Which of the following is not true about the variable overhead rate variance?

The labor rate variance measures the difference between the actual and expected cost of labor. It is calculated as the difference between the actual labor rate paid and the standard rate, multiplied by the number of actual hours worked. The formula is:

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

An unfavorable variance means that the cost of labor was more expensive than anticipated, while a favorable variance indicates that the cost of labor was less expensive than planned. This information can be used for planning purposes in the development of budgets for future periods, as well as a feedback loop back to those employees responsible for the direct labor component of a business. For example, the variance can be used to evaluate the performance of a company's bargaining staff in setting hourly rates with the company union for the next contract period.

Causes of a Labor Rate Variance

There are a number of possible causes of a labor rate variance, which are noted below.

Incorrect Standards

The labor standard may not reflect recent changes in the rates paid to employees. For example, the standard may not reflect the changes imposed by a new union contract.

Pay Premiums

The actual amounts paid may include extra payments for shift differentials or overtime. For example, a rush order may require the payment of overtime in order to meet an aggressive delivery date.

Staffing Variances

A labor standard may assume that a certain job classification will perform a designated task, when in fact a different position with a different pay rate may be performing the work. For example, the only person available to do the work may be very skilled, and therefore highly compensated, even though the underlying standard assumes that a lower-level person (at a lower pay rate) should be doing the work. Thus, this issue is caused by a scheduling problem.

Component Tradeoffs

The engineering staff may have decided to alter the components of a product that requires manual processing, thereby altering the amount of labor needed in the production process. For example, a business may use a subassembly that is provided by a supplier, rather than using in-house labor to assemble several components.

Benefits Changes

If the cost of labor includes benefits, and the cost of benefits has changed, then this impacts the variance. If a company brings in outside labor, such as temporary workers, this can create a favorable labor rate variance because the company is presumably not paying their benefits.

How Standard Labor Rates are Created

The standard labor rate is developed by the human resources and industrial engineering employees, and is based on such factors as:

• The expected mix of pay levels among the production staff

• The amount of overtime likely to be incurred

• The amount of new hiring at different pay rates

• The number of employees retiring

• The number of promotions into higher pay levels

• The outcome of contract negotiations with any unions representing the production staff

An error in these assumptions can lead to excessively high or low variances.

In situations where goods are produced in small volume or on a customized basis, there may be little point in tracking this variance, since the work environment makes it difficult to create standards or reduce labor costs.

Example of a Direct Labor Rate Variance

The human resources manager of Hodgson Industrial Design estimates that the average labor rate for the coming year for Hodgson's production staff will be $25/hour. This estimate is based on a standard mix of personnel at different pay rates, as well as a reasonable proportion of overtime hours worked.

During the first month of the new year, Hodgson has difficulty hiring a sufficient number of new employees, and so must have its higher-paid existing staff work overtime to complete a number of jobs. The result is an actual labor rate of $30/hour. Hodgson's production staff worked 10,000 hours during the month. Its direct labor rate variance for the month is:

The variable overhead efficiency variance is the difference between the actual and budgeted hours worked, which are then applied to the standard variable overhead rate per hour. The formula is:

Standard overhead rate x (Actual hours - Standard hours)
= Variable overhead efficiency variance

A favorable variance means that the actual hours worked were less than the budgeted hours, resulting in the application of the standard overhead rate across fewer hours, resulting in less expense being incurred. However, a favorable variance does not necessarily mean that a company has incurred less actual overhead, it simply means that there was an improvement in the allocation base that was used to apply overhead.

The variable overhead efficiency variance is a compilation of production expense information submitted by the production department and the projected labor hours to be worked, as estimated by the industrial engineering and production scheduling staffs, based on historical and projected efficiency and equipment capacity levels. It is entirely possible that an improperly-set standard number of labor hours can result in a variance that does not represent the actual performance of an entity. Consequently, investigation of the variable overhead efficiency variance should encompass a review of the validity of the underlying standard.

Example of the Variable Overhead Efficiency Variance

The cost accounting staff of Hodgson Industrial Design calculates, based on historical and projected labor patterns, that the company's production staff should work 20,000 hours per month and incur $400,000 of variable overhead costs per month, so it establishes a variable overhead rate of $20 per hour. In May, Hodgson installs a new materials handling system that significantly improves production efficiency and drops the hours worked during the month to 19,000. The variable overhead efficiency variance is:

What is variable overhead rate variance?

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What is the variable overhead efficiency variance quizlet?