Rate Per Machine Hour

Definition

Rate Per Machine Hour: A method used in absorption costing to allocate manufacturing overhead costs to products based on the number of machine hours used in their production. The formula for calculating the rate per machine hour is:

\[ \text{Rate Per Machine Hour} = \frac{\text{Total Manufacturing Overhead}}{\text{Total Machine Hours Used}} \]

While this method helps assign overhead costs to cost units based on machine usage, it might not be as precise if overhead costs do not directly correlate with machine hours. For a more accurate cause-and-effect allocation of costs, activity-based costing (ABC) systems may be employed.

Examples

Example 1: A company has total manufacturing overhead costs of $50,000 for a period and utilized 5,000 machine hours during that period. The rate per machine hour would be:

\[ \frac{50000}{5000} = $10 \text{ per machine hour} \]

This rate implies that for every hour a machine operates, $10 of overhead costs are allocated to the product.
Example 2: If another company had manufacturing overhead costs of $125,000 and 25,000 machine hours used, the rate per machine hour would be:

\[ \frac{125000}{25000} = $5 \text{ per machine hour} \]

Frequently Asked Questions

What is absorption costing?

Absorption costing is an accounting method where all manufacturing costs are absorbed by the units produced. These costs include direct materials, direct labor, and both fixed and variable manufacturing overhead.

How useful is the rate per machine hour for managers?

The rate per machine hour is helpful for managers to cost products based on machine usage. However, it may not be very useful if overheads do not vary directly with machine hours. In such cases, activity-based costing may provide a more accurate allocation of costs.

What is activity-based costing (ABC)?

Activity-based costing is a costing methodology that assigns overhead and indirect costs to related products and services based on their actual consumption of resources.

Can rate per machine hour be used for service industries?

Typically, the rate per machine hour is more applicable in manufacturing industries with significant machine usage. In service industries, other bases for overhead allocation, such as labor hours, may be more appropriate.

How can inaccuracies arise in using rate per machine hour?

Inaccuracies can arise if overhead costs do not change in proportion to machine hours. For instance, fixed costs such as rent will not vary with machine usage, leading to potential distortions in cost allocation.

Absorption Costing: An accounting method where all manufacturing costs are assigned to products, ensuring that each unit of product carries a portion of fixed and variable overhead.
Manufacturing Overhead: All indirect costs associated with manufacturing, including utilities, depreciation, and salaries of supervisory staff.
Cost Units: A standard unit of measure of the product or service to which costs are allocated.
Activity-Based Costing: An accounting method that assigns overhead and indirect costs to specific activities, providing a more precise allocation compared to absorption costing.
Cause-and-Effect Allocation: Allocating costs based on the cause of the costs and how they relate to the production of goods or services.

Online References

Suggested Books for Further Studies

Managerial Accounting by Ray H. Garrison, Eric Noreen, and Peter Brewer.
Cost Accounting: A Managerial Emphasis by Charles T. Horngren, Srikant M. Datar, and Madhav V. Rajan.
Principles of Managerial Accounting by James Jiambalvo.
Management and Cost Accounting by Alnoor Bhimani, Charles T. Horngren, Srikant M. Datar, and Madhav V. Rajan.
Activity-Based Costing: Making It Work for Small and Mid-Sized Companies by Douglas T. Hicks.

Accounting Basics: “Rate Per Machine Hour” Fundamentals Quiz

### What does the Rate Per Machine Hour help to allocate? - [ ] Direct labor costs - [x] Manufacturing overhead costs - [ ] Direct material costs - [ ] Administrative expenses > **Explanation:** The rate per machine hour is used to allocate manufacturing overhead costs to products based on the machine hours used in production. ### Which costing system can provide a more accurate cause-and-effect allocation of costs than the rate per machine hour? - [ ] Standard costing - [x] Activity-Based Costing (ABC) - [ ] Job order costing - [ ] Variable costing > **Explanation:** Activity-based costing systems can provide a more accurate cause-and-effect allocation of costs compared to the rate per machine hour. ### Which of the following is a key component in calculating the rate per machine hour? - [x] Total machine hours used - [ ] Total direct labor hours - [ ] Total material costs - [ ] Total units produced > **Explanation:** The total machine hours used is a key component in calculating the rate per machine hour, as it's divided into the total manufacturing overhead costs. ### Why might the rate per machine hour not be useful for managers? - [x] Overheads might not vary directly with machine hours. - [ ] It does not account for direct materials. - [ ] It is too complicated to calculate. - [ ] It requires too much data. > **Explanation:** The rate per machine hour may not be useful if overhead costs do not vary directly with machine hours. ### In which industry is the rate per machine hour most applicable? - [ ] Service industry - [x] Manufacturing industry - [ ] Hospitality industry - [ ] Retail industry > **Explanation:** The rate per machine hour is most applicable in the manufacturing industry where machine usage significantly influences production costs. ### What is absorption costing? - [ ] Assigning all direct costs to products. - [x] Absorbing all manufacturing costs into units produced. - [ ] Only accounting for variable costs. - [ ] Mixing indirect costs with direct labor costs. > **Explanation:** Absorption costing means absorbing all manufacturing costs, including both fixed and variable overhead, into units produced. ### What type of costs are included in manufacturing overhead? - [ ] Direct labor costs - [x] Indirect costs such as utilities and depreciation - [ ] Direct material costs - [ ] Selling expenses > **Explanation:** Manufacturing overhead includes indirect costs such as utilities, depreciation, and salaries of supervisory staff. ### What term describes the standard measure to which costs are allocated? - [ ] Direct hours - [ ] Finished goods - [x] Cost Units - [ ] Productivity index > **Explanation:** Cost units are the standard measure of the product or service to which costs are allocated. ### What is the primary function of activity-based costing? - [x] Assigning overhead and indirect costs based on actual resource consumption. - [ ] Simplifying the cost allocation process. - [ ] Allocating only variable costs. - [ ] Reducing direct material costs. > **Explanation:** The primary function of activity-based costing is to assign overhead and indirect costs based on actual resource consumption for more accurate allocation. ### Which of the following is a suggested book for further studying the rate per machine hour? - [ ] Principles of Marketing by Philip Kotler - [ ] Freakonomics by Steven Levitt and Stephen Dubner - [x] Managerial Accounting by Ray H. Garrison, Eric Noreen, and Peter Brewer - [ ] The Lean Startup by Eric Ries > **Explanation:** "Managerial Accounting" by Ray H. Garrison, Eric Noreen, and Peter Brewer is a suggested book for studying the rate per machine hour and related cost accounting concepts.

Thank you for embarking on this journey through our comprehensive accounting lexicon and tackling our challenging sample exam quiz questions. Keep striving for excellence in your financial knowledge!

$$$$