Machine Hour Rate, Functions and Steps for Computation of Machine Hour Rate

Machine Hour Rate (MHR) is the cost per hour of running a machine, used to allocate overhead costs in industries where production heavily depends on machinery. It helps in determining the cost of operating a machine, including expenses like depreciation, maintenance, power, fuel, and operator wages. The formula for MHR is:

Machine Hour Rate = Total Machine Expenses / Total Machine Hours Worked​

Where Total Machine Costs include:

• Depreciation – Cost of machine spread over useful life

• Insurance – Annual insurance premium for the machine

• Repairs and Maintenance – Estimated maintenance costs

• Power/Electricity – Cost of energy consumed per hour

• Salaries of Operators – If directly attributable to machine

• Other Overheads – Any indirect cost specifically related to the machine

Total Machine Hours = Number of hours the machine is available for production in a period (after accounting for downtime).

This method ensures accurate cost distribution and helps in pricing decisions, cost control, and efficiency analysis. It is widely used in manufacturing industries where machine usage directly influences production costs.

Example

A machine has the following annual costs:

• Depreciation: ₹20,000

• Insurance: ₹2,000

• Repairs: ₹3,000

• Power: ₹5,000

• Operator Salary: ₹10,000

The machine is available for 5,000 hours per year.

Machine Hour Rate = (20,000+2,000+3,000+5,000+10,000) / 5,000 = 40,0005,000 = ₹8 per hour

Hence, the cost of using the machine per hour is ₹8, which can be charged to products based on usage.

Functions of Machine Hour Rate

• Accurate Cost Allocation

Machine Hour Rate (MHR) ensures accurate allocation of manufacturing overheads to different jobs or products based on actual machine usage. It distributes costs like depreciation, power, and maintenance proportionately, preventing cost distortions. This method is especially useful in industries with significant machine operations, ensuring fair cost distribution. By linking costs directly to machine operation, businesses can make precise product costing decisions, ultimately leading to better pricing strategies and cost control mechanisms.

• Pricing Decision Support

MHR plays a crucial role in determining product prices by providing a clear breakdown of machine-related expenses. Since accurate cost determination is essential for setting competitive and profitable prices, using MHR ensures that all machine costs are factored into the final price. This helps companies avoid underpricing, which leads to losses, or overpricing, which affects market competitiveness. It enables managers to adjust pricing strategies effectively to maintain profitability while remaining competitive in the industry.

• Efficiency Measurement and Cost Control

By tracking machine costs per hour, businesses can monitor efficiency levels and identify areas for improvement. If the MHR is high, it may indicate inefficiencies such as excessive machine downtime, high maintenance costs, or energy wastage. This analysis helps managers implement corrective measures, such as optimizing maintenance schedules, upgrading machinery, or improving machine utilization rates. A well-monitored MHR system ensures operational efficiency, reducing unnecessary expenses while maximizing productivity.

• Budgeting and Forecasting

MHR aids in budgeting and financial planning by estimating future production costs based on expected machine usage. Companies can use this data to prepare realistic production budgets, set financial targets, and allocate resources effectively. By analyzing historical MHR data, businesses can anticipate cost fluctuations, plan capital expenditures, and manage machine-related expenses proactively. This function helps maintain financial stability by ensuring that machine costs are planned and controlled effectively over time.

• Decision Making on Investments

MHR provides valuable insights into the cost-effectiveness of machinery investments. By comparing the machine hour rates of different machines, businesses can determine whether upgrading or replacing machinery is a cost-effective decision. If a machine has a high MHR due to frequent breakdowns or excessive power consumption, investing in newer, more efficient equipment may be justified. Thus, MHR helps managers make informed capital investment decisions, ensuring better utilization of financial resources and long-term cost savings.

• Job Costing and Profitability Analysis

MHR plays a crucial role in job costing by assigning machine-related expenses to specific jobs, projects, or production runs. This ensures that every job accurately reflects the true cost of machine usage, leading to precise cost estimates and profitability analysis. Businesses can evaluate which jobs are more profitable and which ones require cost optimization. This function is especially beneficial for manufacturing and engineering firms, where machine-intensive operations significantly impact production costs and overall profitability.

Steps for Computation of Machine Hour Rate

Machine Hour Rate (MHR) is the cost of operating a machine for one hour, including depreciation, running expenses, and overheads. It is crucial for assigning accurate machine costs to products in industries where machine operations dominate. The computation involves a series of systematic steps, ensuring that all relevant costs are included.

Step 1. Identify the Machine

The first step is to select the machine for which the hour rate is to be computed. Each machine may have different costs, operating hours, and efficiency levels. Identification includes understanding its purpose, production capacity, and contribution to the manufacturing process. Proper identification ensures that only relevant costs and working hours associated with that particular machine are included in the computation, avoiding any misallocation of overheads.

Step 2. Determine Fixed Costs

Fixed costs of the machine include expenses that do not vary with usage, such as depreciation, insurance, and the salaries of permanent operators. Depreciation is calculated based on the cost of the machine, its expected useful life, and residual value. Insurance is annual premiums for coverage. These costs remain constant regardless of machine utilization and must be included in the total machine cost to compute an accurate hourly rate.

Step 3. Determine Variable Costs

Variable costs change with machine operation and include fuel, power, lubricants, repairs, and consumables. The estimation involves assessing the consumption of electricity, fuel, and other resources per hour of operation. Maintenance and repair costs are included on an estimated annual basis, considering machine wear and tear. Accurate estimation of variable costs ensures that machine hour rate reflects the actual cost of running the machine for production purposes.

Step 4. Include Operator Costs

If a machine has a dedicated operator, their wages should be included in the machine cost. Salaries of permanent or full-time operators assigned to the machine are part of the fixed costs, while overtime or hourly payments may be treated as variable costs. Including operator costs ensures that labor directly associated with the machine is reflected in the machine hour rate, providing a realistic basis for overhead absorption.

Step 5. Include Other Overheads

Other overheads specifically related to the machine, such as factory rent proportionate to machine space, lighting, and supervision costs, should be included. These indirect costs ensure that the machine hour rate represents a comprehensive cost of operating the machine. Allocating relevant overheads to the machine improves accuracy in product costing and assists management in better budgeting and controlling machine-related expenses.

Step 6. Estimate Total Operating Hours

Total operating hours represent the actual hours the machine is available for production. It is calculated by deducting downtime for maintenance, repairs, and idle periods from total calendar hours. Accurate estimation is essential because the machine hour rate is sensitive to the number of working hours; fewer hours increase the rate, while more hours reduce it. Consider seasonal variations or expected production schedules while calculating total operating hours.

Step 7. Compute Total Machine Costs

Add all fixed costs, variable costs, operator costs, and other overheads to arrive at the total machine cost for the period. This aggregation includes depreciation, insurance, repairs, power, lubricants, wages, and allocated overheads. Total machine costs represent the full expenditure incurred in making the machine available for production during the accounting period, providing a comprehensive base for calculating the hourly rate.

Step 8. Calculate Machine Hour Rate

Divide the total machine costs by total operating hours to compute the machine hour rate. The formula is:

Machine Hour Rate = Total Machine Costs / Total Operating Hours​

This gives the cost per hour of machine operation, which can then be applied to products based on machine hours used in production, ensuring accurate cost allocation.

Step 9. Apply Machine Hour Rate to Products

Once the machine hour rate is computed, it is multiplied by the actual hours a machine is used to manufacture each product. This allows the absorption of machine overheads into product costs. Accurate application ensures fair distribution of machine costs, prevents under- or over-costing, and supports pricing, budgeting, and profitability analysis.

Step 10. Review and Adjust Periodically

Machine hour rates should be reviewed periodically to reflect changes in costs, operating hours, or efficiency. Increases in power rates, maintenance costs, or operator wages, or changes in machine usage patterns, require adjustments to the rate. Periodic review ensures that product costing remains accurate and relevant, and it assists in maintaining control over machine-related overheads and decision-making regarding production and resource utilization.

These steps ensure that the Machine Hour Rate is accurately computed, covering all relevant costs and operating hours, forming a reliable basis for product costing, overhead absorption, and managerial decision-making.