In this article we will discuss about:- 1. Meaning of Machine Hour Rate 2. Types of Machine Hour Rates 3. Computation 4. Other Points to be Borne in Mind While Computing Machine Hour Rate 5. Advantages 6. Disadvantages.
Contents:
- Meaning of Machine Hour Rate
- Types of Machine Hour Rates
- Computation of Machine Hour Rate
- Other Points to be Borne in Mind While Computing Machine Hour Rate
- Advantages of Machine Hour Rate
- Disadvantages of Machine Hour Rate
1. Meaning of Machine Hour Rate
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Machine hour rate method is one of the methods of absorption of factory overheads into production. In industries like chemicals, engineering, steel and other heavy industries where the work is done mostly by machines, it is desirable to adopt the machine hour rate method for the absorption of factory overheads, because, in such industries, factory overheads largely consist of expenses relating to the maintenance and operation of machines.
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Under the machine hour rate method, first, a separate machine hour rate is established for each machine or a group of similar machines. Then, at the established machine hour rate or rates, factory overheads are charged to production, depending upon the number of hours for which a machine or machines are used for the particular product or job. For example – if on Job No. 51, machine ‘A’ works for 10 hours and the machine hour rate for the machine ‘A’ is Rs. 2.25, then, Job No. 51 will be charged with Rs. 22.50 (i.e. 10 × 2.25) by way of factory overheads.
It refers to the overheads incurred for running a machine for one hour. This is the most scientific method of overhead absorption when compared to all other methods. The institute of Cost and Management Accountants, London, has defined as 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.”
In other words, machine hour rate refers to the amount of factory overheads incurred for running a machine for an hour. In short, machine hour rate means the factory expenses incurred in running a machine for an hour. The machine hour rate is calculated by dividing the total amount of factory overheads incurred in running a machine during a particular period by the total number of working hours of that machine during that period.
It can be expressed in the form of a formula as follows:
This method is most suited where machines are used predominantly for production purpose.
2. Types of Machine Hour Rates
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There are two types of machine hour rate, viz.:
1. Simple or Ordinary Machine Hour Rate.
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2. Composite or Comprehensive Machine Hour Rate.
1. Simple Machine Hour Rate:
Simple machine hour rate, generally, means only the total machine expenses or the total variable expenses like power, fuel, repairs and depreciation of the machine which are directly connected with the operation of the machine per hour.
2. Composite Machine Hour Rate:
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Composite machine hour rate means the total variable expenses per hour plus the total fixed, constant or standing charges per hour not directly connected with the operation of the machine, but are the general factory overheads of the department. In other words, it is the machine hour rate which includes the total machine expenses per hour plus the total fixed charges per hour plus the direct wages of machine operators per hour.
3. Computation of Machine Hour Rate
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The following steps are involved in calculating a machine hour rate:
(1) The factory overheads are first apportioned to production departments under allocation and apportionment.
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(2) Overheads of the departments are further apportioned to different machines or group of machines. For this purpose each machine or a group of machines is treated as a cost centre or a small department.
(3) Specific overheads like power, depreciation, etc., should be directly allocated to the machine.
(4) The working hours of a machine are estimated for the period.
(5) Overheads pertaining to the machine are totalled and divided by the number of effective machine hours. The resultant figures will be machine hour rate. The time required for getting the machine should be deducted from the total working hours to arrive at effective hours.
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(6) Where comprehensive machine hour rate is desired include direct wages along with other expenses incurred for operating the machine.
(7) Those overheads which can be allocated directly to the machine, such as depreciation, power repairs and maintenance are to charged, specifically to the machine.
(8) Along with above, include cost of stand by equipment to calculate machine hour rate.
(9) Make necessary adjustments for calculating the effective machine hours by deducting cleaning and warming up time.
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Departmental overheads can be classified into two broad heads:
(I) Standing or Fixed Charges:
Standing or fixed charges refer to those charges which remain constant or fixed irrespective to the use of running of the machine. Example of standing charges are rent, rates and taxes, lighting and heating, insurance charges of the machine, insurance charges of the building, indirect wages, supervisory charges, general expenses, labour welfare expenses, etc.
In this context, it may be noted that, generally, all expenses other than depreciation of the machine, repairs and maintenance charges of the machine, and power, steam and water are considered as fixed charges. All these expenses are allocated to all the machines of the department on a logical basis.
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The main bases of the allocation of fixed expenses are as follows:
II. Variable Expenses:
Variable expenses refer to those expenses which vary with the use of the machine. Example of variable charges are depreciation of machine, repairs and maintenance charges of the machine, power, steam and water (consumable stores like lubricants, cotton waste and rags etc., are also regarded as variable expenses by some scholars.)
The main variable expenses are:
1. Depreciation on the Machine:
As regards the depreciation on the machine, certain portion of depreciation is attributable to the use of the machine. That means a part of the depreciation is a fixed charged and a part is a variable charge. But it is difficult to ascertain that part of depreciation which is fixed and that part of depreciation which is variable. So, generally, the entire depreciation on the machine is treated as variable charges.
Depreciation is calculated on the cost of machine. Cost of the machine includes not only the purchase price of the machine, but also the freight charges on the bringing of the machine to the factory and the installation charges. Further, the cost of standby or reserve equipment, such as spare motors, switch gears, etc., also should be included in the cost of the machine.
Another point to be noted in the context of depreciation on the machine is that, while calculating the depreciation on the machine, the replacement cost, even if it is given, should not be taken into account. Only its original cost and scrap value should be taken into account.
These can be expressed in the form of formula as follows:
Where,
(1) Cost of Machine = This includes purchase price of the machine, carriage inward and installation charges.
(2) Scrap Value = Value of machine remaining after its exhaustive use.
(3) Total Working Hours of Machine = It means total working hours during the life time of the machine.
2. Repairs and Maintenance Charges:
If the problem does not state whether the given repairs and maintenance charges are for the life time of the machine or for one year, one can assume that the given repairs and maintenance charges are for the life time of the machine. Repairs and maintenance charges are divided by the working hours for the concerned period to find out repairs and maintenance charges per hour.
3. Power Expenses:
Those expenses which are concerned with the operation of the machine are called power expenses.
This can be calculated separately per hour as follows:
Or
(b) Number of Units of power consumed per hour x Rate of Power per Unit
4. Steam and Water:
For its calculation, instructions given in question are followed.
Note:
If expenses per hour are given, they are directly used. In such cases expenses per hour are not required to calculate. Lastly total of standing charges and variable expenses p.h. are added together to find out machine hour rate.
4. Other Points to be Borne in Mind While Computing Machine Hour Rate
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1. Base Period:
In every problem in machine hour rate certain period is taken as the base. Such a period is called base period. The base period may be a year, half year, a quarter, a month, a week or a day. Though any of the above periods can be taken as the base period.
It is preferable to take that period for which most of the fixed charges are given per annum, it is better to take one year as the base period. If most fixed expenses are given for one month, then, it is better to take one month as the base period. If most of the fixed charges are given for a week, it is better to take week as the base period.
2. Effective or Productive Working Hours:
The effective working hours of the machine during the base period is necessary for the calculation of the total fixed charges per hour and each of the variable charges per hour. So, it has to be calculated.
The effective working hours of the machine can be calculated as follows:
From the total normal working hours of the machine, the hours required for maintenance and repairs, setting up, cleaning of machine, warming up, staggering and the time cost due to other normal idle time of the machine must be deducted. The resulting balance is the effective working hours of the machine.
It may be noted that the time required for the setting up of the machine should be deducted from the normal working hours of the machine only if it is considered as unproductive time. On the other hand, if the setting up time is considered as productive time, it should not be deducted.
It should also be noted that the abnormal idle time resulting from break-down of machine, power failure, etc., should not be deducted from the normal working hours. Only the normal idle time due to maintenance and repair, setting up, and staggering should be deducted.
The idea behind deducting the normal idle time from the normal working hours is that when we take only the effective working hours for the calculation of the machine hour rate, the cost of normal idle time, which is one of the factory overheads, is also absorbed in the machine hour rate.
3. Machine Operator’s Wages:
Machine operator’s wages refer to wages of workers, such as turners and fitters who operate the machine. Strictly speaking, wages of machine operators are direct wages and so, it should not be taken into account as factory overhead in the computation of machine hour rate. That is why, some of the authors do not include machine operator’s wages in the computation of machine hour rate.
However, there are some authors who treat the wages of machine operators as indirect wages on the ground that the machine operators cannot be retrenched in the event of fall in production, and so, include their wages as fixed Overhead charges in the computation of the machine hour rate and call the resultant machine hour rate as comprehensive or composite machine hour rate.
Again, there are few authors who are of the opinion that, if the machine operators attend to only one machine, their wages should be treated as direct wages, and so, their wages should not be included in the computation of machine hour rate.
On the other hand, if the machine operators attend to a number of machines simultaneously, then, their wages should be treated as indirect wages, and so proportionate wages of machine operators should be included in the computation of machine hour rate.
In view of the controversy in the examination, students can give to the wages of machine operators any treatment they want, by writing a note.
4. Consumable Stores:
Consumable stores refer to lubricating oil, cotton waste, rages, etc. used for cleaning the machines. There is a different of opinions among the authors as regards the treatment of these expenses. Some authors argue that these expenses vary with the use or running of the machine, and as such, they should be treated as variable expenses. But there are other authors who take them as fixed or standing charges.
In view of this controversy, in the examination, students may treat the consumable stores in any way they want by writing a note to that effect. However, the author is of the view that the consumable stores may be considered as fixed or standing charges.
5. Hire Purchase Instalment:
Sometimes, a machine might have been purchase on hire purchase system. In such a case, the price of the machine is payable in instalments. Each instalment payable is called hire purchase instalment. In each hire purchase instalment, some amount is payable towards the cash price of the machine and some amount is payable towards the interest for the outstanding cash price of the machine.
The hire purchase instalment amount has to be treated as follows:
The amount payable in each instalment towards the cash price of the machine should not be included in the computation of the machine hour rate, as it is capital expenditure, and not revenue expenditure.
However, as regards the amount payable in each instalment towards the interest, there is difference of opinion among authors. Some authors consider the hire purchase interest as one of the fixed charge, and as such, include it in the calculation of the machine hour rate.
But there are others who consider the hire purchase instalment interest as pure financial charges, and as such, exclude it from the computation of the machine hour rate.
In view of this controversy, in the examination, students may treat the hire purchase instalment interest in any way they want by giving a note to that effect.
5. Advantages of Machine Hour Rate
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Machine hour rate method of absorption of factory overheads has certain advantages.
They are:
(1) Machine hour rate method is a scientific, practical and accurate method of absorption of factory overheads in industrial undertakings where the work is done predominantly by machines.
(2) This method takes into account time factor and hence gives accurate results.
(3) It provides useful data for estimating the cost of a job, setting standards and for fixing selling prices for quotations.
(4) It helps the management to decide how far machine work is preferable to manual work.
(5) It makes distinction between skilled and unskilled labour in the absorption of factory overheads into production.
(6) It helps to compare relative efficiencies and the costs of operating different machines.
(7) It brings to light the existence and the extent of idle time of machines, if separate machine hour rates are established for fixed overheads and variable overheads.
(8) This is an ideal method of absorption where production is carried out on machines.
(9) Cost reports prepared with the help of such rate are dependable and can help the management in decision-making.
6. Disadvantages of Machine Hour Rate
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Machine hour rate method of absorption of factory overheads has certain disadvantages.
They are:
(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) This method is not suitable where most of the production work is done by manual work.