The ladder / Level 3 · Manufacturer/ Business math
Machine hour rate, depreciation and payback
What a machine hour costs, straight line and written down value depreciation (textbook methods), and machine payback.
How numbers are rounded on these pages. Calculations are done at full precision and rounded only at the end, half up. Rupee amounts are rounded to the nearest rupee unless shown with paise, in which case to the nearest paisa. Percentages are shown to two decimal places; payback periods in years, and ratios such as degree of operating leverage, to two decimal places. Quantities you must start, buy or sell to reach a target are rounded up to the next whole unit or kg. Depreciation uses textbook straight line and written down value methods, not the rates or lives set by tax or company law. All examples and quiz questions are Hypothetical: they show the method, not real prices or rates.
Machine hour rate
Where machines do most of the work, the fairest way to charge factory costs to a job is by the hours it spends on each machine. The machine hour rate is the cost of running a machine for one productive hour.
Add up the yearly costs of the machine: depreciation, repairs, insurance, its share of rent, supervision and lighting (standing or fixed charges), and divide by the hours it actually works. Costs that arise only while it runs, such as power and tooling, are worked out per running hour and added. Use productive hours, after setup, maintenance and breakdowns: the fewer hours the machine works, the higher the rate.
The standard formulas
Terms used
- Machine hour rate
- The cost of operating a machine for one productive hour.
- Standing (fixed) charges
- Machine costs that do not depend on running hours: depreciation, insurance, share of rent and supervision.
- Running (variable) costs
- Costs that arise only while the machine runs: power, tooling, consumables.
- Productive hours
- Hours the machine actually works on jobs.
Worked examples
HypotheticalBasicA simple machine hour rate
A CNC lathe's yearly costs:
- Depreciation: ₹2,00,000
- Repairs and maintenance: ₹50,000
- Insurance: ₹30,000
- Share of rent, supervision and lighting: ₹1,20,000
- Total = ₹4,00,000 for 2,500 productive hours
- Machine hour rate = ₹4,00,000 ÷ 2,500 = ₹160 an hour
HypotheticalIntermediateProductive hours and power
A press works 300 days, 2 shifts of 8 hours; 10% of that time goes on setup and maintenance. Standing charges are ₹6,48,000 a year. Its motor is rated 15 kW and power costs ₹9 a kWh (treat the motor as running at its rating).
- Available hours = 300 × 2 × 8 = 4,800; productive = 4,800 × 90% = 4,320
- Standing charges per hour = ₹6,48,000 ÷ 4,320 = ₹150
- Power per hour = 15 × ₹9 = ₹135
- Machine hour rate = ₹150 + ₹135 = ₹285
HypotheticalAdvancedWhat idle time does to the rate
Breakdowns and missing orders cut productive hours to 3,240 (67.5% of available).
- Standing charges per hour = ₹6,48,000 ÷ 3,240 = ₹200
- Machine hour rate = ₹200 + ₹135 = ₹335
- A 12-hour job now costs 12 × ₹335 = ₹4,020 in machine time instead of 12 × ₹285 = ₹3,420
Quoting with a rate based on full hours when the machine is often idle under-prices every job.
Machine depreciation and payback
Depreciation spreads the cost of a machine over the years it is used. Two textbook methods are common. Straight line (SLM) charges the same amount every year. Written down value (WDV), also called reducing balance, charges a fixed percentage of the remaining book value, so the charge is largest in the early years.
Payback asks how long the machine takes to repay its cost from the cash it saves or earns. Depreciation is not a cash payment, so payback uses cash savings, not profit after depreciation.
Accounts and tax use their own rules. The Income-tax Act and the Companies Act each set their own depreciation methods, rates or useful lives. These vary by type of asset and change over time, and the figures here are textbook illustrations, not those rates. Ask your chartered accountant for the figures to use in your books and tax return.
The standard formulas
Terms used
- Depreciation
- The part of a fixed asset's cost charged as an expense each year of its useful life.
- Residual (scrap) value
- What the asset is expected to fetch at the end of its useful life.
- Useful life
- The period over which the asset is expected to be used.
- Book value
- Cost minus depreciation charged to date (also called written down value).
- Payback period
- Time for cash savings or inflows to repay the cost.
Worked examples
HypotheticalBasicStraight line depreciation
A machine costs ₹12,00,000, will be used for 5 years and should fetch ₹2,00,000 at the end.
- Yearly depreciation = (₹12,00,000 − ₹2,00,000) ÷ 5 = ₹2,00,000
- Book value after 2 years = ₹12,00,000 − 2 × ₹2,00,000 = ₹8,00,000
HypotheticalIntermediateWritten down value at 30%
The same machine at a WDV rate of 30% (an illustration, not a legal rate).
- Year 1: ₹12,00,000 × 30% = ₹3,60,000; closing book value ₹8,40,000
- Year 2: ₹8,40,000 × 30% = ₹2,52,000; closing book value ₹5,88,000
- Year 3: ₹5,88,000 × 30% = ₹1,76,400; closing book value ₹4,11,600
WDV charges ₹3,60,000 in year 1 against ₹2,00,000 under straight line.
HypotheticalAdvancedThe WDV rate that matches the residual value, and payback
Same machine: cost ₹12,00,000, residual ₹2,00,000, 5 years.
- WDV rate = 1 − (₹2,00,000 ÷ ₹12,00,000)1/5 = 1 − 0.6988 = 30.12% a year
- Check: ₹12,00,000 × (1 − 30.12%)5 ≈ ₹2,00,000
- The machine saves ₹3,50,000 cash a year. Payback = ₹12,00,000 ÷ ₹3,50,000 = 3.43 years
Quiz: machine hour rate, depreciation and payback
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