Understanding Efficiency Variances
Efficiency variances are critical metrics in cost accounting used to assess an organization’s operational performance. They measure the difference between the actual amount of resources used in production—such as labor and overhead—and the standard or expected amount of these resources. These variances can provide insights into areas where a company may be able to reduce costs or improve efficiency.
There are two primary types of efficiency variances discussed extensively in accounting:
Direct Labour Efficiency Variance
This variance measures the difference between the actual hours worked and the standard hours expected for the actual production level, multiplied by the standard labor rate.
Formula: \[ \text{Direct Labour Efficiency Variance} = ( \text{Actual Hours Worked} - \text{Standard Hours Allowed} ) \times \text{Standard Labour Rate} \]
Overhead Efficiency Variance
This variance assesses the efficiency in the use of variable overhead resources and is calculated by comparing the actual hours used to the standard hours for actual production, then multiplying by the overhead rate per hour.
Formula: \[ \text{Overhead Efficiency Variance} = ( \text{Actual Hours} - \text{Standard Hours Allowed} ) \times \text{Variable Overhead Rate} \]
Examples
-
Direct Labour Efficiency Variance:
- Standard Hours Allowed: 1,000 hours
- Actual Hours Worked: 1,200 hours
- Standard Labour Rate: $20 per hour
\[ \text{Variance} = (1,200 - 1,000) \times 20 = 200 \times 20 = $4,000 \text{ unfavorable} \]
This means the company spent $4,000 more on direct labor than anticipated for the production level achieved.
-
Overhead Efficiency Variance:
- Standard Hours Allowed: 800 hours
- Actual Hours Used: 900 hours
- Variable Overhead Rate: $15 per hour
\[ \text{Variance} = (900 - 800) \times 15 = 100 \times 15 = $1,500 \text{ unfavorable} \]
This indicates an additional $1,500 was spent on variable overheads beyond the expected amount.
Frequently Asked Questions
What causes efficiency variances?
Efficiency variances can be caused by several factors, including worker productivity, machine breakdowns, inefficient work practices, or inaccurate standard measurements.
Why are efficiency variances important?
They help managers identify areas in production where resources are not being used efficiently, thus highlighting opportunities for cost savings and process improvement.
How can efficiency variances be addressed?
To address unfavorable efficiency variances, companies can implement better training programs, update machinery, streamline processes, or reassess the accuracy of their standard measurements.
What is the role of standard costs in determining efficiency variances?
Standard costs provide a benchmark against which actual resource usage is compared. They are essential for calculating efficiency variances.
Can efficiency variances impact profitability?
Yes, significant unfavorable efficiency variances can increase production costs and reduce profitability, while favorable variances can contribute positively to the bottom line.
Related Terms
- Standard Costing: A method in accounting which involves assigning predetermined costs to goods and services, to assess performance by comparing actual results to these standard costs.
- Variance Analysis: The process of analyzing the differences between actual and budgeted figures, identifying the reasons behind those differences.
- Direct Materials Variance: Measures the difference between the actual cost of materials and the standard cost allocated for production.
- Fixed Overhead Variance: The difference between the actual fixed overhead incurred and the standard fixed overhead chargeable to production.
Online References
- Investopedia: Variance Analysis
- AccountingTools: Direct Labor Efficiency Variance
- YourArticleLibrary: Overhead Variances
Suggested Books for Further Studies
- Cost Accounting: A Managerial Emphasis by Charles T. Horngren, Srikant M. Datar, Madhav V. Rajan
- Managerial Accounting by Ray H. Garrison, Eric Noreen, Peter C. Brewer
- Accounting for Decision Making and Control by Jerold Zimmerman
Accounting Basics: “Efficiency Variances” Fundamentals Quiz
Thank you for exploring the concept of efficiency variances. Perfecting this knowledge will enhance your abilities in cost control and operational efficiency within your organization!
