Computation of Machine Hour Rate

What is Machine Hour Rate?

Machine hour rate represents the hourly cost of factory overhead for operating a particular machine and is obtained by dividing the factory expenses connected with a machine for a given period by the number of hours worked by the machine during that period.

The Institute of Cost and Management Accountants, London, defines the machine hour rate as “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 do we need for Computation of Machine Hour Rate?

Machine hour rate is computed for the recovery or absorption of factory overhead. This basis for recovery of overhead is adopted in those industrial concerns where most of the work is carried on with the help of machines and as such most of the factory expenses are caused by machine operations.


For computing the machine hour rate, each machine or a group of similar machines in a production department is considered as a smaller department and the departmental expenses are re-apportioned to the machines or groups of machines in the department. For this purpose, the following basic factors are to be considered:

(i) Base Period

A ‘Base Period’ is to be taken for each machine for computing the machine hour rate. The base period refers to the period of time for which the hourly rate is to be computed and may be a year, a quarter, a month or a week.

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(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

All the departmental expenses to be considered for computing the machine hour rate are divided into two parts:


(a) Standing charges (or fixed expenses).
(b) Running charges (or variable expenses or machine expenses).

Standing Charges

Standing charges include all those expenses which remain fixed or constant and relate to the department as a whole. These are not affected by the operation of the machines e.g., rent, rates and insurance of factory building, cost of factory supervision, factory lighting, insurance of machine etc.

Running Charges

These include the expenses which are incurred in connection with the operation of the machines e.g., depreciation, repairs and maintenance, power, steam, water, etc.

(iv) Computation of Hourly Rate of Standing Charges

For computing the machine hour rate all the standing charges relating to the Production department will be apportioned to the individual machines on the following bases:

ItemsBasis 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) Insurance of Machinery(d) Time devoted by supervisory staff of each machine and value of machinery
(e) Miscellaneous Expenses e.g., lubricating oil, grease, cotton waste, sundry stores(e) Actual quantity used (whenever possible) or any other equitable basis.
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The standing charges will be taken for the ‘base period’. The total of the standing charges apportioned to each machine for the base period will be divided by the total working hours of the machine in the base period to obtain the ‘hourly rate of standing charges’.

(v) Computation of Hourly Rate of Machine Charges

The hourly rate of various items of ‘machine charges’ or ‘running charges’ will
be computed separately in the following manner:

(a) Depreciation

For the purpose of calculating the hourly rate of depreciation of machine, the original cost of the machine, its effective working life in terms of running hours after giving due consideration to the risk of obsolescence and its estimated scrap value (or residual value) at the end of its working life will have to be ascertained. The hourly rate of depreciation of the machine will be calculated by 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 of the machine over its effective working life is estimated on the basis of past experience. The hourly rate of repairs and maintenance cost will be ascertained by applying the following formula:

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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 will be ascertained on the basis of:

(i) actual hourly consumption, or
(ii) estimated hourly consumption ascertained on the basis of past experience.

The hourly rates of standing charges and running charges will be aggregated to obtain the machine hour rate.

Example

Computation of machine hour rate can be explained with the help of the following illustrations:

From the following information compute a machine hour rate in respect of 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 this machine for January 2019: 100
Power consumed by the machine: 10 units per hour at 10 paise per unit.

Solution:

Computation of Machine Hour Rate

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