Burden Rate

A burden rate is a rate used to add indirect costs, often called burden, to a direct cost base. In manufacturing, it is the factory overhead rate: the amount of manufacturing overhead assigned per direct labor hour, machine hour or dollar of direct labor. In payroll and project costing, a labor burden rate is the percentage added to an employee's wages to cover employer payroll taxes, insurance and benefits, producing a fully loaded cost per hour.

Both uses share the same purpose: to make sure that the cost of a product, job or hour of work reflects not only what can be traced directly but also a fair share of the supporting costs behind it. In factory costing, the burden rate is normally a predetermined rate set from budgets at the start of the year and used to calculate applied overhead.

A plumber who pays an apprentice $25 an hour actually spends more than $25 for every hour the apprentice works. There are payroll taxes, insurance, holiday pay and the van they drive. If the plumber charges customers based only on the $25, the business slowly loses money.

A burden rate is the extra amount added on top to cover these hidden costs. It turns "what we pay per hour" into "what an hour really costs us", which is the number a business needs when setting prices.

In manufacturing, the burden rate is calculated as:

A machine shop budgets $720,000 of factory overhead and 24,000 machine hours for the year, so its burden rate is $30 per machine hour. A job that uses 12 machine hours is charged $360 of overhead on top of its direct materials and labor. The rate is used throughout the year in job costing and for quoting prices. At year end, any difference between overhead applied and actual overhead incurred is closed out.

A single plantwide burden rate is simple but can distort costs when departments differ greatly, so many manufacturers use a departmental overhead rate for each production department. Activity-based costing goes further, setting separate rates for activities such as setups, inspections and material handling.

The labor burden rate expresses the employer's additional costs as a percentage of wages:

Typical components include:

• Employer payroll taxes, such as the employer share of Social Security and Medicare, and federal and state unemployment taxes.
• Workers' compensation insurance, which varies by job classification and claims history.
• Health insurance, retirement contributions and other employee fringe benefits.
• Paid time off, since holidays and vacation are paid but not worked.

Suppose a technician earns $30 an hour, or $62,400 a year for 2,080 hours, and the employer's extra costs total $21,840 a year. The labor burden rate is $21,840 ÷ $62,400 = 35%, so the fully loaded cost is $30 × 1.35 = $40.50 per hour. Some companies also divide by productive or billable hours rather than paid hours, which raises the loaded cost further.

Burden rates are used for pricing, bidding on contracts, valuing inventory, judging the profitability of jobs and customers, and comparing the cost of employees with contractors. Government contractors often must calculate burden rates in a defined way to support the costs they bill.

The main weakness of any burden rate is that it is an average based on estimates. If actual activity is far below budget, fixed overhead is spread over fewer hours and the rate understates true cost. If the allocation base is poorly chosen, for instance labor hours in a highly automated plant, some products absorb more burden than they cause. A burden rate also includes many fixed costs that will not change in the short run, so it should not be treated as the incremental cost of one more hour when evaluating special orders. Reviewing rates at least annually, and separating fixed and variable elements, keeps them useful.