What is the Burden Rate?
Burden Rate is the rate of allocation of indirect cost to direct cost of either labor or inventory to give a truer picture of the cost of producing or delivering a product or service. In other words, it is the rate of allocation of the hidden labor and inventory overheads costs to direct costs and is calculated by simply adding of the burden cost to direct costs in order to present the total absorbed cost of the items.
There are many indirect costs involved in running a business. These costs are not always apparent; that’s why they are called the hidden costs of running a business. These hidden variable costs create a lot of confusion for business owners. These costs are required to be applied to the company’s direct costs where the direct costs are the costs that go directly into the production or delivery of your product or service and are categorized as cost of goods sold (COGS).
These direct costs appear in the income statement and are used to calculate the gross profit. On the other hand, the indirect costs are other than direct costs used in running a business. They are subtracted from the gross profit to show a net profit or bottom line. Now the rate at which burden costs are applied to direct cost is known as the burden rate.
Burden Rate Formula
This can either be related to labor or inventory
The formula for calculating the labor burden rate is –
- Total labor cost refers to the salary of the staff or total payroll cost
- Labor burden cost refers to the burden cost related to the labor
The formula for calculating the inventory burden rate is –
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- Inventory burden cost refers to the Manufacturing overhead cost
- Total Inventory cost refers to the total cost of the inventory to the company
How does it Work?
The burden rate incorporates extra liabilities related to labor costs, such as any lawfully ordered protection, extra advantages, and paid leave. This consists of the expenses that are well beyond the worker’s related base pay or remuneration, or those determined independently inside the unburdened rate. It is frequently viewed as a concealed expense of keeping up employee.
Using Burden Rates is a good way to manage your projects’ costs by knowing just how much money you are spending on burden costs to get a project done and collectively all your projects. This knowledge will help you do projects with high value and reasonable costs against those with high costs and marginal or low value.
Let’s say you own a business, and you have sales and marketing people on your staff. These employees’ time is to be billed to your clients. In this, the salary to the above staff is reported under COGS. When you review your profit and loss statement, you will find that the staff’s salaries are subtracted from income, and accordingly, the gross profit is calculated. Here, you can glance if your services are profitable, at least from a higher level.
However, there are other costs also that are incurred by the organization for every employee on staff. These expenses are not billable to clients but are incurred- payroll taxes, insurance, etc. There may be other such costs also depending on the profitability and structure of the organization. These additional costs are added cost together to arrive at the total labor burden cost and the cost of employing the staff above and beyond their salaries.
Suppose there is a company in which marketing staff is paid $50,000, and the sales staff salary is paid $30,000 per annum. Annual taxes and other benefits paid to market staff are $13,000 and to sales staff is $10,000 per annum. What is the labor burden rate for marketing staff and sales staff?
Here the total labor cost is considered as the salary of the staff labor burden cost is calculated as annual taxes and other benefits.
As per the formula, the labor burden rate is calculated as:
For marketing staff, it is calculated as:
- = $13,000 / $50,000
- = $ 0.26
And for sales staff, it is calculated as:
- = $10,000/ $30,000
- = $0.333
From the above calculation, we conclude that the company incurred $0.26 overhead costs for every dollar of salary is paid to market staff and $0.33 overhead costs for every dollar of salary is paid to sales staff.
- The most important benefit of the burden rate is in decision making. It helps the organization decide if it can afford to undertake certain activities, considering total direct and indirect costs and net profit. Apart from the decision making of current activities, one can decide on budgeting decisions as well. Also, considering the results of burden rate analysis, the companies decide on opening the manufacturing plants outside their home country, because generally, the burden rate of labor or machinery operation is higher in the area in which they reside
- Many significant hidden costs are included in labor costs that are often viewed as company overhead. So, we can have a clearer picture of small finances also
- With the overhead burden rate, you can find how much your items truly cost to make. You can decide the absolute minimum you should sell them for. Furthermore, you can utilize the weight rate to show signs of improvement in how various materials and assembling costs will influence the all-out expense to create an item.
This has been a guide to What is Burden Rate & its Definition. Here we discuss its formula and calculations along with examples and benefits. You can learn more about from the following finance articles –