Direct Labor Price Variance

The direct labor price variance sometimes referred to as the direct labor rate variance, is one of the main standard costing variances, and results from the difference between the standard cost and the actual cost of labor used by a business.

Together with the efficiency variance, the price variance forms part of the total direct labor variance.

As can be seen the variance is calculated using the direct labor price variance formula which takes the difference between the standard labor price per unit (standard rate) and the actual labor price per unit (actual rate), and multiplies this by the quantity of units of labor used.

Example of Direct Labor Price Variance

Suppose, for example, a manufacturer sets the standard labor rate at 15.00 per hour.

Additionally on a production run they find they have used 230 hours of labor at an actual labor rate of 18.00 per hour. Accordingly the direct labor price variance for the production run is given as follows:

Direct labor price variance = (Standard rate - Actual rate) x Actual quantity
Direct labor price variance = (15.00 - 18.00) x 230
Direct labor price variance = -690

As can be seen this is summarized in the table below:

In this example, the direct labor variance is negative (unfavorable), as the actual price per labor hour (18.00) was higher than the standard price (15.00), and therefore the business paid more for the labor than it expected to. Consequently this variance would be posted as a debit to the direct labor price variance account. Additionally full details of the journal entry required to post the variance, standard cost and actual cost can be found in our direct labor variance journal tutorial.

Reasons for the Direct Labor Price Variance

Any major direct labor price variance needs to be investigated by the business in order to find the specific reason for the variation from the expected standard cost, the most common causes include the following:

• Firstly the standard labor rate does not reflect agreed labor rate changes.
• The standard rate does not include bonuses, overtime premiums and additional charges.
• The employees manufacturing the items are on a different pay rate than those on which the standard rate was based.
• Finally the variance calculation uses an incorrect actual price per hour.

Clearing the Direct Labor Price Variance Account

The financial statements of the business must ultimately show the actual costs incurred by the business. Consequently at the end of an accounting period, having investigated the direct labor price variances using the variance report, the balance on the direct labor price variance account needs to be cleared. Additionally the rules for clearing the account are discussed in our standard costing and variance analysis tutorial and are available for download in PDF format here. These rules can be summarized as follows:

1. Firstly for small, insignificant direct labor price variances it is not worth the time and effort apportioning the balance, so it is simply transferred to the cost of goods sold account.
2. Larger unfavorable variances (debit balances) which have resulted from errors and inefficiencies in the business, are also transferred to the cost of goods sold account, as apportioning them to an inventory account would incorrectly increase the value of the inventory.
3. Finally all other significant direct labor price variances (debit or credit balances) are split between inventory accounts and the cost of goods sold account in proportion to the amount of the standard labor cost remaining on that account.

Variance Apportionment Example

To illustrate in the example used above the direct labor price variance was unfavorable leaving a debit balance of 690 on the variance account. Furthermore assume for simplicity that this was the only direct labor price variance for the year.

If the balance is insignificant in relation to the size of the business, then simply transfer it to the cost of goods sold account.

If however, it is considered to be significant in relation to the size of the business, then the direct labor price variance needs to be analyzed between the inventory accounts (work in process, and finished goods) and the cost of goods sold account.

Suppose for example, 40% of the standard labor cost remained in the work in process inventory, and 60% had been used in production and the items sold, then the direct labor price variance account balance needs to be split as follows:

Furthermore the bookkeeping journal to post the transaction to clear the direct labor variance account would be as follows:

The debit balance on the direct labor price variance account (690) splits between the work in process inventory account (276) and the cost of goods sold account (414).This split increases both accounts by the appropriate amount, and clears the variance account balance.