In factories or departments, where production is largely by machinery, this method gives greater accuracy than any of the other methods discussed earlier. The terminology defines a machine hour rate as “a rate calculated by dividing the budgeted or estimated overhead or labour and overhead cost attributable to a machine or group of similar machines by the appropriate number of machine hours. The hours may be the number of hours for which the machine or group is expected to be operated, the number of hours which would relate to normal working for the factory, or full capacity”. In a highly mechanised cost centre, majority of the overhead expenses are incurred on account of using the machine, such as, depreciation, power, repairs and maintenance, insurance, etc. Machine hour rate, therefore, provides the most equitable basis for absorption of overheads in machine intensive cost centres.
The overhead expenses are to be departmentalized first. Then, each machine or a group of machines within the department shall be treated as a cost centre, and all the items of expenses are allocated to the machine cost centres on some suitable basis. A machine hour rate is then computed by dividing the total overhead for the machine cost centre by the anticipated machine hours. For example, in the cigarette making department, there are twenty machines of which eight machines manufacture filter cigarettes, five machines plain medium cigarettes, and seven machines produce magnum size cigarettes. In such a situation, three different machine hour rates are to be computed for three groups of machines. Machine hour rate can be bifurcated into variable or running expenses and standing or fixed expenses in order to differentiate between expenses being incurred while running the machine compared to when it remains idle. For example, power, oil, grease and cotton waste, repairs and maintenance expenses are running or variable, while depreciation, rent and taxes, lighting and heating, insurance and supervision are included under standing or fixed charges. Lastly, a machine hour rate may include the wages of the machine operator and attendance, if they become part of the complements. For example, in cigarette making machine, the operator and two catchers become part of the machine, because as long as the machine operates, they have to attend the machine and gain the same speed, say 2000 cigarettes per minute, as the machine produces. Such rate is called comprehensive machine hour rate. Needless to mention that operators wages shall be included as variable overhead expenses.
Computation of Machine Hour Rate in different from all the above mentioned methods. Under this method, the machine is treated as a small department or cost center to apportion various expenses to the machines just as the expenses charged to bigger departments.
While computing machine hour rate, the fixed and variable expenses need to be segregated to yield a better result. Even if the machine is idle, it does not have any impact on the fixed overheads, whereas it has a significant effect on the variable expenses. Because of these reasons we need to compute Machine Hour Rate in a systematic manner.
Steps for Computation of Machine Hour Rate
Step-1: Each machine or group of machines should be treated as a separate cost center.
Step-2: Overheads are classified into two groups such as standing charges and machine expenses. Standing charges are fixed expenses which do not vary with the use of machine. Examples of standing charges are rent, rates, lighting, insurance, etc.
Machine expenses are variable expenses which vary with running of machines, such as depreciation, repairs, power, maintenance, etc. Some accountants treat depreciation as a standing charge.
Infect depreciation can be treated as fixed or variable expenses depending upon the method followed for its calculation. However for all practical purposes we have treated depreciation as a machine expense for computation of machine hour rate.
Step-3: The effective machine hours of each machine for a given period need to be calculated as shown below:
Step-4: The standing charges are estimated for a given period (year, month or week) for every machine and the total sanding charges are divided by the total number of effective working hours of the machine to arrive at the hourly rate of standing charges.
Step-5: The machine expenses of each machine are treated separately in order to compute the hourly rate. Each machine expense of a machine is calculated either by allocation or by apportionment.
Step-6: The aggregate of the standing charges per hour and hourly rate of all the individual machine expenses is calculated to arrive at the simple Machine Hour Rate. When the machine operator's wages added to the simple machine hour rate, it is known as Comprehensive Machine Hour Rate.
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