Complete Guide To Efficiency Variance (With Examples)

Efficiency variance is the difference between the theoretical amount of inputs required to produce a unit of output and the actual number of inputs used to produce the unit of output. The expected inputs to produce the unit of output are based on models or past experiences.

Managers use various ratios and budgets to analyze the productivity of factory output in manufacturing processes. Before the manufacturing process even begins, management frequently sets benchmarks and expectations for costs and output. In this manner, management can assess the discrepancy between anticipated and actual performance.

Labor Efficiency Variance

Types of efficiency variance

There are three types of efficiency variance:

Labor efficiency variance

The labor efficiency variance calculates the discrepancy between the number of hours you paid your employees and the actual amount you paid them. Depending on the average wage you pay your team members, labor efficiency may change.

To increase your profits, for instance, you might hire a new worker at a rate that is lower than the typical wage you currently pay your staff. However, the cost of training them and the fact that it takes longer for them to finish tasks as they become more proficient at their work may have an impact on this profit.

Other factors that may impact labor efficiency include:

Material yield variance

The difference between the number of units you anticipate producing and the number of units you actually produce, multiplied by the standard rate you paid for the raw materials, is known as the material yield variance.

Variance in Material Yield = SC (Actual Yield Standard Yield)

SC refers to standard product unit cost.

This formula illustrates how your profit varies depending on how many items you produce in relation to your anticipated production. Your anticipated output might be determined by analytical models or your typical output rate. A favorable (or positive) variance indicates that you produced more goods than anticipated and will generate more revenue than anticipated.

When the calculation is done, a negative value displays this. An unfavorable (or negative) variance indicates that you may have produced fewer products and earned less money, which is reflected by a positive value once the calculation is complete.

To determine your production efficiency, such as whether your machinery is operating properly, you can use material yield variance. The labor efficiency variance can also be used to determine whether production has been impacted by changes in labor hours. This formula is also helpful for figuring out whether you need to change the manufacturing process or renegotiate the price of your raw materials.

Overhead variance

The overhead variance is the discrepancy between your planned and actual business costs. The formula for overhead variance is:

(Actual overhead – budgeted overhead) = overhead variance

Costs associated with operating a business that are unrelated to the primary operations are known as overhead expenses. These might include:

Many companies establish an overhead budget to set aside money for these expenses. At the conclusion of a fiscal period, which is typically after a month, quarter, or year, you can compare this budget to the actual amount you paid. If your actual overhead costs are higher than your budgeted ones, you under-applied overhead; if you budgeted more than you actually spent, you over-applied overhead. Depending on changes in the use of electricity or gas, on the law or on tax regulations, your overhead may change.

What is efficiency variance?

Efficiency variance is the discrepancy between the number of inputs you anticipate being required and the actual inputs used to produce an output. Direct labor hours, money spent on overhead, or raw materials are examples of possible inputs. Outputs include manufactured products, services and paid bills.

If your efficiency variance is positive, it means that you used more inputs than you had planned to in order to produce the outputs. When the variance is negative, it means that fewer inputs were used to generate the outputs. The calculation’s results can be either positive or negative; a positive result does not necessarily indicate that the efficiency is favorable. Negative values can occasionally represent a surplus over your budget, indicating a favorable or positive variance.

An unfavorable (or negative) labor variance indicates that you paid your employees for fewer hours than you anticipated, which is reflected by a positive value when you solve the calculation.

When you solve the equation, a negative value indicates that they worked more hours than were budgeted, which is known as a favorable (or positive) variance. Many analysts base their expected result determination on ideal conditions, which means they frequently forecast a negative efficiency variance.

Efficiency variance can be used to assess how well your resources are being utilized. While some variation is to be expected, you can use this formula to analyze your costs and set expectations for your staff. Having a precise model can help you plan your labor and costs, as well as figure out whether your equipment is operating at its best.

How to calculate efficiency variance

Here are the steps to calculating efficiency variance:

1. Determine your budgeted quantity

You can use computer simulations or prior knowledge to determine your budgeted amount. You can estimate how much you will spend on utilities, fuel, and maintenance when figuring out your overhead budget, for instance. Then, you can include any software subscription costs, rent, and your advertising budget. Depending on how many employees you have and whether they are full- or part-time, you can predict how many hours they will work.

2. Calculate the standard rate

You can determine the standard rate by calculating your average labor or raw material expenditures. To determine an average, add up all of the costs associated with the materials or salaries that will be paid during the measurement period, then divide by the total number of materials or salaries.

For instance, if you have five hourly workers and pay two of them $20 and the other three $15, your calculation would be as follows:

(20 + 20 + 15 + 15 + 15)/585/5 = 17.

Your standard labor rate will be $17 per hour.

3. Find the actual amount

At the conclusion of the reporting period, the precise number of hours your employees worked, expenses you incurred, or goods you produced will be available. Depending on which variance you are calculating, you can use the amounts that you tracked through payroll, inventory, or bookkeeping. Make sure that your budget and the actual quantities you are using are based on the same time period. Check that the budgeted amount and the actual amount are from the same fiscal quarter, for instance, if you are calculating the variance over a quarter.

4. Use the formula

The efficiency variance formula is:

(Actual quantity – Budgeted quantity) × (standard price or rate)

Unless you are calculating overhead variance, use this formula. You deduct your budgeted overhead from the actual overhead you paid to calculate the variance in overhead, which is already expressed in currency units.

As an illustration, if you use the following calculations to determine the labor efficiency variance for a week:

Here is what your labor efficiency variance is:

(145 – 150) x 17
(-5) x 17 = -85

This equation demonstrates that since you budgeted for 150 hours of labor but are only paying for 145 hours, your labor costs were $85 less than you anticipated.

Example efficiency variance calculations

Here are some examples of calculating efficiency variance:

Material yield variance

If you are a book printer, then this is how you would figure out your material yield variance.

With a standard raw material cost of $2, you anticipated producing 6,000 books, but only printed 5,750 of them.

(5,750 – 6,000) x 2
(-250) x 2
-500

You overestimated your material yield by $500, according to your material yield variance.

Overhead variance

If your office space costs $500 per month to rent, then:

Your overhead variance calculation would be as follows if you discovered at the end of the month that you spent $125 on electricity, $100 on your internet and phone service, and $40 on advertising:

(500 + 125 + 100 + 40) – (500 + 150 + 100 + 50)(765) – (800)-35.

Your calculation of the overhead variance reveals that you spent $35 less on overhead than you had anticipated.

FAQ

How do you calculate efficiency variance?

The number of direct labor hours you budget for a period less the actual hours your employees worked multiplied by the average hourly wage is the labor efficiency variance.

What does a positive efficiency variance mean?

If your efficiency variance is positive, it means that you used more inputs than you had planned to in order to produce the outputs. When the variance is negative, it means that fewer inputs were used to generate the outputs.

What is price variance and efficiency variance?

Price variance is calculated using the following formula: Price variance = (Actual price – budgeted price) (actual quantity) Efficiency variance is the difference between the actual and budgeted quantities you bought for a given price.

Which variance is sometimes known as the efficiency variance?

An efficiency variance is sometimes called a usage variance. the difference between actual results and expected performance.

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