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.
- Definition of Machine Hour Rate
- Treatment of Machine Setting Time and Idle Time
- Advantages of Machine Hour Rate
- Disadvantages of Machine Hour Rate
- Method of Computation of Machine Hour Rate
- Comprehensive of Composite Machine Hour Rate
- Setting Times and Idle Time
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:
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.
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.
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.
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.
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