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Manufacturing, service, food, and not-for-profit organizations all make use of standard

costs. Many organizations, such as hospitals, use standard costs for food, laundry, and
other items, as well as standard time allowances for certain routine activities, such as
laboratory tests. Variance analysis is an important part of an organization's information
system. An organization can use a variance analysis for planning, standards, benchmarks,
control mechanisms, and responsibility accounting.

Direct Labor Variances


Labor efficiency variance - the difference between the actual hours worked and the
standard hours allowed for the actual output, multiplied by the standard hourly labor rate
= SR (AH-SH)
Labor rate variance - The difference between the actual hourly labor rate and the standard
rate per hour, multiplied by the actual number of hours worked during the period = AH
(AR SR)
Example
A baseball bat company, Louisville Bats, manufactured 9,000 bats using 2,000 direct
labor-hours. The company paid its direct labor workers at an average pay rate of $8.00
per hour. According to the standard cost card, each bat should required .25 direct-hours at
a cost of $6.60 per hour. Calculate the labor rate variance and labor efficiency variance.
Labor rate variance = AH(AR SR) = 2,000 (8.00 6.60) = $2800 unfavorable
Labor efficiency variance = SR(AH SH) = 6.60(2,000 2,250 ) = ($1650) favorable.
Standard hours = 9,000 x 0.25 = 2250
Note: A favorable variable overhead efficiency variance indicates that fewer
manufacturing hours were expended during the period than the standard hours required
for the level of actual output. Raw materials, a higher skilled labor workforce, and more
efficient equipment can all contribute to a favorable outcome.

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