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.
Advantages of Using Efficiency Variances
Using efficiency variances provides several advantages, particularly in performance evaluation and cost management. Here are the key benefits:
Performance measurement. Efficiency variances allow organizations to assess the performance of specific departments, teams, or employees by comparing actual resource usage to standard resource expectations. They highlight areas where operational efficiency is above or below standard levels, enabling targeted interventions.
Cost Control. By identifying variances in resource usage (e.g., labor hours, material consumption), businesses can pinpoint inefficiencies and implement measures to reduce waste or optimize processes.
Goal setting and accountability. Efficiency variances provide clear benchmarks (standards) against which actual performance is measured. They create accountability among employees and managers by linking performance metrics to efficiency targets.
Problem identification. Highlighting areas with significant variances can draw attention to underlying issues, such as outdated machinery, poor workforce training, or flawed processes.
Budgeting improvements. Historical efficiency variances can inform more accurate budget planning and forecasting by providing insights into realistic resource utilization rates.
Incentive plan enhancements. Organizations can use efficiency variances to design incentive programs that reward teams or individuals for achieving or exceeding efficiency targets. This promotes a culture of continuous improvement.
Bolsters continuous improvement activities. Regular analysis of variances fosters a mindset of ongoing optimization and refinement of processes. This encourages the organization to challenge existing practices and seek innovative solutions.
By leveraging efficiency variances effectively, businesses can not only improve operational performance but also align their cost management strategies with overall organizational objectives.