Hi,

Its often difficult for top management differentiate between cost and charge rate on machines. In my experience the best route to follow is to break the final cost rate up into 3 sections. Total absorption (full costing required and allocatin fixed costs), variable (True variable costs showing the increased cost for an additional hour of work - careful what you do with labour as this is in most cases fixed) an fixed portion

This is better for decisionmaking as you can choose what rate to use depending on capacity constraints. Ultimitely you need to recover full costs , ie. profit after full absoroption costing.

We use full absorption costing for COSTING (Often the price is what the markets will bear and has little to do with cost of the job) purposes and report the profit in a breakdown using full costing, variable cost only and TP (Throuput) in 3 different columns.

This way you can see if you're covering variable costs  and allows management to guage how much they can drop prices to cover either material only or variable should they need to quote aggresively on a job or are running at full capacity.

Your approach is absolutely correct and just needs to be broken down. Maybe consider using replacement value instead of historical cost to allow for inflation over a long period or to make the division compareable with others running newer machinery. You will end up over recovering this way if your machines are old but will make your costing rates more realistic in curent markets....

cheers

David Esterhuizen

Financial Manager

Eurosteel

South Africa

Hi,

Did u mean u are treating Machine cost as Fixed Cost?

Because I feel it is a variable cost, the life of machine depends upon its usage So better to charged it on production basis rather that treating it as a fixed cost.

 Thx.

Virendra H.