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.
Definition of Machine Hour Rate
Institute of Cost and Management Accountants defined as machine hour rate as, “an actual or predetermined 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.”
It 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.
Types of Machine Hour Rates
1. Simple Machine Hour Rate: It 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: It 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
- It helps to compare the relative efficiencies and cost of operating different machines.
- It brings to light the existence and extent of idle time of machines.
- It enables the management to decide how far the use of machine work is preferable to manual work.
- It is most scientific, practical and accurate method of recovery of manufacturing overheads.
- Cost reports prepared with the help of such rate are dependable and can help the management in decision-making.
- It provides useful data for estimating cost of production, setting standards and for fixing selling prices for quotations.
- It involves additional work in assessing the working hours of machines and thus it is a costly method.
- It does not take into account expenses that are not proportional to the working hours of machines.
- It gives inaccurate results if manual labour is equally important.
- It is difficult to estimate the machine hours especially when production programme is not available in advance.