INTRODUCTION TO COST ESTIMATION

INTRODUCTION TO COST ESTIMATION

1. UNIT III INTRODUCTION TO COST ESTIMATION Importance of costing and estimation M ethods of costing-elements of cost estimation Types of estimates Estimating procedure Estimation labor cost, material cost A llocation of over head charges Calculation of depreciation cost

2. 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

3. 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

4. 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 .

5. 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

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

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

8. To decide about the profit to be charged, taking into consideration other manufacturers of same product in the market To calculate the selling price of the product To maintain records of previous estimating activities of the company for future references To decide the most economical method of making the product To submit cost estimates with the competent authority for further action FUNCTIONS OF ESTIMATING Contd.,

9. 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

10. 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.

11. 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

12. 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

13. 4. Cost of Raw Material A list of all the materials used in the manufacture of the product is made which includes the direct as well as indirect materials 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.

14. 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 Estimated cost of all the materials is added to get the overall estimated material cost 4. Cost of Raw Material Contd.,

15. 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

16. 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

17. 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

18. 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

19. BASIC STEPS IN COST ESTIMATION 1. Make thorough study of cost estimation request to understand it fully. 2. Make an analysis of the product and prepare a bill of materials . 3. Make separate lists of parts to be purchased from the market and parts to be manufactured in plant. 4. Determine the cost of parts to be purchased from outside . 5. Estimate the material cost for the parts/components to be manufactured in plant.

20. 6. Make manufacturing process plan for the parts to be manufactured in plant. 7. Estimate the machining time for each operation listed in the manufacturing process plan. 8. Multiply each operation time by the labour wage rate and add them up to find direct labour cost 9. Add the estimate of step 4, 5, and 8 to get prime cost of component. 10. Apply overhead costs to get the total cost of the component. The selling price of the component is estimated by adding profit to the total cost obtained in step 10. BASIC STEPS IN COST ESTIMATION

21. TYPES OF COST ESTIMATES (a) Factor Method of Cost Estimation (b) Material Cost Method of Estimation (c) Function Method of Cost Estimation Other types ( i ) Product comparison (ii) Data base calculations

22. Factor Method of Cost Estimation Estimated cost of an item = Factor for total cost estimate × Amount of major cost item Example: ( i ) Cost of construction per km of highway (ii) Cost of fabricated component per kg of casting (iii) Cost of house construction per Sq.m . of livable space

23. Example Problem: If a casting weighed 15 kg, and the factor of the cost of casting per kg of casting is Rs . 75, what is the estimated cost of the casting ? Estimated cost of the casting = Rs . 75 per kg of casting × wt. of the casting (15 kg) = Rs . 1125 per casting

24. Material Cost Method of Estimation Material cost method predicts the total cost of the product based on the ratio of the material cost of the product to the material cost share of the total cost .  

25. Examples of material cost share : Product Material cost share (%) Passenger car 65% Diesel engine 50% Clocks, watches 25% Glass product 10% Example Problem: If the material cost of an automobile was Rs . 2.50 Lakhs, what would be the total cost of the automobile ? Use the table above. Estimated total cost of automobile = Rs . 2.50 Lakhs / 0.65 = Rs . 3.85 Lakhs

26. This method is similar to the factor method, but more variables are used . Function method uses a mathematical expression with constants and parameters derived for specific process, such as casting or machining or for specific classes of parts based on material, size, weight or other cost parameters. Function Method of Estimation

27. According to this method : Estimated cost of an item = G × (a + b) + (R × c) + (N × d) where G = Weight of the item, kg a = Material cost per kg b = Tolerance cost per, kg R = Weight of material Removed, kg c = Cost per kg of material removed N = No. of dimensions of a product surface d = Cost per dimension Function Method of Estimation Contd.,

28. Product comparison : The new product is compared with existing products (of similar function , design etc.) and adjustments/modifications are made for the differences. (ii) Data base calculations : The product cost estimate is determined from cost data bases which a company is expected to maintain over a period of time (Historical Cost Data Base).

29. Elements of Cost Material cost Direct material cost ( b) Indirect material cost Labour cost Direct labour cost ( b ) Indirect labour cost Other expenses Direct expenses ( b) Indirect expenses Factory expenses ( ii) Administrative expenses (iii) Selling and distribution expenses

30. Material cost Direct material cost ( i ) From the product drawing, make a list of all the components required to make the final product. (ii) Calculate the volume of each component from the drawing dimensions after adding machining allowances, wherever necessary. (iii) The volume of component multiplied by the density of material used gives the weight of the material per component.

31. Direct material cost ( iv) Add process rejection and other allowances like cutting allowance to get the gross weight per component . (v) Multiply the gross weight by the cost of material per unit weight to get the cost of raw material per component. (vi) The cost of raw material for all the components is, similarly, calculated and added up which gives the cost of direct material for the product. Material cost Contd.,

32. Indirect material cost The indirect materials include oils, general tools, grease , sand papers, coolants, cotton waste etc . The cost associated with indirect materials is called indirect material cost. Material cost

33. Labour cost Direct labour cost Direct labourer is one who actually works and processes the materials to convert it into the final shape . The cost associated with direct labour is called direct labour cost . The direct labour are the workers operating lathes, milling machines or welders, or assemblers in assembly shop.

34. Indirect labour cost Indirect labourer is one who is not directly employed in the manufacturing of the product but his services are used in some indirect manner . The cost associated with indirect labour is called indirect labour cost. The indirect labour includes supervisors, inspectors, foreman, storekeeper, gatekeeper, maintenance staff, crane driver etc. Labour cost

35. Direct expenses Direct expenses include all that expenditure which can be directly allocated and charged to a particular job . The direct expenses include cost of special jigs or fixtures , patterns, toolings made for job, or cost of research and development work done for that specific job. Other Expenses

36. Indirect expenses Except direct expenses, all other indirect expenditure incurred by the manufacturer is called indirect expenses The indirect expenses are also called overhead expenses or on-cost The indirect expenses are further classified as ( i ) Factory expenses ( ii) Administrative expenses ( iii) Selling and distribution expenses Other Expenses

37. Indirect expenses - Factory expenses Factory expenses comprise of the indirect expenses incurred from the receipt of the order to the completion of production . Includes rent of factory building, licence fee, electricity and telephone bills of factory, insurance charges etc. Other Expenses

38. Indirect expenses - Administrative expenses Administrative expenses or office expenses include the expenditure incurred on control and administration of the factory It includes the salaries of office and administrative staff, rent of office building, postage and telephone charges, water and electricity charges for office, Director’s fee, legal and audit charges etc. Other Expenses

39. Indirect expenses - Selling and distribution expenses this is the expenditure incurred on Sales Department for selling the product It includes the wages, salaries, commission and travelling allowances of salesmen and officers in Sales Department, cost of advertisement, packing, delivery and distribution expenses, rent of warehouses etc. Other Expenses

40. Methods of Estimating Conference method Comparison method Detailed analysis method

41. Conference method A co-ordinator from either accounting or estimating collect costs and applies overhead factors to develop a total manufacturing cost for the product If vague or only verbal information is available, then the total product material, labour and tooling will be estimated as one lump sum for each The degree of accuracy of this method depends upon the availability of specificaitions , samples and drawings

42. Comparison method In this method of estimating the costs of similar parts are applied to the product and are adjusted to suit variations in the workpiece , material and labour costs. It is based on the accumulation of past experience data

43. Detailed analysis method This method involves Calculation of raw material usage including scrap allowance and salvage material Processing each individual component (writing the operation sheet) Determining the production time (direct labour ) for each operation The equipment required (new, network, or on hand) Tools, gauges, and special fixtures or dies, Inspection and testing equipment Packaging and shipping requirements

44. COST ESTIMATING PROCEDURE Step 1 : Study the cost estimation request thoroughly and understand it completely Step 2: Analyse the product and decide the requirements and specifications of the product Step 3: Prepare the list of all the parts of the product and their bill of materials Step 4: Take make or buy decisions and prepare separate l ists of parts to be manufactured within the plant and parts to be purchased outside the plant

45. Step 5: Estimate the materials cost for the parts to be manufactured in the plant Step 6 : Determine the cost of parts to be purchased from outside Step 7: Make a manufacturing process plan for the parts to be manufactured in the plant   COST ESTIMATING PROCEDURE Contd.,

46. Step 8: Estimate the machining time for each operations listed in the manufacturing process plan Step 9: Determine the direct labour cost Step 10: Determine the prime cost by adding direct expenses, direct material cost, and direct labour cost   COST ESTIMATING PROCEDURE Contd.,

47. Step 11: Estimate the factory overheads, which include all indirect expenditure incurred during production such as indirect material cost, indirect labour cost, depreciation and expenditure on maintenance of the plant, machinery, power, etc. Step 12: Estimate the administrative expenses COST ESTIMATING PROCEDURE Contd.,

48. Step 13: Estimate the selling and distribution expenses which include packing and delivery charges, advertisement charges, etc . Step 14: Now calculate the total cost of the product   COST ESTIMATING PROCEDURE Contd.,

49. Step 15: Decide the profit and add the profit to the total cost to fix the selling price of the part Step 16: Finally estimate the time of delivery in consultation with the production and sales department   COST ESTIMATING PROCEDURE Contd.,

50. ESTIMATE FORM After estimating all the elements of cost estimate, these estimated datas are entered into an estimate form

51. COST OF PRODUCT ( LADDER OF COSTS) 1. Prime cost = Direct material cost + Direct labour cost + Direct expenses 2. Factory cost = Prime cost + Factory expenses 3. Production cost = Factory cost + Administrative expenses 4. Total or Ultimate cost = Production cost + Selling and distribution expenses. 5. Selling price = Ultimate cost + Profit

52. BLOCK DIAGRAM

53. Example: Calculate prime cost, factory cost, production cost, total cost and selling price per item from the data given below for the year 2003-04 .

54. Example : From the following data for a sewing machine manufacturer, prepare a statement showing prime cost, Works/factory cost, production cost, total cost and profit.

55. Example : From the following data for a sewing machine manufacturer, prepare a statement showing prime cost, Works/factory cost, production cost, total cost and profit.

56. ESTIMATION OF MATERIALS COST Procedure Study the gi v en drawing carefully. T hen break up the product into simple geometrical shapes such as cubes, prisms, cylinders, etc., Calculate the volume of each parts using formulae Add volumes to get total volume Calculate the weight of material by Volume × Density  

57. Example

58. Allowance The amount of time added to the normal time to provide for personal delays, unavoidable delays and fatigue of the operator.

59. Types of allowances Relaxation allowance Contingency allowances Process allowances Interference allowances Special allowances

60. Relaxation allowance This is the time provide to the worker to recover from the physiological effects of carrying out a specified task under specified conditions and to allow attention to personal needs. These are of two types: Personal allowances Fatigue allowances

61. Personal allowances Personal allowances are provided to the worker to fulfill his/her personal needs such as washing hands, going to the lavatory, getting water or tea. T hey are usually taken as 5% for males and 7% for female worker of the total working time.

62. Fatigue allowances: Fatigue allowances are intended to provide a work man an opportunity to recover from physiological effects of fatigue caused by carrying out a specified task under special condition. It may be due to excessive work, repeated work, poor lighting, poor ventilation, machine noises Generally 5% of the total work time is considered as fatigue allowances.

63. Contingency allowances These allowances are provide for small unavoidable delays as well as for occasional and minor extra work, like tool breakage, sharpening, replacing, filling coolant reservoirs, consulting with foreman, power failures of small duration, daily oiling and cleaning . They are less than 5% of the time

64. Process allowances They are provided to compensate for enforced idleness such as loss of time due to no work, power failure, faulty material, tools or equipment.

65. Interference allowances This is provided when two or more elements occur simultaneously . This occurs when an operator is attending on more than one machine at a time, resulting in idle time occurring in more than one machine .

66. Special allowances These allowances are provide for activities that are not part of the normal cycle of operations, but they are essential for the satisfactory performance of a given task These include, for example : Start-up allowance , Shut-down allowance , Cleaning allowance , Time for adjustment and maintenance of tools , Changeover allowance.