What it means
Standard costing sets a target for how many hours a unit of output should take and how much each hour should cost. At the end of a period, the business compares what actually happened with that target.
The labour efficiency variance is the part of the difference that comes from using too many or too few hours. The calculation applies the standard rate to the hour difference, and this is deliberate.
By valuing the extra or saved hours at the planned rate, the measure strips out pay-rate effects, which are reported separately as the labour rate variance. That way each variance points to a different cause and a different manager.
An unfavourable efficiency variance can come from many causes, such as poorly trained staff, machine breakdowns, poor-quality materials that need rework, bad scheduling or unrealistic standards. A favourable variance, meaning fewer hours than planned, is not automatically good news.
It may reflect rushed work that causes defects, or standards that were set too loosely. The standard hours used are the hours that should have been needed for the actual output achieved, not the hours originally budgeted.
If the factory made 5,000 units and the standard is 2 hours per unit, the standard hours allowed are 10,000, whatever the plan said at the start of the year. This is called a flexed comparison, and it keeps the measure fair when volume is different from budget.
Managers use the variance to prompt investigation rather than to assign blame. Small variances are normal, so many firms set a threshold, such as 5% of standard cost, below which no action is taken.
Larger ones are traced to the production line, shift or supervisor to find the cause. Reliable time recording is essential for this measure to work.
If workers log hours against the wrong job, or supervisors estimate time after the fact, the variance will point at the wrong product or line. Many firms therefore use job cards, scanners or software time sheets to capture hours as the work is done.
In practice
Real-world examples
Example 1
A furniture workshop budgets 3 hours to assemble each wardrobe but averages 3.4 hours after switching to a new supplier of flat-pack parts. The extra hours show up as an unfavourable efficiency variance. The operations manager discovers that the new parts do not fit properly and need re-drilling.
Example 2
A call centre sets a standard of 6 minutes per customer query. After a software upgrade and new training, the actual average falls to 5.2 minutes. The favourable variance is investigated and confirmed as real, and the standard is tightened for next year.
Example 3
A bakery sets a standard of 40 loaves per labour hour. A new oven that heats unevenly forces staff to turn trays by hand, and output drops to 34 loaves per hour. The finance team uses the variance figure to support the case for replacing the oven.
Think of it
Imagine baking cakes where your recipe states each cake should take 30 minutes to mix. If you finish in 20 minutes, you have saved time. If it takes 40 minutes, you are lagging behind your schedule.
Formula
Calculation
Labour efficiency variance = (Actual hours - Standard hours allowed) x Standard rate per hour
A factory made 5,000 units. The standard is 2 hours per unit, so standard hours allowed are 5,000 x 2 = 10,000 hours. Workers actually used 10,600 hours, and the standard rate is $20 per hour. The variance is (10,600 - 10,000) x 20 = 600 x 20 = $12,000. Because more hours were used than allowed, the variance is $12,000 unfavourable.Case study
Seen in the real world
Kestrel Components is an illustrative, fictional maker of metal brackets. For three months running, its monthly accounts showed an unfavourable labour efficiency variance of between $9,000 and $14,000 on its main assembly line. The plant manager insisted the staff were working as hard as ever.
The cost accountant broke the variance down by shift and found that all of the excess hours came from the night shift, which spent time waiting for materials that day staff had not staged. A simple handover checklist solved the problem within weeks. The variance returned to near zero, and the lesson was that the number pointed to a process issue, not a performance issue.
Watch out
Common mistakes
- Using the actual pay rate instead of the standard rate, which mixes pay-rate effects into a measure meant to isolate efficiency.
- Comparing actual hours with the budgeted hours rather than the standard hours allowed for actual output.
- Assuming a favourable variance is always good, when it can signal rushed work, quality problems or loose standards.
Questions
People also ask
Is an unfavourable labour efficiency variance always the fault of the workers?
No, it can result from poor materials, breakdowns, scheduling or unrealistic standards, so the cause should be investigated before conclusions are drawn.
How does it relate to the labour rate variance?
Together the two add up to the total labour variance, with efficiency covering hours and rate covering the price paid per hour.
Does the variance apply to service businesses?
Yes, for example a consultancy can compare the hours it expected a project to take against the hours actually logged.