Calculating the Machine Hour Rate
What Is Machine Hour Rate?
A machine hour rate is the hourly cost in terms of factory overheads to operate a particular machine. It is obtained by dividing the factory expenses associated with the machine for a given period by the number of hours worked by the machine during that period.
In Thothadri, Nafeesa, and Jalalutheen’s seminal 2019 book entitled Cost Accounting, the machine hour rate is defined as follows:
An actual or pre-determined rate of cost apportionment or overhead absorption which is calculated by dividing the cost to be apportioned or absorbed by the number of hours for which a machine or machines are operated or expected to be operated.
Why Calculate the Machine Hour Rate?
The machine hour rate is computed to recover or absorb factory overheads.
This basis for the recovery of overheads is adopted in industrial concerns where most of the work is driven by machines. In these companies, most of the factory expenses result from machine operations.
To compute the machine hour rate, each machine or a group of similar machines in a production department is considered a smaller department, and departmental expenses are re-apportioned to the machines or groups of machines in the department.
To this end, the following fundamental factors should be considered:
(i) Base Period
A base period is taken for every machine to compute the machine hour rate. This base period is the period for which the hourly rate is to be computed (it may be a year, quarter, month, or week).
(ii) Normal Hours of Working
The number of normal or standard working hours of each machine in the base period has to be estimated.
(iii) Distribution of Expenses
The departmental expenses to be considered when calculating the machine hour rate are divided into two parts:
- Standing charges (or fixed expenses)
- Running charges (or variable expenses or machine expenses)
Standing charges include all the expenses that remain fixed or constant, and which relate to the department as a whole. These are not affected by the operation of the machines.
Examples of standing charges include rent, rates, and insurance for the factory building, the cost of factory supervision, factory lighting, and machine insurance.
Running charges include the expenses that are incurred in connection with the operation of the machines (e.g., depreciation, repairs, and maintenance, as well as power, steam, and water use charges).
(iv) Calculating the Hourly Rate of Standing Charges
To compute the machine hour rate, all standing charges relating to the production department are apportioned to the individual machines on the following bases:
|Items||Basis of Apportionment|
|(a) Factory rent, rates, and insurance||(a) Floor area occupied by each machine|
|(b) Factory lighting||(b) Number of lighting points|
|(c) Factory supervision||(c) Number of workers engaged on each machine or floor area|
|(d) Machinery insurance||(d) Time devoted by supervisors of each machine and value of machinery|
|(e) Miscellaneous Expenses (e.g., lubricating oil, grease, cotton waste, and sundry stores)||(e) Actual quantity used (whenever possible) or any other equitable basis|
The standing charges are taken for the base period. To obtain the hourly rate of standing charges, the total of the standing charges apportioned to each machine for the base period is divided by the total working hours of the machine during the base period.
(v) Calculating the Hourly Rate of Machine Charges
The hourly rate of various items of machine charges (or running charges) is calculated separately in the following way:
To calculate the hourly rate of depreciation for a machine, the following information must be available:
- Machine’s original cost
- Machine’s effective working life (in terms of running hours)
- Risk of obsolescence
- Machine’s estimated scrap value (or residual value) at the end of its working life
Using this information, the hourly rate of depreciation of the machine can be calculated by applying the following formula:
Hourly rate of depreciation = (Original cost of machine — Estimated scrap value) / Effective working life of machine in terms of running hours
(b) Repairs and Maintenance
Generally, the cost of repairs and maintenance for a machine over its effective working life is estimated based on previous experience. The hourly rate of repairs and maintenance can be ascertained using the following formula:
Hourly rate of repairs and maintenance = Estimated cost of repairs and maintenance over the life of the machine / Effective working life of machine in terms of running hours
(c) Power, Steam, and Water
The hourly cost of power, steam, and water consumed is ascertained based on either of the following:
- Actual hourly consumption
- Estimated hourly consumption (ascertained using previous experience)
The hourly rates of standing charges and running charges will be aggregated to obtain the machine hour rate.
From the following information, compute the machine hour rate for Machine No. 51 for the month of January 2019:
- Cost of machine: $6,000
- Estimated scrap value: $1,000
- Effective working life: 5,000 Hours
- Hours worked in January 2019: 100
- Estimated cost of repairs and maintenance over the life of machine: $1,250
- Standing charges allocated to the machine for January 2019: 100
- Power consumed by machine: 10 units per hour at 10 paise per unit
About the Author
True Tamplin, BSc, CEPF®
True Tamplin is a published author, public speaker, CEO of UpDigital, and founder of Finance Strategists.
True contributes to his own finance dictionary, Finance Strategists, and has spoken to various financial communities such as the CFA Institute, as well as university students like his Alma mater, Biola University, where he received a bachelor of science in business and data analytics.