INTRODUCTION TO COST ESTIMATION

ME6005
PROCESS PLANNING AND COST
ESTIMATION

• UNIT I INTRODUCTION TO PROCESS
PLANNING
• UNIT II PROCESS PLANNING ACTIVITIES
• UNIT III INTRODUCTION TO COST ESTIMATION
• UNIT IV PRODUCTION COST ESTIMATION
• UNIT V MACHINING TIME CALCULATION

UNIT III INTRODUCTION TO COST
ESTIMATION
• Importance of costing and estimation
• Methods of costing-elements of cost
estimation
• Types of estimates
• Estimating procedure
• Estimation labor cost, material cost
• Allocation of over head charges
• Calculation of depreciation cost

What is mean by cost estimation?
• Estimation of the expected cost of producing a
job
• Executing a manufacturing order before the
actual production is taken up
• Predicting what new products will cost before
they are made.

Definition
Costing or cost accounting means classifying,
recording and allocating the appropriate
expenditure for determining the cost of
production and achieved by keeping a
continuous record of all the costs involved in
manufacturing

REASONS FOR DOING
ESTIMATES
• Should the product be produced?
• When a company designs a new product
• To assist management in making an
intelligent decision about producing the
product.

General procedure
• A cost estimate must be developed for jigs,
fixtures, tools, dies and gauges.
• Also, the cost of any capital equipment must
be entered into the estimate. These figures are
usually supplied through quotation by vendors.
• An estimate of this nature will include a vast
amount of details, because if management
approves the project, the estimate now
becomes the budget.

OBJECTIVES OR PURPOSE OF
ESTIMATING
(i) To establish the selling price of a product.
(ii) To ascertain whether a proposed product can be
manufactured and marketed
profitably.
(iii) To determine how much must be invested in
equipment.
(iv) To find whether parts or assemblies can be more
cheaply fabricated or purchased from outside (make or
buy decision).
(v) To determine the most economical process, tooling or
material for making a product.

FUNCTIONS OF ESTIMATING
(i) To calculate the cost of new material needed to
manufacture a product.
(ii) To find the cost of parts to be purchased from
outside vendors.
(iii) To find the cost of equipment, machinery, tools, jigs
and fixtures etc. required to be
purchased to make the product.
(iv) To calculate the direct and indirect labour cost
associated with the manufacture of the
product, based upon work study.
(v) To calculate various overhead charges associated
with the product.

Cont.…
(vi) To decide about the profit to be charged, taking into
consideration other manufacturers of same product in the
market.
(vii) To calculate the selling price of the product.
(viii) To maintain records of previous estimating
activities of the company for future
references.
(ix) To decide the most economical method of making the
product.
(x) To submit cost estimates with the competent authority
for further action.

COMPONENTS OF A COST ESTIMATE
OR JOB ESTIMATE
1. Cost of design.
2. Cost of drafting.
3. Cost of research and development.
4. Cost of raw materials.
5. Cost of labour.
6. Cost of inspection
7. Cost of tools, jigs and fixtures.
8. Overhead cost

1. Cost of Design
• The cost of design of a component or product is
estimated by ascertaining the expected time for the
design of that component
• The estimate design time multiplied by the salary of
designer per unit time gives the estimated cost of
design
• If the design of the component is done by some
outside agency, the total amount paid to outside
agency gives the cost of design.

2. Cost of Drafting
• Once the design of the component is
complete, its drawings have to be prepared
by draftsman
• The expected time to be spent in drawing or
drafting is estimated and is then multiplied by
the standard drafting rate or by the salary of
the draftsman per unit time to get estimated
cost of drafting

3. Cost of Research and Development
Work
• Before taking up the manufacturing of actual
components/parts considerable time and
money has to be spent on research and
development.
• The research may be theoretical, experimental
or developmental research.
• The cost of R and D can be estimated by
considering various items of expenditure
incurred during R and D work

4. Cost of Raw Material
(i) A list of all the materials used in the manufacture of the
product is made which includes
the direct as well as indirect materials.
(ii) The quantity (weight or volume) of all the material
expected to be used in the manufacture of the product is
estimated. The allowance for material wastage, spoilage and
scarp are also added for each component/part.
(iii) Cost of each material is estimated by multiplying the
estimated quantity of each material with its estimated future
price. The estimate of future price of a material is made keeping
in view of present prices and general trends and variations.
(iv) Estimated cost of all the materials is added to get the overall
estimated material cost.

5. Cost of Labour
• The cost of labour involved in the manufacture of a
product is estimated by estimating the labour time
needed to manufacture the product and multiplying it
by cost of labour per hour.
• In order to estimate the labour time expected to be
spent on a job, one must have thorough knowledge of
the various operations to be performed, machines to
be used, sequence of operations, tools to be used and
labour rates

6. Cost of Inspection
• A product being manufactured is inspected at
various stages during its manufacture.
• It may be inspection of raw material or in-
process inspection or inspection of finished
goods.

7. Cost and Maintenance Charges of
Tools, Jigs and Fixtures
• The cost of tools, jigs, fixtures etc., is estimated
considering their present prices, market trend and the
number of times a particular tool can be used during
its life-time.
• The estimated cost divided by the number of jobs it
can make, gives the tool cost per unit produced

8. Overhead Costs
• Overhead or indirect costs are those which are not
incurred specifically for any one order or product and
these can not be charged directly to a specific order or
product
• The overhead costs may be estimated by referring
to the records of overhead costs in similar items
produced in past

METHODS OF COSTING
• 1. Job costing or order costing,
• 2. Batch costing,
• 3. Process costing,
• 4. Departmental costing,
• 5. Operating cost method,
• 6. Unit cost method, and
• 7. Multiple cost method.

Classification of cost
• 1. Classification of cost according to elements
• (i) Materials cost (ii) Labour cost
• (iii) Overheads
• 2. Classification of cost according to function
• (i) Production cost
• ii) Administrative cost
• (iii) Selling cost
• (iv) Overhead cost
• 3. Classification of cost according to variability
• (i) Fixed cost
• (ii) Variable cost
• (iii) Semi-variable cost
• 4. Classification of cost into direct and indirect costs
• (i) Direct cost
• (ii) Indirect cost

• 5. Classification of cost according to
capital and revenue
• (i) Capital cost
• (ii) Revenue cost

INTRODUCTION TO COST ESTIMATION

Analysis of overhead expanses
• (a) Factory expenses,
• (b) Administrative expenses,
• (c) Selling expenses, and
• (d) Distribution expenses.

COST OF PRODUCT (LADDER OF COST)
1. Prime cost: It consists of direct material cost,
direct labour cost and direct expenses.
Prime cost = Direct material cost + Direct labour cost
+ Direct expenses.
Prime cost is also called as direct cost.
2. Factory cost: It consists of prime cost and
factory expenses.
Factory cost = prime cost + factory expenses.
Factory cost is also named as works cost.

3. Office cost: It consists of factory cost and
administrative expenses.
Office cost = Factory cost + Administrative expenses
It is also named as manufacturing cost (or) cost of
production.
4. Total cost: It includes manufacturing cost and
selling and distribution expenses.
Total cost = Manufacturing cost + selling and
distribution expenses.

Selling price
• If the profit is added in the total cost of the
product, it is called selling price.
Selling price = Total cost + Profit
= Total cost – Loss

• Estimate the weight of material required
for manufacturing 220 pieces of shaft as
shown in Fig. The shafts are made of mild
steel which weighs 7.87 gm/cm3 and costs
Rs.100 per kg. Also calculate the material cost
for 220 such shafts.

ESTIMATION OF LABOUR COST
• Since the labour cost contributes a
significant amount of total cost of product,
therefore the effective and efficient
determination of labour cost is essential.
• In order to calculate the labour cost,
an estimator must have the · knowledge
of (i) all the operations involved, (ii)
the tools, and (iii) the machines used for
production.

(i) Set up time,
(ii) Operation time,
(a) Handling time, and
(b) Machining time.
(iii) Tear down time,
(iv) Miscellaneous allowances,
(a) Personal allowances,
(b) Fatigue allowances,
(c) Contingency allowances,
(d) Process allowances,
(e) Interference allowances,
(f) Special allowances.

• Set up Time
Set up time is the time required for setting
and fixing the jobs and tools on the machine.
• Operation Time
Operation time is the time required to
perform all the elements of an operation
(a) Handling time
It is the time required for loading and
unloading operations.
(b) Machining time
It is the time taken by the job to perform
the operation on the machine .

• Tear Down Time
Tear down time is the time taken to remove job,
tools, and other auxiliary equipment from the
machine after the last element of operation has
been completed.
• Miscellaneous Allowances:
Allowance is the additional time allowed to
perform the work over and above the basic time.
Standard time = Basic time + Allowances

Types of Allowances
1.Relaxation allowances
(a)Personal need allowances
Personal allowances are provided to the worker to fulfill
his/her personal needs such as washing hands, going to the
lavatory, getting water, tea, etc.
(b) Fatigue allowances.
Fatigue allowances are intended to provide a work
man an opportunity to recover from physiological and
psychological effects of fatigue caused by carrying out a
specified task under specified condition.
2. Contingency allowances,
Contingency allowances are provided for small
unavoidable delays as well as for occasional and minor extra
work.

3. Process allowances
Process allowances are provided to compensate
for enforced idleness during a process.
4. Interference allowances
Interference allowance is provided when two or
more work elements occur simultaneously.
5. Special allowances.
• Special allowances are provided for activities
which are not normally a part of the operation
cycle, but they are essential for satisfactory
performance of the work .
These include the following:
(a) Start-up allowance, (b) Shut-down allowance,
(c) Cleaning allowance. (d) Tool allowance
(d) (f) Changeover allowance.

Calculation of Standard Time
• Standard time is the time allowed to an operator
to carry out the specified task under specified
conditions and defined level of performance.
• Standard time is defined as the total time in
which a job should be completed at standard
performance.
Standard time = Normal time + Allowances
Normal time, also known as basic time, is the time for
carrying out a work at standard rating.
Normal (or basic) time =Observed time x Rating factor

• Rating factor, also known as performance
rating, is a levelling factor to convert
observed timings into normal timings

1.In a manual operation, observed time for a cycle of operation is
0.5 minute and the rating factor as observed by the time study
engineer is 125%. All allowances put together is 15% of normal
time. Estimate the standard time. [A.U, Nov/Dec 2014]

2.In a manufacturing process, the observed
time for one cycle of operation is 0.75 minute.
The rating factor is 110%. The following are
the various allowances as the percentage of
normal time.
• Personal allowance = 3%
• Relaxation allowance = 10%
• Delay allowance = 2%
Estimate the standard time.

ESTIMATION OF OVERHEADS AND
VARIOUS COST COMPONENTS
• Prime cost
• Factory or workers cost
• Manufacturing or production cost
• Total or ultimate cost, and
• Selling price.

2. Factory cost = Prime cost + Factory expenses

1.For manufacturing a 'milling machine', the
expenditure is tabulated in Table

• Find out (a) Prime cost, (b) Factory cost,
(c) Total cost of production, (d) Cost of
sales, and (e) Selling price.
• Given Data: Refer Table
• To find:
(a) Prime cost, (b) Factory cost,
(c) Production cost, (d) Cost of sales and
(e) Selling price.

From the following .data for a sewing machine
manufacturer, prepare a statement showing
prime cost, works/factory cost, production cost, total
cost and profit.
Rs.
• Value of stock of material as on 1.04.2010 26,000
• Material purchased 2,74,000
• Wages to labour 1,20,000
• Depreciation of plant and machinery 8,000
• Depreciation of office equipment 2,000
• Rent, taxes and insurance of factory 16,000
• General administrative expenses 3,400.
• Water, power and telephone bills of factory 9,600
• Water, lighting and telephone bills of office 2,500
• Material transportation in factory 2,000

• Rent of office building 2,000
• Direct expenses 5,000
• Commission and pay of salesman 10,500
• Repair and maintenance of plant 1,00
• Works manager salary 30,000
• Salary of office staff 60,000
• Value of stock of material as on 31.03.2011 36,000
• Sale of products 6,36,000
Solution:

3.Calculate prime cost, factory cost, production
cost, total cost and selling price per item from the
data given below in Table for the year 2012-13.
S.No. Particulars Expenses
1 Cost of raw material in stock as on 25,000
01.04.2012
2 Raw material purchased 40,000
3 Direct labour cost 14,000
4 Direct expenses 1,000
5 Factory/work overheads 9,750
6 Administrative expenditure 6,500
7 Selling and distribution expenses 3,250
8 Number of items produced 650
9 Cost of raw material in stock as on 15,000
31.03.2013
Net profit of the items is 10% of the total cost of the product.

Given Data: Refer Table
To find:
(a) Prime cost (b) Factory cost (c) Production cost
(d) Total cost (e) Selling price
Solution: It may be noted that 650 number of items were
produced during 2012-13.

• A manufacturer is making 100 units of an
item per hour and incurs the following
expenses:
• Direct material cost = Rs. 35
• Direct labour cost = Rs. 200
• Direct expenses = Rs. 75
• Factory on cost = 150% of labour
cost
• Office on cost = 30% of
factory cost
Find out the selling price for a profit of 15% on
the selling price. [A. U., Nov/Dec 2015)

ALLOCATION OF OVERHEAD EXPENSES
• The different methods of allocation of overhead expenses
are:
1. By percentage (i.e., allocation by cost proportion)
(a) Percentage on prime cost,
(b) Percentage on direct labour cost, and
(c) Percentage on direct material cost.
2. By hourly rate (i.e., allocation by hourly rate)
(a) Man-hour rate
(b) Machine hour rate, and
(c) Combination of man-hour and machine-hour rate .
3. By unit rate (i.e., allocation by unit rate)
(a) Unit rate method

Allocation by Percentage on Prime Cost
This percentage multiplied by the prime cost of individual
item
gives the part of total overheads to be allocated to that
item of manufacture.
Suitability: This method is suitable (a) where only one type
of product is being manufactured, and (b) where direct
labour and direct material costs are nearly same .
Disadvantages: This method ignores the difference in labour
rates, material, and machines employed for the manufacture
of different items.

A manufacturing firm has total overheads of•
Rs.1,20,000 and total prime cost Rs.2.5 lacs for the year
2002-03. Find out the share of over heads to be allocated to
products A and B
by proportional to prime cost method using the following
data.
Product A ProductB
Direct material cost Rs. 900 Rs. 1000
Direct labour cost Rs. 700 Rs. 600
Direct other expenses Rs. 300 Rs. 250

Allocation by Percentage on Direct
Labour Cost
• This percentage of overheads multiplied
by the direct labour on the manufacture
of the item gives the part of total
overhead costs allocated to that item.

• Total overheads of a factory for the year
2000-01 were Rs. 7, 75,750 and total direct
labour wages during that year were
Rs.4,50,000. Find out the overheads
allocation to a product for which direct
labour cost is Rs.950. Use allocation by
proportional to direct labour cost method.

Allocation by Percentage on Direct
Material Cost
• In this method, allocation of overheads
depends upon the total direct material cost.

A foundry department of a factory manufacturing
engine crankcase had Rs.1,82,000 as total overheads
while the material cost was Rs.4,20,000. Calculate the
percentage on-cost.

Allocation by Man-hour Rate
• In this method, the overhead cost is
allocated on the total hours spent by the
direct labour and not on the wages paid to
them .

A factory has 15 lathes of same make and
capacity and 5 shapers of same make and
capacity. Lathes occupy30 m2 area while shapers
occupy 15 m2 area. During the calendar year,
factory expenses for this section are as follows:
(i) Building rent and depreciation = Rs.
5,000; (ii) Indirect labour and material = Rs.
15,000; (iii) Insurance = Rs. 2,000; (iv)
Depreciation charges of lathes = Rs. 5,000; (v)
Depreciation charges of shapers = Rs. 3,000; (vi)
Power consumption for lathes = Rs. 2,000;
(vii)Power consumption f or shapers= Rs. 1,000.
Find out tile machine hour rate for lathe and
shapers, if all the lathes and shapers work for
25,000 hours and 8,000 hours respectively.

Allocation by Combination of Man-
hour and Machine Hour Rate
• This method is used in manufacturing
industries where work in some
departments are carried out by hand
and work in the other departments are
done by machines.

DEPRECIATION
• The reduction in the value and efficiency
of the plant, equipment or any fixed asset
because of wear and tear, due to passage
of time, use and climatic conditions is known
as depreciation.
• Depreciation is the process of allocating the
acquisition cost of the tangible asset less salvage
value, if any, in a systematic and a rational
manner over the estimated life of the asset.

METHODS OF DEPRECIATION
1. Straight line method
2. Diminishing balance (or reducing balance) method.
3. Sinking fund method.
4. Annuity method
5. Sum of year's digits method.
6. Insurance policy method.
7. Machine-hour method.
8. Production-unit method.
9. Revaluation (or regular valuation) method
10.Retirement method

1. Straight line method
• In this method, the amount of depreciation
is distributed over the useful life of the
machine in equal periodic instalments.
C = Initial cost of the machine in rupees,
S = Scrap (or salvage) value in rupees,
n = Estimated life of the machine in years,
D = Depreciation amount per year.

2.Diminishing Balance (or Reducing
Balance) Method
• The book value of the machine goes on
decreasing as its existence continues. Hence in
this method a certain percentage of the
current book value is taken as depreciation.
c = Initial cost of the machine in rupees,
S = Scrap value in rupees,
p =Fixed percentage for calculating yearly
depreciation
n = Estimated life of the machine in years,

3. Sinking Fund Method
4. Annuity Method
5.Sum of the Year's Digit Method
The scrap value of the asset is deducted from its original cost and the
remaining balance is spread over the asset's life.in decreasing proportion.
Formula used:
"If 'n' is the estimated life of the asset, the rate is calculated each
period as a fraction in which the denominator is always the sum of the
series I, 2, 3,……, n and the numerator for the first period is 'n ',for the
second 'n - l ',and so on."

6.Insurance Policy Method
In this method, an insurance policy
is made for the amount required to replace
the machine at the end of its useful life.
. Premiums are paid on the insurance
policy. When the policy matures, the
insurance company provides sufficient sum
to replace
the machine.

7.Machine Hour Method
8.Production Unit Method
9. Revaluation (or Regular Valuation) Method
The depreciation is equal to the difference
between the values assigned to the asset at the beginning
and end of each year.
10.Retirement Method
whole original cost of the asset is charged to
depreciation expenses in the year in which it is being
retired from the service.

INTRODUCTION TO COST ESTIMATION

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