Standard Costing - Labour Variances

COST AND MANAGEMENT ACCOUNTING

STANDARD COSTING (VARIANCE ANALYSIS)

LABOUR VARIANCES

 

Part A: Discussion of basic theories including various formulas for computing different variances

Part B: 2 illustrations with solutions

Part A

Definition of Standard Costing

Standard Costing is a method of costing where actual costs/revenues are compared with pre-determined standard costs/revenues in order to:-

1. Calculate different variances (namely Material Variances, Labour Variances, Overhead Variances and Sales Variances);

2. Analyse the reasons for the variances, which may be positive as well as negative;

3.  Identify the concerned departments responsible for such variances;

4.  Fix responsibilities for the concerned departmental heads towards achieving   certain standards in the future; and

5. Take necessary steps wherever required either for achieving the standards or for modifying the standards.

 

Therefore, in standard costing the most important pre-requisite is ‘fixing the standards’ which is actually carried out by the technical persons. Once the standards are determined, then only different variances can be calculated by comparing the actual results with the pre-determined standards. The variances are basically of two types: (a) Cost Variances and (b) Sales Variances.

 

Cost Variances may be of the following four types:

1.  Material Variances

2.  Labour Variances

3.  Variable Overhead Variances

4.  Fixed Overhead Variances

 

Sales Variances may be of the following two types:

1.  Sales Turnover Variances

2.  Sales Margin Variances

 

Standard Costing is also termed as Variance Analysis because the whole of the Standard Costing System revolves around calculating the variances and analysing them in order to control different costs and operations of the business.

 

 Labour Variances

1	Labour Cost Variance	= L5 – L1
2	Labour Rate Variance	= L2 – L1
3	Labour Gross Efficiency Variance	= L5 – L2
4	Labour Idle Time Variance	= L3 – L2
5	Labour Net Efficiency Var.	= L5 – L3
6	Labour Mix / Gang Variance	= L4 – L3
7	Labour Yield / Sub-Efficiency Variance	= L5 – L4

 

 Where,

L1	= AR x AHA
L2	= SR x AHA
L3	= SR x AHU
L4	= SR x AHU in SP
L5	= SR x SHAO
AR	= Actual Rate
SR	= Standard Rate
AHA	= Actual Labour Hours Available i.e. Actual Labour Hours Paid for
AHU	= Actual Labour Hours Utilised
AHU in SP	= Actual Labour Hours of the mix in Standard Proportion
SHAO	= Standard Labour Hours of the mix for Actual Output

 

Note A:

When there is no mix of labour in the actual input i.e. when the direct labour is actually only one type of labour, then

1.  Do not calculate L₄;

2.  Do not calculate Labour Mix Variance;

3.  Do not calculate Labour Yield Variance.

 

Note B:

If there is no idle time i.e. where AHA = AHU, there will be no Idle Time Variance, and then

1.     Do not calculate L₃;

2.     There will be only one Labour Efficiency Variance = L₅ – L₂;

3.     Labour Mix Variance = L₄ – L₂;

4.   Labour Cost Variance, Labour Rate Variance and Labour Yield Variance will remain unchanged.

 

Note C:

Negative variances are adverse variances and positive variances are favourable variances.

Check:

1.   Labour Cost Variance (L₅ – L₁)

= Labour Rate Variance (L₂ – L₁) + Labour Gross Efficiency Variance (L₅ – L₂)

2.   Labour Gross Efficiency Variance (L₅ – L₂)

= Labour Idle Time Variance (L₃ – L₂) + Labour Net Efficiency Variance (L₅ – L₃)

3.   Labour Net Efficiency Variance (L₅ – L₃)

= Labour Mix Variance (L₄ – L₃) + Labour Yield Variance (L₅ – L₄)

 

Part B

 Illustration: 1

 The standard and actual figures of a firm are as under:

Particulars	Standard	Actual
Time to complete a job (Hours)	1,000	900
Wages rate per hour (Rs)	50	40

 Compute the variances.

 

 Solution: 1

L1	= AR × AHA	= Rs. 40 × 900 hours	= Rs. 36,000
L2	= SR × AHA	= Rs. 50 × 900 hours	= Rs. 45,000
L5	= SR × SHAO	= Rs. 50 × 1,000 hours	= Rs. 50,000

 

 Variances:

Lab. Rate Variance	= L2 – L1	=45,000 - 36,000	= Rs. 9,000	(F)
Lab. Efficiency Variance	= L5 – L2	=50,000 - 45,000	= Rs. 5,000	(F)
Lab. Cost Variance	= L5 – L1	=50,000 - 36,000	= Rs. 14,000	(F)

 

Illustration: 2

The standard labour employment and the actual labour engaged in a week for a job are as under:

 

	Standard		Actual
	Number of Workers	Wage rate per hour (Rs)	Number of Workers	Wage rate per hour (Rs)
Skilled workers	32	3	28	4
Semi-skilled workers	12	2	18	3
Unskilled workers	6	1	4	2

 

During the 40 hours working week the gang produced 1,800 standard labour hours of work.

 

Calculate:

a.   Labour Cost Variance,

b.   Labour Rate Variance,

c.   Labour Efficiency Variance,

d.   Labour Mix Variance, and

e.   Labour Yield Variance.

 

Solution: 2

Analytical Arrangement of Given Data

Labour	Standard			Actual
	Hours	Rate (Rs)	Value (Rs)	Hours	Rate (Rs)	Value (Rs)
Skilled	1,280	3	3,840	1,120	4	4,480
Semi-skilled	480	2	960	720	3	2,160
Unskilled	240	1	240	160	2	320
Total	2,000		5,040	2,000		6,960

 

 L₁ = AR × AHA

Labour	AR (Rs)	AHA (Hrs)	L1 (Rs)
Skilled	4	28 × 40	4,480
Semi-skilled	3	18 × 40	2,160
Unskilled	2	4 × 40	320
TOTAL			6,960

 

 L₂ = SR × AHA

Labour	SR (Rs)	AHA (Hrs)	L2 (Rs)
Skilled	3	28 × 40	3,360
Semi-skilled	2	18 × 40	1,440
Unskilled	1	4 × 40	160
TOTAL			4,960

 

 Note: 

 L₃ is not to be calculated here, because AHA = AHU, i.e. there is no idle time as per the given problem.

 

 L₄ = SR × AHU in Standard Proportion

Labour	SR (Rs)	AHU in SP (Hrs)	L4 (Rs)
Skilled	3	32 × 40	3,840
Semi-skilled	2	12 × 40	960
Unskilled	1	6 × 40	240
TOTAL			5,040

 

 L₅ = SR × Standard Hours for Actual Output [W.N.]

Labour	SR (Rs)	SHAO (Hrs)	L5 (Rs)
Skilled	3	1,152	3,456
Semi-skilled	2	432	864
Unskilled	1	216	216
TOTAL			4,536

 

 VARIANCES:

Variances	Details	Rs	F / A
Labour Rate Variance	L2 – L1
Skilled	3,360 – 4,480	1,120	A
Semi-skilled	1,440 – 2,160	720	A
Unskilled	160 – 320	160	A
		2,000	A
Labour Efficiency Variance	L5 – L2
Skilled	3,456 – 3,360	96	F
Semi-skilled	864 – 1,440	576	A
Unskilled	216 – 160	56	F
		424	A
Labour Mix Variance	L4 – L2
Skilled	3,840 – 3,360	480	F
Semi-skilled	960 – 1,440	480	A
Unskilled	240 – 160	80	F
		80	F
Labour Yield Variance	L5 – L4
Skilled	3,456 – 3,840	384	A
Semi-skilled	864 – 960	96	A
Unskilled	216 – 240	24	A
		504	A
Labour Cost Variance	L5 – L1
Skilled	3,456 – 4,480	1,024	A
Semi-skilled	864 – 2,160	1,296	A
Unskilled	216 – 320	104	A
		2,424	A

 

 Workings:

 Standard Hours for Actual Output (SHAO):

Skilled	= (1,280 ÷ 2,000) × 1,800	= 1,152 hrs
Semi-skilled	= (480 ÷ 2,000) × 1,800	= 432 hrs
Unskilled	= (240 ÷ 2,000) × 1,800	= 216 hrs