Conceptual overview
Standard labor hour is the standard time required by labor to make a product. This time is estimated by the business to be used in the production budget. Further, it’s helpful in controlling aspects of the business.
For instance, a normal loss is estimated at the time of preparing the production budget. So, once production is completed, abnormal loss of time is calculated by deducting the normal loss of time from the total time lost during the production process.
Detailed explanation of the concept
Standard hours are the hours that are required for the production/output. The production department of a manufacturing company has sufficient knowledge and access to information. This information is useful for the calculation of the standard time required for the production of units. Further, the industry average can also be considered as an important input in the process of calculating standard labor time.
How to calculate standard hours allowed for a production process?
Standard hours per unit are the number of hours estimated by a production department of a company that should be utilized by labor to produce one unit of product. The total standard hours for the whole production process are computed by using the actual output units. Here is the formula for calculating standard hours:
Standard hours allowed = Standard hours required per unit * actual number of units produced.
The formula will give you the numbers of standard hours required for the production of a specified number of products.
It’s simple science that if an actual number of units to be produced are more, standard labor hours allowed are expected to be more and vice versa.
The science behind calculating standard labor hour
Standard labor hour calculation is usually made for manufacturing businesses that need to pay close attention to labor time when a large number of units are to be produced. If a manufacturing company wants to maintain higher profitability, then it needs to pay close attention to the labor hours used for production.
Production efficiency can be achieved if a company’s actual hours spent on working are less than standard hours of production. This will lead to less labor cost that will ultimately lower our cost of production and translate into the achievement of profitability targets.
Standard hours per unit are estimated by using the labor routing technique. Labor routing is a method that is used to evaluate the estimated amount of labor time needed to manufacture a unit. The normal inefficiencies are included in labor routing.
Examples of inefficiencies are setup time for machines, waiting time to receive a unit from one manufacturing process to another, break time, etc. Standard labor time is used in the calculation of standard cost that is an estimation of the per-unit cost of the finished product.
It’s important to note that standard labor hour is more effective when analyzed in conjunction with labor rate as both are related. For instance, if the business intends to use highly skilled labor, standard labor time is expected to be lower. On the other hand, if the business intends to use less skilled labor, standard labor time is expected to be higher.
The logic is that skilled labors are expected to have a learning curve on account of more experience and consume less time than unskilled labor. Further, there can be a massive difference in material wastage due to skills or no skills. So, things should be interpreted logically and connect different dots.
However, for a decision-making process, the concept of theoretical labor hours can be used, which is different from normal standard hours (attainable standard).
Attainable and theoretical standard labor hours
Theoretical standards assume that situations are perfect and there are no errors or time wastage due to setup time of machines, labor inefficiency, break time, scrap, or other similar issues.
Further, if a company is following theoretical standards, then it’s probable that the calculated amount of standard labor hours for any production process will be less than the actual hours used by the workers. It means that there is a likelihood of adverse labor variance when a company is using theoretical standards of labor hour’s calculation.
On the other hand, attainable standard hours are the standard hours allowed for a production process needed to produce finished goods. It considers environmental and other aspects.
Example
XTCL is engaged in the business of producing crockery items and exporting them to international markets. The standard labor hours required for a special design of crockery items were estimated by using labor routing.
Labor routing for each crockery item stated that a single unit needs 1.5 standard hours. The total standard time allowed to the labor for producing 500 crockery items of special design will be calculated as:
Total standard time = Standard hours required per unit * the actual number of units produced.
= 1.5 hours * 500 units
The total standard time =750 hours
Standard labor calculation is useful for manufacturing businesses as they use standard labor hours for the absorption of actual overhead costs. Likewise, manufacturing business concerns can bid jobs more efficiently if standard labor hour’s calculation is more accurate and realistic. Standard labor hour calculation is further elaborated with another example below.
Example 2
A company produces two products, Alpha and beta. It is expected that units of Alpha will be manufactured, and the standard hours required will be 0.5 hours per unit of output. The other product beta will require 0.6 hours per unit. The following number of units are to be manufactured for January.
Number of units for Alpha = 10,000 units
Number of units for Beta = 5,000 units
Calculate the total number of hours required for Alpha and Beta.
Standard hours per unit of Alpha = 0.5 hours/unit
Standard hours per unit of Beta = 0.6 hours/unit
Total number of standard hours needed
for Alpha:
= hours per unit * total number of units
= 0.5 hours * 10,000 units of Alpha
= 5,000 hours
The total number of standard hours needed for Beta:
= hours per unit * total number of units
= 0.6 hours * 5,000 units of Beta
= 3,000 hours
The total number of standard hours needed for Alpha and Beta:
= standard hours for 10,000 units of Alpha + standard hours for 5,000 units of Beta
= 5,000 hours + 3,000 hours
= 8,000 hours
The prime purpose of calculating standard labor hours is to monitor and control the time of production. This can be more efficiently done by using a ratio like labor efficiency and calculating variance on it.
Labor efficiency variance
It is the difference between the standard hours required for actual output and actual hours worked at a standard rate. The formula used for calculating labor efficiency (without considering the impact of idle time) is as:
Labor efficiency = (Standard hours – Actual hours) * Standard rate
Illustration of labor efficiency variance
A product X52 has a standard labor cost per unit as:
Standard rate = $10 per hour
Standard hours allowed per unit of X52 = 1.5 hours
During the first quarter of the year 20XX, 2,000 units of X52 were produced that took 2600 hours. Direct labor cost was estimated to be 35,000.
Calculate labor efficiency variance.
Labor efficiency = (Standard hours – Actual hours) * Standard rate.
= (1.5 hours*2,000 units – 2,600 hours) * $10
= ( 3,000 hours – 2,600 hours) * $10
= 400 hours * $10
= $4,000
Since the actual hours worked by the labor are less than the standard hours allocated for the production of X52, the resultant variance is favorable.
Conclusion
Standard labor hour is an estimated time taken by labor to produce a unit of finished goods. It’s calculated based on the knowledge of the production manager that how much time is required for the production process. Further, the industry average can be helpful in making estimates.
The science behind calculating standard labor hours is to monitor and control production time. If labors are skilled and experienced, they are expected to have a learning curve and produce goods in less time and vice versa. So, things need to be interpreted in conjunction.
Further, standard hours are used in absorption costing to absorb overhead. Likewise, it’s one of the main inputs in calculating variance.
Frequently asked questions
Is standard labor variance completely controllable by managers?
Standard labor variance is not completely controllable by managers. Sometimes, there may be unforeseen events not in control of managers. So, a customized situation needs to be analyzed.
Who is responsible for the labor efficiency ratio?
Usually, the production department is responsible for the efficiency ratio. They are responsible for planning, monitoring, and controlling production functions.
How is labor efficiency connected with the labor rate?
Usually, labor efficiency is inversely proportional to the labor rate. The reason is that skilled labor with a higher rate is expected to be more efficient and vice versa.