Equipment rental direct or indirect

pirate

Is equipement rental ie the actual rental costs and the price per machine hour always treated as direct cost
For example a machine is hired for a production department and is used for the preparation of some basic raw materials.
The raw materials are input then into several different products.
In the above scenario I would say that the machine hire cost is an indirect cost

However if the machine is only used in the production of one product ie one unit of production then the hire cost and the price per machine hour would be a direct cost

is this correct

thanks

PGM

I'd generally class machinery as direct costs and take those costs off revenue before getting to gross profit.

Overheads or indirect cost I'd class as admin etc.

pirate

thanks PGM

am wondering for ECR really, although it will apply in a financial scenario I wasnt sure if there was a hard and fast rule for hire of machinery and where to put it ie does it go with the direct expenses always.
I am sure it would if this machine were used only for the production of a single unit of production
So imagine a machine that is hire in for mixing various ingredients like flour and so on to make a batter. This batter can then go on to make cakes, or fairy cakes or muffins so different lines of production. The machine is rented so has a fixed cost per year associated with it, but also there is a charge made for the number of hours it is used.

If we could isolate how many hours to make the muffins then we could charge this part of the rental to the direct costs, if we cant then I think the machine rental costs and costs per hour of usage would be an overhead and then would become part of the OAR when calculating the marginal costs and the absorption cost.

In the book it implies that a the hire of a machine is always a direct cost but I would think it would depend if you can actually associate the cost of the machine with the actual thing being produced.

anyway would welcome thoughts

mge

Hi pirate. The Osborne book gives one example of a direct expense as being:

"hire of specialist machinery/equipment for a particular product or job".

Equipment rental is therefore a direct cost in some circumstances.

However, I would agree with you that if the machinery is being hired to produce a number of different types of product or for a number of different jobs then it is likely to be considered an indirect cost (because the cost can't be attributed to a specific unit of output).

SandyHood

Pirate

There is no hard and fast rule.
If the use of the equipment is specific to the product, as you know, it is a direct cost of that product.
If it is there to produce many products it is treated in the same way as supervisor salaries or light and heating (indirect production cost).

Unrelated to your question, but possibly of interest to students trying to look at links between variable/fixed cost behaviour and directly/indirectly part of a product cost, the hire of equipment can often be a fixed cost as it does not vary depending how many units are produced but also a direct cost of the product.

SandyHood

pirate wrote: »

thanks PGM

am wondering for ECR really, although it will apply in a financial scenario I wasnt sure if there was a hard and fast rule for hire of machinery and where to put it ie does it go with the direct expenses always.
I am sure it would if this machine were used only for the production of a single unit of production
So imagine a machine that is hire in for mixing various ingredients like flour and so on to make a batter. This batter can then go on to make cakes, or fairy cakes or muffins so different lines of production. The machine is rented so has a fixed cost per year associated with it, but also there is a charge made for the number of hours it is used.

If we could isolate how many hours to make the muffins then we could charge this part of the rental to the direct costs, if we cant then I think the machine rental costs and costs per hour of usage would be an overhead and then would become part of the OAR when calculating the marginal costs and the absorption cost.

In the book it implies that a the hire of a machine is always a direct cost but I would think it would depend if you can actually associate the cost of the machine with the actual thing being produced.

anyway would welcome thoughts

I like this scenario. It is clear.
It meets the direct cost criteria if the cost of producing the product includes the machine hire. Sure there are a lot of muffins, but that is no different to having to pay direct labour to produce 16 units per hour etc.

But watch out if there is a production process that is used for many different products.
Here it is much easier to include the machine hire are an overhead and absorb it along with the other overheads.
So if I want the cost of the batter (cake mix) that is then input into the various other processes, I want my cost per litre to include all the costs incurred in getting it there.
£x for the ingredients, £y for the labour time and £z for the overhead absorbed.

We have to absorb the cost in this case because it is shared across production, and to say 20% of it belongs to muffins would be wrong in terms of direct costs. It is an idirect cost, and that is why we share the cost out across everything we produce on the machine using our absorption rate basis.

pirate

Many thanks Sandy
just as I hoped

Karen