Burden Rate

Updated on April 25, 2024
Article byWallstreetmojo Team
Edited byPallabi Banerjee
Reviewed byDheeraj Vaidya, CFA, FRM

What Is 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.

Burden Rate

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It is calculated by simply adding of the burden cost to direct costs in order to present the total absorbed cost of the items. 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.

Burden Rate Explained

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 the product or service and are categorized as cost of goods soldCost Of Goods SoldThe Cost of Goods Sold (COGS) is the cumulative total of direct costs incurred for the goods or services sold, including direct expenses like raw material, direct labour cost and other direct costs. However, it excludes all the indirect expenses incurred by the company. read more (COGS).

These direct costsDirect CostsDirect cost refers to the cost of operating core business activity—production costs, raw material cost, and wages paid to factory staff. Such costs can be determined by identifying the expenditure on cost objects.read more appear in the income statement and are used to calculate the gross profitGross ProfitGross Profit shows the earnings of the business entity from its core business activity i.e. the profit of the company that is arrived after deducting all the direct expenses like raw material cost, labor cost, etc. from the direct income generated from the sale of its goods and services.read more. 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 lineBottom LineThe bottom line refers to the net earnings or profit a company generates from its business operations in a particular accounting period that appears at the end of the income statement. A company adopts strategies to reduce costs or raise income to improve its bottom line. read more. Now the rate at which manufacturing burden rate are applied to direct cost is known as the burden rate.

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Formula

Burden Rate Formula

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This can either be related to labor or inventory

The formula for calculating the labor burden rate is –

Labor Burden Rate = Labor Burden Cost / Total Labor Cost 

Here,

  • 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 –

Inventory Burden Rate = Inventory Burden Cost / Total Inventory Cost

Here,

Uses

Using manufacturing burden rate is a good way to manage the projects’ costs by knowing just how much money we are spending on burden costs to get a project done and collectively all the projects. This knowledge will help us do projects with high value and reasonable costs against those with high costs and marginal or low value. It is always necessary to evaluate any project before investing in them, so that there is maximum return with minimum cost. This method helps in estimating how much fund will move out of the business in the form of indirect cost and to what extent the can be controlled.

Let’s say one has their own a business, and they have sales and marketing people as their staff. These employees’ time is to be billed to the clients. In this, the salary to the above staff is reported under COGS. When they review their profit and loss statementProfit And Loss StatementThe profit and loss statement is a financial report that summarizes the company's revenues and expenses over a period of time to determine profit or loss for that period.read more, they will find that the staff’s salaries are subtracted from income, and accordingly, the gross profit is calculated. Here, they can glance if their services are profitable, at least from a higher level.

However, there are other costs also that are incurredCosts Also That Are IncurredIncurred Cost refers to an expense that a Company needs to pay in exchange for the usage of a service, product, or asset. This might include direct, indirect, production, operating, & distribution charges incurred for business operations. read more by the organization for every employee on staff. These expenses are not billable to clients but are incurred- payroll taxesPayroll TaxesPayroll taxes are statutory deductions made by the employer from an employee’s regular salary and wages, and usually, such withholdings mostly have both employer and employee equal contributions. These taxes are collected by tax authorities from respective employers and paid for human welfare schemes, infrastructure development.read more, 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 calculate burden rate and the cost of employing the staff above and beyond their salaries. .

Examples

Let us try to understand the concept with the help of a suitable example.

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?

Solution:

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 employee burden rate is calculated as:

Labor Burden Rate = Labor Burden Cost / Total Labor Cost

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 costsOverhead CostsOverhead cost are those cost that is not related directly on the production activity and are therefore considered as indirect costs that have to be paid even if there is no production. Examples include rent payable, utilities payable, insurance payable, salaries payable to office staff, office supplies, etc.read more for every dollar of salary is paid to sales staff. Thus, the above example clearly explains how the rate is calculated and what are the factors taken into consideration while calculating the same.

Benefits

Let us try to understand some of the benefits of the calculation for the organization.

Limitations

Even though it can be useful in calculating the same and may provide great insights on the total cost incurred on the labor of production process of the organization, it has some limitations also as follows:

  • The process of allocating the indirect costs as per the various departments can be tedious and challenging. Since to calculate burden rate, it uses some standard method of calculation, this may not properly reflect the actual resource used in each project or department. Thus, the cost my be distributed disproportionately.
  • Indirect cost can change over time due to demand and other market conditions, change in rules and regulation in the country, etc. To calculate burden rate, we normally take historical data, that will not be able to capture these fluctuations.
  • Some entities may have a very complicated cost structure. They may not be able to capture all the elements of their cost in a standard employee burden rate for the calculation. Cost like research and development or marketing, may be incurred in different departments an become difficult to represent.
  • The rate provides a rough estimate, not actual figures that can be used for taking informer decisions related to pricing, profitability or budget.

It is necessary for companies using this formula to review their burden rate on a regular basis after accounting for the industrial and economic changes, the various cost involved in the specific business or business environment in general.

Burden Rate Vs Overhead Rate

Both the burden and overhead rate are used to refer to the cot of production or labor. But let us understand the differences between them.

  • The former refers to all indirect costs associated with the business which may be either labor or production process, whereas the latter is only related to the production process.
  • The employee burden rate includes elements like payroll tax, insurance, fringe benefit, etc whereas the latter includes elements like rent, utilities, maintenance expense which are indirectly associated with the production facility.
  • The former is calculated as labor burden cost divided by total labor cost whereas the latter is calculated dividing the total overhead cost by direct labor hours.

Thus , the above terms are quite different from each other even though they are often used interchangeably.

Recommended Articles

This has been a guide to what is Burden Rate. We explain it with formula, along with example, differences with overhead rate, uses, benefits & limitations. You can learn more about from the following finance articles –