Machine Hour Rate: Calculation, Advantages and Disadvantages

Article shared by
Machine Hour Rate: Calculation, Advantages and Disadvantages!
Machine hour rate is the cost of running a machine per hour. It is one of the methods of
absorbing factory expenses to production. It is used in those industries or departments where
machinery is predominant and there is little or practically no manual labour. In such industries or
departments, overhead consists of indirect expenses in running and operating the machine.
Therefore, it is desirable to allocate overhead to production on the basis of working hours of the
machines. It is not desirable to calculate the machine hour rate for the entire factory but
different rates may be calculated according to their make, type, size, capacity, wattage, horse
power and other factors relating to each machine or group of machines as a cost centre.
Machine hour rate is obtained by dividing the total running expenses of a machine during a
particular period by the number of hours the machine is estimated to work during that period.
Calculation of Machine Hour Rate:
The information required for calculation of machine hour rate is cost of the machine; cost of
installation of the machine; scrap value, if any; life of the machine in hours; standing charges
like rent etc. allocated to the machine; repairs and maintenance of the machine; power
consumption; set up time; cost of lubricants applied on the machine and insurance premium of
the machine, if any.
Following steps are required to be taken for the calculation of machine hour rate:
1. Each machine or a group of machines should be treated as a cost centre so that all overheads
relating to that machine or machines may be identified.
2. Overheads relating to a machine are divided into two parts i.e., fixed or standing charges and
variable or machine expenses. Standing charges are those expenses which remain constant
irrespective of the use or running of machine and examples of such expenses are rent and rates,
lighting and heating, insurance, supervising labour etc. Machine expenses as power, fuel,
depreciation, repairs etc. vary with the use of the machine.
3. Standing charges are estimated for a period for every machine and amount so estimated is
divided by the total number of normal working hours of the machine during that period in order
to calculate an hourly rate for fixed charges. For machine expenses an hourly rate is calculated
for each item of expenses separately by dividing the expenses by the normal working hours.
While calculating the normal working hours, the hours which are required for maintenance or for
setting- up or setting-off are to be deducted.
4. Total of standing charges rate and the machine expenses rate will give the ordinary machine
hour rate. If machine operator’s wages are also added into the simple machine hour rate then it
will be called comprehensive machine hour rate.
5. Sometimes supplementary rate is used when the charge for all other overhead cost is not
included in the machine hour rate i.e., only machine expenses are taken for the purpose
of machine hour rate. It is also used for correcting any error in the determination of machine
hour rate due to which there is heavy over- or under-absorption of overheads.
The bases which may be adopted for apportioning the different expenses for the
purpose of calculation of machine hour rate are given below:
Advantages:
1. It helps to compare the relative efficiencies and cost of operating different machines.
2. It brings to light the existence and extent of idle time of machines.
3. It enables the management to decide how far the use of machine work is preferable to manual
work.
4. It is most scientific, practical and accurate method of recovery of manufacturing overheads.
5. Cost reports prepared with the help of such rate are dependable and can help the
management in decision-making.
6. It provides useful data for estimating cost of production, setting standards and for fixing
selling prices for quotations.
7. It provides ready method for measuring the cost of idle machines if separate rates for fixed
and variable overhead rates are calculated. When hourly rate is fixed on the basis of anticipated
running hours of the machine, there is under-absorption of fixed overhead expenses if actual
running hours are less than the estimated.
Disadvantages:
1. It involves additional work in assessing the working hours of machines and thus it is a costly
method.
2. It does not take into account expenses that are not proportional to the working hours of
machines.
3. It gives inaccurate results if manual labour is equally important.
4. It is difficult to estimate the machine hours especially when production programme is not
available in advance.
5. Blanket rate cannot be used and it makes the method more costly.
Illustration 14:
A machine is purchased for cash at Rs 9,200. Its working life is estimated to be 18,000 hours
after which its scrap value is estimated at Rs 200.
It is assumed from past experience that:
Illustration 18:
A manufacturing company uses two identical large and four identical small machines. Each large
machine occupies one quarter of the workshop and fully employs three workers; each small
machine occupies half the space of a large machine and fully employs two workers. The workers
are paid by piece work.
Each of the six machines is estimated to work 1,440 hours per year, while the effective working
life is taken as 12,000 working hours for each large machine and 9,000 working hours for each
small machine. Large machines cost Rs 20,000 each, and small machines Rs 4,000 each. Scrap
values are Rs 4,000 and Rs 100 respectively.
Repairs, maintenance and oil are estimated to cost for each large machine Rs 4,000 and for each
small machine Rs 1,200 during its effective life.
Power consumption costs 5 P. per unit and amounts for a large machine 20 unit per hour and Tor
a small machine 2 unit per hour.
The manager is paid Rs 4,800 a year and workshop supervision occupies of his time, which is
divided equally among the six machines.
Details of other expenses are:
Rent and rates for workshop Rs 6,400 a year, Lighting (to be apportioned in the ratio of workers
employed) Rs 1,820 a year.
Taking a period of three months as a basic, calculate the Machine Hour Rate for a large machine
and a small machine respectively.
Solution:
Computation of Machine Hour Rate:
Set-up Time:
In the factories it is absolutely normal that some time is lost or consumed on the frequent setting
up the machines. The loss of time may be because of changes from one job to another or
because of breakdown etc. This time means the time when the machine is just idle. This is called
making machines ready time.
The cost of all such hours lost in setting up of the machines (including wages of workers as well
as other overheads) may be spread over the jobs actually completed. Sometimes even
separate machine hour rate are computed for running (productive) and this set up
(unproductive) time. Through this method one can ensure the full absorption of the
manufacturing overheads.
Illustration 19:
A manufacturing unit has purchased and installed a new machine of Rs 12, 70,000 to its fleet of
7 existing machines. The machine has an estimated life of 12 years and it is expected to realize
Rs 70,000 as scrap at the end of its working life.
Other relevant data are as follows:
(i) Budgeted working hours are 2,592 based on 8 hours per day for 324 days. This includes 300
hours for plant maintenance and 92 hours for setting up of plant.
(ii) Estimated cost of maintenance of the machine is Rs 25,000 (p.a.)
(iii) The machine requires a special chemical solution, which is replaced at the end of each week
(6 days in a week) at a cost of Rs 400 each time.
(iv) Four operators control operation of 8 machines and the average wages per person amount
to Rs 420 for week plus 15% fringe benefits.
(v) Electricity used by the machine during the production is 16 units per hour at a cost of Rs 3
per unit. No current is taken during maintenance and setting up.
(vi) Departmental and general works overhead allocated to the operation during last year was Rs
50,000. During the current year it is estimated to increase 10% of this amount.
Calculate machine hour rate, if (a) setting up time is unproductive; (b) setting up time is
productive.

Rate per Unit of Production:

This method is simple, direct and easy. It is suitable for mining and other extractive industries,
foundries, brick laying industries, where the output is measured in convenient physical units like
number, weight, volume etc.
The rate is calculated as under:

For example, if the overhead expenses (budgeted) are Rs 60,000 and budgeted production is
10,000 tonnes then overhead rate according to this method will be Rs 6 per tonne.
The main limitation of this method is that it is restricted to those concerns which produce only
one item of product or a few sizes, qualities or grades of the same product. If more than one
item is produced then it is essential to express dissimilar units against a common denominator
on weightage or point basis.
Sale Price Method:
Under this method budgeted overhead expenses are divided by the sale price of units of
production in order to calculate the overhead recovery rate.
The formula is:
The method is more suitable for apportioning of administration, selling and distribution,
research, development and design costs to costs of products. It can also be used with advantage
for the preparation of joint products costs.
This method is arbitrary and recovery made by this method is inequitable because overhead
costs have practically no relationship with the sale price of the products.
Overhead Rates for Service Cost Centres:
Generally overhead rates are fixed for production cost centres. Service departments’ costs are
apportioned to production departments on equitable basis.
Sometimes, under the following circumstances, separate overhead rates are
determined for service departments:
(i) When the base adopted for the recovery of production overhead is not suitable for service
departments.
(ii) When a service department is partly producing and partly rendering services to other
departments.
A separate rate for material storage and handling costs is fixed. Similar rates may be fixed for
the Tool Room, Inspection and Packing Department.
Choice of an Overhead Rate:
The method adopted for overhead absorption varies from industry to industry and from one
undertaking to another. Some firms use separate overhead rates for each type after classifying
the overhead expenses into several types. The choice of a most equitable method is very
important as the method adopted, if unsuitable, will distort costs and will be useless for control
and decision-making purposes.
Type of industry, nature of products and process of manufacture, organisation set up, individual
requirements and policy of management are the factors which affect the choice of an overhead
rate. Besides these, a satisfactory overhead rate should be simple, easy to operate, practical,
accurate, economic in application, fairly stable and related to time factor. It should be preferably
departmental rates as compared to blanket rates, homogeneous cost unit and should lay stress
on the main production element of the concern.
Following factors should be taken into consideration before formulating overhead
rates or deciding upon the basis for applying overheads to products:
1. Equitable apportionment of overhead:
The overhead rate should be such that overhead should be equitably apportioned to the cost
centres or cost units. The amount of overheads recovered should also be equivalent to the
amount of overheads incurred.
2. Simple and easy to understand:
The overhead rate should be simple to calculate and easy to understand. It should be convenient
in application. It should not require unnecessary or additional clerical work.
3. Relation with time factor:
Overhead rate should have some relation to the time taken by various jobs for completion. Thus,
if a job takes twice as much time as another job, the first job should be charged twice the
amount charged to the second job. It is because of this reason that direct wages percentage rate
is preferred over direct material cost percentage rate.
4. Separate rates for manual or machine work:
The work done by manual labour should be distinguished from work done by machines and
different overhead rates should be applied for manual and machine work. For example, when
work is done by manual labour, it should not be charged for anything in respect of machine
expenses like depreciation, repairs, maintenance etc.
5. Different overhead rates for different departments:
Different overhead rates should be ascertained for different departments where the nature of
the work done by one department is different from the work done by other department or
departments.
6. Selection on availability of information:
The selection of most appropriate overhead rate depends on the extent of information available
or recorded. For example, labour hour rate can only be applied where labour time cards are
maintained to record time spent by workers on each job, process or product.
7. Change of method:
The method should be subject to change from time to time depending upon the changes in the
factors on which it is based.
8. The work done by skilled workers should be distinguished from work done by
unskilled workers:
Normally unskilled workers do more wastage of materials, more wear and tear of machinery and
greater supervision on them is required because they are not skilled in doing the work. Hence,
method of absorption should make distinction between work done by skilled workers and that by
unskilled workers because work done by unskilled workers should have correspondingly higher
proportion of factory expenses. As a matter of fact, separate rate should be calculated for each
category of workers.

In this article we will discuss about the Machine Hour Rate:- 1. Definition of Machine
Hour Rate 2. Treatment of Machine Setting Time and Idle Time 3. Advantages of
Machine Hour Rate 4. Disadvantages of Machine Hour Rate 5. Method of Computation
of Machine Hour Rate 6. Comprehensive of Composite Machine Hour Rate 7. Setting
Times and Idle Time.
Contents:

1. Definition of Machine Hour Rate:

Machine hour rate is a rational method for absorption of factory overhead. The factory overhead
costs are allocated to a machine or a group of machines doing the same type of job and the cost
per hour of the machine is ascertained dividing the total allocated overhead costs to the
machine by number of hours the machine worked during the same period of time for which the
costs have been considered.
In this method of overhead absorption each machine is considered as cost centre.
The formula used to derive the machine-hour rate is given below:

Machine hour rate =

The machine-hour method is based on the principle that, in plants where production processes
are primarily mechanical, machines constitute a more important and costly element than labour.
Factory overhead costs are equitably apportioned to production on the basis of some rational
and accepted principles.
This method of overhead absorption can satisfactorily be used when all production overheads
are departmentalized and the overheads of the service departments are apportioned to the
production departments.
2. Treatment of Machine Setting Time and Idle Time:
It is the usual practice to find out the total potential hours for the computation of machine hours.
The cost of idle time may be calculated separately. Alternatively, only effective machine hours
may be ascertained by making allowance for idle time or setting time. By doing this, the
machine hour rate is inflated by absorbing the machine hour cost for idle time.
For example:
The total indirect cost allocated to a particular machine is Rs.20,000. Machine hours are 2,200
out of which 200 hours are for idle time.
The machine hour rate will be:
20,000/2,000 = Rs.10
Effective machine hours = 2,200 hours – 200 hours (idle time) = 2,000 hours.
3. Advantages of Machine Hour Rate:
The following are the advantages of Machine Hour Rate:
(i) It is perhaps the most realistic and accurate method of allocating expenses to each job from
cost accounting point of view.
(ii) This is the best and logical method of charging overheads where one operator attends to
several machines or several operators are engaged on one machine.
(iii) It is a scientific method of absorbing overheads since it takes into consideration the time
factor completely.
(iv) From the management point of view, it is the best method of absorption of overheads since
it is a scientific and logical method and it can be used easily.
(v) Under-absorption will reveal the extent to which the machines remained idle.
4. Disadvantages of Machine Hour Rate:
The following are the disadvantages of Machine Hour Rate:
(i) This method involves increased costing work.
(ii) This method of absorption can be applied to job which is performed by machines only.
5. Method of Computation of Machine Hour Rate:
The following steps have to be taken for the computation of machine-hour rate:
Expenses are apportioned on the basis of accepted principles.
Step I:
All standing or fixed expenses for a particular period of time say for a year or for a month, are
added up. The total standing expenses thus arrived at, is divided by number of hours the
machine worked i.e. machine hours for that period of time.
It is essential that standing charges for the machine or group of machines which has been
considered as cost centre should be considered. The resultant figure will give us the fixed
expenses per hour. Fixed expenses are rent, rates and taxes for the factory, insurance, lighting,
supervision expenses, canteen and other welfare expenses.
Step II:
Variable expenses pertaining to the cost centre, i.e. machine or group of machines are
considered. Variable expenses comprise depreciation, power, fuel, repairs and renewals. An
hourly rate is calculated by dividing each item of variable expenses by normal working hours of
the machine.
Step III:
Hourly rate of standing charges and hourly rates of each item of variable expenses are added up
to derive the total machine hour rate.
Basis of apportionment of standing and variable expenses pertaining to the machine:

6. Comprehensive of Composite Machine Hour Rate:

Generally, in the computation of Machine hour Rate only indirect expenses in connection with
the factory are apportioned or allocated. Machine operator’s wages are treated as direct wages
and charged to the job directly. But, machine operator’s wages are included, in certain cases, in
the machine hour rate itself.
The machine hour rate so arrived at is known as a comprehensive or composite machine hour
rate. This rate is useful where not only the operator but a distinct group of workers can be
identified directly with the machine or group of machines. It is to be noted that this method
converts the elements of prime cost (direct labour) into factory overhead. It is, therefore, of
advisable to compute comprehensive machine hour rate.
7. Setting Times and Idle Time:
In a factory, machines do not work for the full working hours. Certain hours become
unproductive because machines remain idle for some hours because of certain factors like
setting of tools, waiting for raw materials.
In estimating the total machine hours for the computation of the machine hour rate it is the
general practice to consider the total potential hours including the possible idle hours. The
positive aspect of this method is that the cost of idle time can be separately worked out which
will help the management in controlling the idle expenses from period to period.
Conversely, in computing machine hour rate, only the net effective or productive hours are
considered. The object of this treatment is to absorb the idle time cost into cost of production.
Similarly, certain machine hours are lost in tool setting. Logically, the tool setting time should
form a part of the actual machine hours against the job and the setting hours are also charged to
the jobs at the same machine hour rate.
In practice, many Cost Accountants favour the method of finding out machine hour
rate for effective productive hours which is calculated as follows:
Effective hours = Machine Hours – Idle time – Setting time

Some Steps Meant For Computation of Machine Hour Rate

Under this computation technique, machine hours are used as a foundation for determining operating cost
absorption rate. It is the operating cost of the machine for one hour.
This technique is suitable for industries where foremost portion of the production is performed via the
machines. It is not enviable to compute machine hour rate of the entire industry since all the machines
may not be consistent in every respect.
Hence part rate is computed for each machine or for a set of identical machines. Machine hour rate is
resolute by dividing the amount of overheads relating to the machine by the number of effectual machine
hours.

About The Computation Technique of Machine Hour Rate

Computation of Machine Hour Rate in dissimilar from all the above mentioned techniques. Under this
technique, the machine is treated as a little department or cost center to allocate various expenses to the
machines presently as the expenses charged to superior departments.
While computing machine hour rate, the fixed and variable expenses require to be segregated to yield a
better effect. Even if the machine is at rest, it does not have any force on the fixed overheads, while it has
a significant effect on top of the variable expenses. Owing to these reasons we require to compute
Machine Hour Rate in a systematic way.

Some Steps for Computation Technique Of Machine Hour Rate

Step-1: Each machine or group of machines should be handled as a separate cost center.

Step-2: Overheads are categorized into two groups for example standing charges and machine expenses.
Standing charges are fixed expenditures which do not vary with the make use of of machine. Instances of
standing charges are rent, lighting, rates, insurance, etc.
Machine expenses are changeable expenses which fluctuate with running of machines, for example
depreciation, power, maintenance, repairs, etc. Some accountants treat reduction as a standing charge.
Infect reduction can be treated as fixed or variable expenses depending upon the technique pursued for
its calculation. On the other hand for all practical purposes we have handled depreciation as a machine
cost for computation of machine hour rate.

Step-3: The effectual machine hours of each machine for a specified period need to be calculated as
shown under:

Step-4: The standing charges are approximated for a given period (year, month or week) for every
machine and the whole sanding charges are divided by the total number of effectual working hours of the
machine to turn at the hourly rate of standing charges.

Step-5: The machine expenses of each one machine are treated unconnectedly in order to compute the
hourly rate. Every machine cost of a machine is calculated either by portion or by apportionment.
Step-6: The collective of the standing charges per hour and hourly rate of all the human being machine
expenses is intended to arrive at the simple Machine Hour Rate. When the machine operator's wages
added to the easy machine hour rate, it is well-known as Comprehensive Machine Hour Rate.

Comprehensive M.H.R. = Machine operator's wages + Simple M.H.R.

While computing machine hour rate a number of the overheads may require to be apportion for the
desired machine cost center.

Cost accounting assignment help is easy to get to online from scores of experts they are available to
provide assignment help and also multiple answers to problems.