Burden Rate

Published on :

21 Aug, 2024

Blog Author :

Wallstreetmojo Team

Edited by :

Pallabi Banerjee

Reviewed by :

Dheeraj Vaidya

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.

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 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 manufacturing burden rate are applied to direct cost is known as the burden rate.

Formula

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,

• Inventory burden cost refers to the Remunerations of maintenance personnel, Rent of the manufacturing building, etc. " url="https://www.wallstreetmojo.com/manufacturing-overhead/"]Manufacturing overhead cost
• Total Inventory cost refers to the total cost of the inventory to the company

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 statement, 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 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 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 costs 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.

• 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, we can find how much items truly cost to make. We can decide the absolute minimum we should sell them for. Furthermore, we 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.

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.