Evaluating Direct Labor Variances

Evaluating Direct Labor Variances Most large companies assign responsibility for the employment function to a personnel department, and individual supervisors or department heads have a minimum of control over employee wage rates. When the personnel department has the responsibility for assigning workers to job tasks, the responsibility for maintaining the direct labor rate standard should be assigned to the personnel manager. When the production manager has the responsibility for scheduling work tasks, as is frequently the case in a job order machine shop, worker skill levels may vary considerably. Consequently, the production manager must be careful to assign workers to jobs requiring their particular level of skill. The underutilization of workers will undoubtedly result in unfavorable direct labor rate variances. In these cases the direct labor rate variance should be attributed to the production manager responsible for scheduling the assignment of work tasks. Other factors may affect labor wage rates. For example, the wage level in a particular firm also is heavily influenced by the prevailing wage rates in the community, and a company located in a small town will probably have a relatively lower direct labor cost than a company located in a larger city. Or in a union shop the labor wage rates may be set by contract. The responsibility for maintaining direct labor efficiency variances should be assigned to the production manager. Direct labor efficiency variances may be the result of such factors as improper training pro-cedures, the lack of appropriate skills by employees, or improper scheduling. Additionally, the direct labor efficiency standard is usually set for an experienced work force, and newer employees probably will not have acquired the level of skills necessary to achieve standard performance. Factory Overhead Variances The flexible budget factory overhead variance is the difference between the actual factory overhead incurred (total of fixed and variable) and the total factory overhead budgeted for the level of production achieved. Bellow Corporation's flexible budget factory overhead variance for January 1992 is computed: Several methods may be used to analyze the total factory overhead var-iance. In this text we will illustrate the two-variance method by computing a flexible budget factory overhead variance and a production volume variance. Before calculating these variances, it is necessary to calculate the total factory overhead rate. The total factory overhead rate comprises a variable component and a fixed component. The Bellow Corporation's variable factory overhead rate is $4 per direct labor hour used in production or $2 per unit of product. The fixed factory overhead rate is calculated by dividing the budgeted fixed factory overhead of $48,000 by the expected units of production contained in the static budget or 24,000. This results in a fixed factory overhead rate of $2 per product and a total factory overhead rate of $4 per unit ($2 variable + $2 fixed). The unfavorable flexible budget factory overhead variance suggests that total overhead costs were not controlled effectively by the production manager. Closer analysis reveals that fixed factory overhead costs were actually $2,000 less than budgeted ($48,000 - 46,000), whereas variable factory overhead costs were $3,000 more than budgeted ($43,000 - 40,000). Production managers generally have more control over variable costs than fixed costs, and a company using the management by exception philosophy should investigate the reasons behind this increase in variable costs. The production volume variance is the difference between the factory overhead budgeted for the production level achieved and the factory overhead applied to production using the standard factory overhead rate. The Bellow Corporation's production volume variance for the month of January is computed: When the flexible factory overhead budget amount is greater than the standard factory overhead applied to production, as in the Bellow Corporation example, the variance is unfavorable. This is because the volume achieved was less than budgeted and production capacity was underutilized. If the flexible budget amount is less than the standard factory overhead applied to production, the variance is favorable because production capacity is more fully utilized. The total factory overhead variance is the difference between the actual cost and the standard factory overhead applied to production. For the Bellow Corporation this results in an unfavorable variance of $9,000 calculated as follows: