This variance tells us how efficient the direct labor was in making the actual output that was produced by the direct labor.
The direct labor efficiency variance compares the standard hours that it should have taken to make the actual output Vs. the actual hours it took and multiplies the difference in hours by the standard cost per direct labor hour.
Here's an example with amounts. Let's assume the standard for direct labor is 3 hours per unit of output and the standard cost for an hour of direct labor is $10. Let's say the output for the period is 6,000 units and the actual direct labor hours were 18,400 hours and the labor earned $10.30 per hour. The standard direct labor cost for the actual output should have been 18,000 hours (6,000 units of output times 3 standard hours) at $10 per hour for a total of $180,000. The actual direct labor cost was $189,520 (18,400 hours at $10.30 per hour). This means a TOTAL (efficiency and rate) variance of $9,520. Some of that variance is due to the rate being $0.30 too much and some of that variance is due to the direct labor using too many hours—not being efficient.
The direct labor efficiency variance focuses on the direct labor hours: 6,000 units of output should have taken 3 hours each for a total of 18,000 direct labor hours. The actual direct labor hours were 18,400 hours. This means there was an unfavorable direct labor efficiency variance of 400 hours times the standard rate of $10 for a total of $4,000.
The direct labor rate variance is the $0.30 unfavorable variance in the hourly rate ($10.30 actual rate Vs. $10.00 standard rate) times the 18,400 actual hours for an unfavorable direct labor rate variance of $5,520.
The combination of the unfavorable direct labor efficiency variance of $4,000 + the unfavorable direct labor rate variance of $5,520 is the total unfavorable direct labor variance of $9,520.