Efficiency variance definition
/What is an Efficiency Variance?
The efficiency variance is the difference between the actual unit usage of something and the expected amount of it. The expected amount is usually the standard quantity of direct materials, direct labor, machine usage time, and so forth that is assigned to a product. However, the efficiency variance can also be applied to services. For example, an efficiency variance can be calculated for the number of hours required to complete an audit versus the budgeted amount.
Types of Efficiency Variances
The efficiency variance can be applied to direct materials. This is called the material yield variance, and is calculated as actual unit usage minus standard unit usage, which is then multiplied by the standard cost per unit. The formula is as follows:
(Actual unit usage - Standard unit usage) x Standard cost per unit = Material yield variance
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The efficiency variance can be applied to direct labor. This is called the labor efficiency variance, and is technically related more to material usage than to efficiency. It is calculated as actual hours minus standard hours, multiplied by the standard labor rate. The formula is as follows:
(Actual hours - Standard hours) x Standard rate = Labor efficiency variance
The efficiency variance can be applied to overhead. This is known as the overhead efficiency variance, and is calculated as actual hours minus standard hours, multiplied by the standard overhead rate. The formula is as follows:
(Actual hours - Standard hours) x Standard overhead rate = Overhead efficiency variance
How to Develop an Efficiency Variance
Another key component of any efficiency variance is the basis upon which the standard is set. For example, the number of units of direct material could assume the absence of scrap, when in fact a standard amount of scrap is normally realized, causing a continuing negative efficiency variance. This would be a theoretical standard, that can only be met if the circumstances are optimal. Or, a realistic standard could be used that incorporates reasonable inefficiency levels, and which comes close to actual results. Generally, the latter approach is preferable, if only to avoid a depressing series of negative efficiency variances.