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Source: Burden Rate (wallstreetmojo.com)
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.
Explanation
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 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 costs are costs incurred by an organization while performing its core business activity and can be attributed directly in the production cost, such as raw material costs, wages paid to factory staff, power & fuel expenses in a factory, and so on, but do not include indirect costs such as advertisement costs, administrative costs, etc.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 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 –
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 Manufacturing overhead costManufacturing Overhead CostManufacturing Overhead is the total of all the indirect costs involved in manufacturing a product like Property Tax on the production premise, Remunerations of maintenance personnel, Rent of the manufacturing building, etc. read more
- 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 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, 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 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 arrive at the total labor burden cost and the cost of employing the staff above and beyond their salaries.
Examples
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 labor 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.
Benefits
- 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 costsIndirect CostsIndirect cost is the cost that cannot be directly attributed to the production. These are the necessary expenditures and can be fixed or variable in nature like the office expenses, administration, sales promotion expense, etc.read more 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.
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