How to Calculate Overhead Rate per Machine Hour
In manufacturing environments—especially those that are capital intensive and rely heavily on automation—allocating costs based on direct labor is often inaccurate. Instead, businesses use the Overhead Rate per Machine Hour to allocate indirect costs to production based on how long machinery is utilized. This ensures accurate product pricing and profitability analysis.
What is the Formula?
The calculation involves two main figures: the total estimated manufacturing overhead costs for a period and the total estimated machine hours for that same period.
Overhead Rate = Total Manufacturing Overhead Costs / Total Machine Hours
Step-by-Step Calculation Guide
- Identify Overhead Costs: Sum up all indirect costs associated with production. This includes indirect materials (lubricants, small tools), indirect labor (supervisors, maintenance staff), factory rent, utilities (electricity for machines), and equipment depreciation.
- Determine Total Machine Hours: Calculate the total number of hours your machinery operated during the period. This should be the actual running time, excluding downtime for repairs if you are calculating based on capacity.
- Divide: Divide the total cost by the total hours to get the rate per hour.
Why is this Important?
If a factory produces two products, and Product A requires 10 hours of machine time while Product B requires only 1 hour, allocating overhead based on machine hours will assign significantly more cost to Product A. This prevents Product B from subsidizing Product A, allowing management to price both products correctly according to the actual resources they consume.
Example Calculation
Let's say a CNC machining shop has the following monthly costs:
- Indirect Materials: $2,000
- Indirect Labor: $10,000
- Utilities & Rent: $5,000
- Depreciation: $3,000
Total Overhead: $20,000.
If the machines ran for a total of 800 hours that month, the calculation is:
$20,000 / 800 hours = $25.00 per machine hour.
This means for every hour a machine runs to produce a part, you must add $25.00 to the direct material and labor costs to break even on overhead.