Rate variance is a concept used in cost accounting to determine the difference between the actual hourly rate paid to an employee or for a resource and the standard or expected hourly rate that was budgeted or anticipated for that resource. It helps managers understand if they’re overpaying or underpaying for labor or other resources relative to what was expected.
The formula for calculating rate variance is:
Rate Variance = (Actual Rate − Standard Rate) × Actual Hours Worked
- Actual Rate is the hourly rate actually paid.
- Standard Rate is the hourly rate that was expected or budgeted.
- Actual Hours Worked is the number of hours the employee worked or the number of hours the resource was utilized.
Example of Rate Variance
Let’s dive deeper with a detailed example involving a manufacturing company.
Scenario: ABC Manufacturing
ABC Manufacturing produces electronic devices. They budgeted (standardized) that the hourly rate for their technicians would be $25 per hour. However, due to increased demand in the job market, they had to pay a higher rate to attract and retain skilled technicians.
- Standard Rate (SR): $25 per hour
- Actual Rate (AR) paid to Technician A: $28 per hour
- Hours Technician A worked in a week: 35 hours
Let’s calculate the rate variance for Technician A:
Rate Variance (RV) = (Actual Rate − Standard Rate) × Actual Hours Worked
Inserting the provided values:
RV = ($28 – $25) x 35
RV = $3 x 35
RV = $105
Result: The unfavorable rate variance for Technician A for the week is $105. This means ABC Manufacturing paid $105 more for Technician A’s labor than what they had budgeted for that week.
- Budgeting and Planning: The unfavorable variance indicates that the company may need to revisit its budgets and forecasts. If they expect the trend of higher wages to continue, they should adjust their standard rates accordingly.
- Pricing: If labor costs are consistently higher than budgeted, the company might need to consider adjusting the pricing of their products to maintain desired profit margins.
- Operational Decisions: If the company finds that the high wage trend is not isolated to just one or two technicians but is widespread, they might explore options such as training programs to develop skills internally rather than hiring from the market at a premium.
It’s essential to understand that variances, whether favorable or unfavorable, are tools for analysis. They highlight areas that may require attention but should be interpreted in the context of the overall business environment and strategy.