fixed overheads efficiency variance**

This partly explains why the actual production was greater than the budgeted production. It accrues to labour efficiency or inefficiency. For instance, a team may be assigned a specific task, which in ordinary circumstances can take 10 hours (standard). However, the team may cooperate and finish the task in eight hours (being more efficient). The saving will be expressed in monetary units by multiplying the difference with standard fixed overhead absorption rate to reflect the amount of fixed overheads equivalent that was not absorbed at the standard rate.

It means that the part of overheads that could be absorbed in the 2 hours saved shall not be

absorbed in the cost of the job. However, fixed cost being fixed shall still be incurred.

**Distinguish between efficiency ratio and capacity ratio**

**Efficiency ratio:** This is the standard hours equivalent to the work produced, expressed as a percentage of the actual hours spent in producing that work. It measures the efficiency in the utilization of hours available. It compares the standard time and the actual time taken. Efficiency ratio, therefore, represents the measure of fixed budgeted hours to match the actual level of production achieved.

**Capacity ratio:** This is the relationship between the budgeted number of working hours and the maximum possible number of hours in a budget period. Capacity measures whether there is enough resources as was budgeted for. If the hours that were available are less than the budgeted hours, then the firm operated below its capacity.

**Total fixed overhead variance**

Total fixed overhead is given by the summation of fixed overhead expenditure variance and fixed overhead volume variance. But fixed overhead variance has two portions; Fixed overhead capacity variance and Fixed overhead efficiency variance.

**>>> Illustration**

JVM Company uses a standard absorption costing system. Last month budgeted production was 8,000 units and the standard fixed production overhead cost was Shs15 per unit. Actual production last month was 8,500 units and the actual fixed production overhead cost was Shs17 per unit.

What was the total adverse fixed production overhead variance for last month? Calculate the fixed overheads volume variance

Total fixed overheads variance = Absorbed fixed overheads – actual fixed overheads