G. F Wetzel.

Machine hour rate method of distribution of factory indirect expense online

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IaT 499

Wetzel, G. F.

Machine hour rate method of
distribution of factory

Digitized by tine Internet Arciiive

in 2009 witii funding from

CARLI: Consortium of Academic and Researcii Libraries in Illinois













MAY 29, 1918



Professor of Mechanical Engineering
Dean of Ereineering Studies

Dean of Cultural Studies

This thesis consists of tv/o sec-
tions, first a discussion of the several meth-
ods of distributing factory indirect expense,
called also burden, loading or over-head, the
second part being a statement of conditions,
and the actual axjplication of the machine hour

rate method of taking care of the indirect ex-
penses in a large maniifacturing plant.

Included in the second part are;
some of the instiructions issued to the factory,
the machine classification, accounting instruct-
ions, forms and descriptions written by the
author, for use in the departments interested,
to assist in getting the method into use. VOiile
some of the material m.ay not be directly applic-
able to other plants, it is believed that a de-
tailed description of the problem as a whole v/ill
be of interest and assistance to any one who
might be required to apply the method, as well as



to engineers in general, as the engineer's
field of work is constantly coming closer to
the field of management.

The author is an engineer, hence this
thesis is written from the technical rather
than the accounting standpoint, but the aim was
constantly kept in mind to harmonize to the
greatest possible degree the view points and
practical requirements of both shop and office.



-: Part; One :-
The work of the engineer, especially
the one who is connected with factory work, is
constantly broadening, and embracing more of
the field of management. To be sure, there are

many who will confine their work to purely
professional lines, but industrial management
reqaires the trained mind of the engineer,
applied to management and business problems ai
most as much as to technical problems. One of
the principal things with v/hich the engineer
must be at least somewhat familiar is factory
and construction costs.

The life and deatb of most manufact-
uring concerns depends to a large extent on
their cost systems, how well they perform their

duties and how the facts they bring out are
made use of. It is, of course, self evident,
that factories are run for the purpose of earn-

Ho. 2.
ing money, and if they don't do it, they can
not remain in "business very long. To earn
money, the goods which are produced by the
factory must be sold for more than they cost,
hence to know the selling price, the cost must
be known. The accuracy with which the selling
price is fixed is a direct function of the
accuracy of the costs, except in the case of
certain monopolies and patented articles, and
even in the latter cases, to know what the
earnings are, the costs must be known. Thus
it will be seen that factory costs are very
important, and are among the principal items
which must be closely watched by the manage-
ment. This is summed up very well by 0. R.
Thompson in his book on Factory Costs,- "An
accurate cost system faithfully reflects the
changes, not only in the cost of materials and
labor, but in the efficiency of operation and
management from one period to another. It is,
therefore, a valuable guide to the manager.

Ho, 3.

directing Mm where and* when to apply his par-
ficular attention to these details."

The object of cost accounting is to
charge each unit of the production with its
share of the production cost, so that every
element going into this expense will be absorb-
ed in the selling price. There are three prin
-oipal divisions of the manufacturing costs,
which are labor, material and indirect expense,

(also spoken of as burden, loading or over-head)
The labor and material can usually be readily
figured, but the indirect expense is made up of
so many items, some of which are indeterminate,
thatbthe accurate determination of the total
amount is difficult. The method of distribution
to the product brings in another variable, since
the different methods of assigning the indirect
expense will give, in raanv- cases, different manu-
facturing costs on the same article. Thus the
necessity of careful analysis and study of con-
ditions in a given plant will be evident.


The indirect "expense is madle up of
charges for factory administration, general
administration, indirect or so called nonpro- '
ductive lal3or, light, heat, power, expense
supplies such as waste, oil, tools, belting,
etc*, maintenance and despreciation on "build-
ings and equipment, and in some cases rent and
interest on the investment. It includes in
fact all the expenditures which are not includ-
ed under the heads of lahor, material or Cap-
ital Account, i. e,, expenditures involving
additional plant value. The depreciation
charge cannot he definitely determined, as there
are so many indefinite and changing factors en-
tering into it and at hest it can only be estimat
-ed as accurately as possible from the data .
based on previous experience.

All that can be expected of the best
cost system is a fairly accurate approximation,
and the accuracy of results obtained depends on
how detailed and careful an analysis has been


made of the elements which go to make up the
cost and the method in which they are combin-
ed and distrihuted for a final result. There '
are several methods of distributing the indirect
expense of the product, the principal ones of
which are percentage of direct labor, a charge
on labor hours, charge per pound, or other unit,
and the machine -hour-rate method. In the first
method, the expense is distributed either by-
means of a departmental percentage on the cost
of productive labor or in some places a percent-
age covering the total productive pay-roll for
the plant; in the second method, the expense is
divided up on the basis of labor hours and in
the third spread over the product directly. The
machine -hour -rate method, which is herein des-
cribed, distributes the expense by means of an
hourly rate for each productive machine, which
is based as nearly as possible on the actual
operating expense of the machine, plus charges


for the other indirect expenses, such as ad-
ministration, depreciation, building charge,
etc., pro -rated among the machines on the most
logical basis for each item. The first method,
or percentage of direct labor cost is ttie one
most generally used, because it is easy of
application and in many cases is sufficiently
accurate for all requirements. The second and
third methods are used to a certain extent,
while the fourth method or machine -hour-rate
plan of distribution, though not so widely
used, is coming into use more and more among
progressive concerns. With the increase in com-
petition and corresponding close margins in
pricesiji which are sure to come after the war,
the machine -hour-rate method, being the most
accurate of the four, where it applies, will
come into still more extensive use. In decid-
ing which method will be used, the nature of
the product must be considered as well as other
conditions in the factory, for example in a


paper n^ll, making one general line of pro-
duct, it may be much more satisfactory to dis-

tibute the over-head on a basis of poiinds of
paper made , or a plant turning out but few
lines of product and equipped with machines of
practically the same type, could use either a
rate per pound, or percentage of direct labor
or charge per labor hour with equal satis fac-!- -
tion, Hov/ever, in a factory having a large
variety of machines and equipment, which will
have very different operating expenses, the
most accurate way of figuring cost is by the
machine -hour-rate method.

After labor and material are tafcen
care of, the first requirement for any method
of distribution of indirect expense is the
determination of the amount to be distributed.

Salaries and indirect labor can be obtained
from the pay-roll; expense supplies and other
expenses can be obtained from requisitions,
vouchers and bills, after these have been


properly classified. Depreciation on "build-
ings and equipment is usually figured in '
accordance with standard practice, with modi-
fications to fit special conditions, and is
assumed to "be correct, until shown otherv/ise
by experience.

Assuming now that the amount of
over-head is knov/n, and that an analysis of
conditions indicates that the machine rate
method is the most suitable for distributing
this amount to the product, we will proceed
with the further study of the machine-rate

The machine -hour-rate plan re-
quires the collection- of all factory indirect
expense into an hourly charge against the
product going through the machine, "machine"
being taken to mean benches, furnaces used
on the product and other equipment contribut-
ing directly to some productive process, as
well as true machines. Each machine, or


group of machines which are of the same type,
and near enough the same size to have the sam^
rate, is treated as a production center, for
use of which the product pays a charge, similar
to rent, based on the rate and numher of hours
it occupies the machine or center. Thus the
product of rate and hours for a given period of
time, gives the amount of burden earned by the
machine to be credited to its share of the total
indirect expense*

The machine rate is made up of three
classes of charges,- (l) the operating charges
which can be easily allocated to the machines,
(S) the building charge, and (5) the administra-
tion charge. The operating rate includes clean-
ing and oiling, depreciation, maintenance and
repairs, power, special lighting, tools, and
supplies. The different factors entering into
the operating cost require analysis to be sure
that the true cost is used. For example, the
electric oower charge should include in addition


to the cost per kilowatt hour, the maintenance
of the electrical distributing system, trans-
formers, motor generators, electrician's i^Dor,
and electrical expense supplies. On machines
driven by line shaft, the cost of maintenance,
depreciation, etc., on this should be added to
the cost of pov/er for the motor, and charged
to the machines. A similar analysis is necess-
ary for determining the cost of v/ater, fuel oil,
cutting compound, compressed air and steam,
where these are used. In most plants some non-
productive machines are necessary, which use
power, but will not have a machine rate. A
very satisfactory v/ay to charge their power is
to take the total department power charge and
distribute it over the productive machines in
the department, on the basis of kilov;att-hours
used per month per machine. The same method
will apply to the other items mentioned.

Each production center occupies a cer-
tain amount of space, for the use of v/hich it


must pay its proportionate share of total
building charges, including rent (if charged),
taxes, depreciation, insurance, fire-protection,
janitor service, maintenance and repair. There
are several ways of dividing this expense among
the machines, hut the one which is easiest to
apply, and is as accurate as any is to find the
floor space occupied hy each productive machine
and operator hy measurement, add these spaces to
get a department total, and then use the ratio
of machine floor space to department machine
floor as a hasis of division. This automatically
takes care of department store or tool rooms,
aisles, and space not used. In the case of
stores departments serving the v/hole plant, the
charge can he equitably spread over the depart-
ments on the basis of department productive
machine floor space compared with total plant
productive machine floor space. The building
charge for non-productive and administrative de-
partments may either be added to the store space


charge, and divided as above, or added to the '
administration charge, to "be divided v/ith the
rest of the administration charges. There are
often other charges v/hich may conveniently/- oe
included in the building charge such as crane
service, trucking and janitor service.

The administration cost covers the sal-
aries of officers, superintendents and foremen,
store keepers, inspectors, accountants, clerks
and so on. It also includes supplies such as
stationery and equipment used by them. The
building cost for administrative departments may
either be incliided here, or in the charge dis-
tribiited to the departments with the storage
space item, as mentioned before. Since a more
accurate rate can be established if the indirect
expenses are departmentalized as much as poss-
ible, it is advisable to divide administration
into general and shop administration. The
former vn.ll include plant office force, engineer-
ing department, president, secretary, treasurer.



general superintendent, factory manager and
others whose services henefit the plant as a
whole. The latter includes foremen, shop clerks,
department indirect la"bor and department time
keepers. The general administration expense
may "be apportioned to the departments on the
"basis of machine-hours compared with total mach-
ine-hours, of other department indirect expense
compared with total other indirect expense, or
of department rate -hours compared with plant
rate-hours, the rate here being before the
general administration is added. In a i^lant
having a v/ide variety of equipment, the latter
is the fairest method of distribution. Rate-
hours will be in terms of dollar-hours, that is,
the product of machine hours and machine hourly

The current opinion seems to be that the
machine hour rate method is very complicated
and difficult of application, but there are in
reality but two difficulties. The first is the


jlroblem of getting "into the rate every item th^t
belongs there. These are very numerous, "but
starting with a familiarity with the plant and
its operation, a oareful analysis and study of
the proposition should enahle one who knows
v/hat is wanted, to gather them all together.
klfhere fairly complete records are kept, the
data can "be ohtained through the accounting de-
partment, time-keeping department, shop offices,
and observation and tests in the plant. Pro-
vision should he made for adjustment to take
care of items that might be omitted, and later
discovered, or that may be changed by conditions
in shop or business in general.

The second difficulty is in the disposi-
tion of the unearned burden because of idle
time, that is, time when the machines should be
in operation to earn their predetermined share
of the operating expenses of the business, but
are not. In liearly every manufacturing plant,
it is necessary to have machines which are in


■ftse only part of the time, even v/hen the plant
is v/orking at normal capacity. To put into
these rates all the charges that would ordinar- '
ily ^0 into them would make an ahnormally high
rate. It would seen that this rate should be
modified by distributing part of its charges to
the other machines that are busy a high percent-
age of the time, but this is a question which
must be decided by the management, taking into
consideration the conditions, and effect on the
price of work going through the machine. Some
machines such as ordinary floor grinders, drill
presses, or tool tempering furnaces are better
treated as non-productive machines when they are
used only occasionally, because they would have
to carry a rate that would be out of proportion
for the work they perform, and because of the
difficulty of obtaining accurate reports of the
hours occupied. Time which is idle for the
reasons stated can be disposed of fairly easily
in setting the rate, but idle time due to un-


e'xpected interuptions to produotion through
accident, lack of work, labor trouble, or lack
of necessary supplies must be handled different-
ly. In this case, there will be a deficit in the
burden account, that is, the burden charges will
not be completely written off as planned.

One waj'' in which idle time deficit may be
handled is to establish two rates for each mach-
ine, one which is called the machine rate, being
the rate based on working the normal number of
hours, and the other a supplementary rate, which
is adjusted from month to month, or other account-
ing period, and added to the m-achine rate for the
next period, or as long as necessary to completely
balance the account for the machines in question.
Idle time thiis becomes a factory cost. Another
way of handling the deficit is to add a percent-
age to the cost of all work going through the de-
partments not carrying their burden, which also
makes it a factory cost. A third method, v/hen the
idle time is due to not providing sufficient work


to keep the plant busy, is to charge the deficit

to the business as a whole. This is the most
correct way, since the function of the factory
is to perform the worl: and not to make the
sales or get the business. Another point to
consider is that, allowing for small differences
due to quantity, the true factory cost will not
vary at the same rate as the apparent factory
cost, if idle time is made a factory charge.
Thus the manner in which this question is handl-
ed may make quite a difference in the business
policy, and on prices quoted. Making this
charge against tlie business brings out to the
management very strongely the importance of
keeping the plant well supplies with v;ork.

Alter the total department indirect
charges, including the share of the general
plant and factory administration charges, have
been determined, these must be distributed to
the productive machines. It now becomes necess-
ary tolaiow the probable number of hours that
the machines will operate for the next month


for other period). "This data can best be ob-


tained from records of the past few months, if
these are available. If no records have been
kept, an estimate must be made, and proper pro-
vision made for keeping records of machine

It will be best to separate the build-
ing che.rge and the administrative charges, and
divide these among the machines in two different
v;ays. The building charge is a function of the
space occupied by the machine, so that it
should be pro-rated on the basis of machine floor
space. A simple way of handling this is to get
a cost per square foot by summing up all depart-
ment machine floor space, and using this fig-ure as
a divisor, into the total department building
charge. The machine floor space multiplied by
the rate per square foot gives the building
charge for the machine. The shop administration
charge should be divided on the basis of machine
hours, since the machine which works the most


will require tlie most supervision. To obtain the
figure for each machine, the division may be
handled in a similar manner as the floor space,
that is,- divide the shop administration charge
for the department by the total estimated number
of machine hours for the given period, which
v/ill give a rate per machine -!g.our, to cover the
administration cost. With the machine operat-
ing cost determined, plus the building charge,
we have the amount for the month or other per-
iod, to be divided by the machines hours for
that period. This result added to the hourly
administration charge mentioned above gives the
machine -hour-rate for the factory expense.
There is nne more factor which must be added
to obtain the final rate v;hich will be used, and
that is the general administration. This may be
added as a percentage, which is worked out by
comparing the total amount of the general ad-
ministration cost with the total burden for the
plant, and increasing the latter hv the result-


ing ratio, or in one 'of the other ways previoui^-
ly mentioned, . It may be more desirable in some
plants to include the general v/ith the shop ad-
ministration, which is somewhat easier, but if
the former is very large in proportion, is not
as accurate.

In some plants, where orders are
worked on that last for some time, or conditions
are such that it will not be inconsistent with
good management to get the costs at the dnd of
each month, the machine rate plan furnishes the
means of getting the most accurate distribution
of burden of any of the methods used for the
purpose, VJhen this is the case, all the items
entering into the burden except some of those
v^hich are not determined by exx)enditures from
month to month, such as depreciation, can be
summed up into one amount which is the knovm
burden for the month. The actual number of
machine -hours which were operated during the

month can be determined from the time reports.


In this v/ay, the element of uncertainty (in i
predicting the number of hours each machine
will he occupied for the coming month) is
eliminated by using records of actual per-
formance. The expense material entering into
the rate can also be accurately ascertained from t
the requisitions for the month, which when
properly classified can be allocated to the
proper equipment. Thus the rate used is
based on pre-determined amounts and not on
preliminary estimates, making possible a very
close balance between the burden earned (or
accounted for by the machine-rate) and the
expense for the month.

V/hen the machine -rate method is first
installed, the rate vdll probably need ad Jus t-
m.ent from month to month. It will be necess-
ary to check over machine hours for each mach-
ine, to see hov/ closely these approximate the
estimated hours on which the rate was based,
to see that each machine earns the burden it


is supposed to cari^r. To make the checking up
as simple as possilDle, it vrould "be advisable to
develop forms and standard methods of collecting
and handling the various items that make up the
factory indirect expense. V/here rates are found
to he inaccurate or where conditions req[uire them
to he charged, provision should be made for making
this adjustment. A good way of providing for this
is to issue a sheet monthly or at some other def-
inite period, giving the machine rate for each
machine v/hich is to cover that period and be in
use until the next sheet, is issued, thus v/ith the
rates taken from the current sheet, the proper
rate v/ill always be in use.

Because of the importance of the time
element in determining the am.ount of burden to
charge, it is very necessary that v/hatever system
is devised should be consistent viith the method
adopted by the time keeping department to avoid
duplication of effort and to get the results in
the simplest possible manner. The duties of the


timekeeping department and the cost department
some-times over-lap, so that anj^- plan that is
adopted for keeping the time records should he
consistent with the v/ork of each department.

The determination of the amount of over-
head expense to he charged to any job is very
'simple when the rate has once heen set. It is
necessary tliat three items be known, that is, the
order number or name of the v/ork, the number of
hours the vrork occupied any of the production
centers^and the number of the machines occupied.
Hours multiplied "oj rate gives the amount of
burden and this added to the direct cost of
labor and material gives the factory cost of
the work. It will be a good policy to open a
burden account to keep track of the amount of
burden through the application of the machine
hour rate and the actual total amount of the
burden as shown in the accounting records. If
under conditions of normal operation the burden

earned does not approximately equal the actual
burden, some of the rates must be adjusted accord-
ingly .


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Online LibraryG. F WetzelMachine hour rate method of distribution of factory indirect expense → online text (page 1 of 4)