COST ESTIMATING

• Definition
• Cost estimating may be defined as process of forecasting the
expenses that must be incurred to manufacture a product.
• These expenses take into consideration all expenditures
involved in design and manufacturing, with all related service
facilities , general administration and selling costs.
• Cost estimates are the joint product of the engineer and the
cost accountant , and involves two factors: physical data and
costing data. The engineer do the manufacturing planning by
determine the physical data. The cost accountant compiles
and applies the costing data
 Purpose of Cost estimation .
• To determine the selling price of a product for a quotation or
contract to ensure a reasonable profit to the company.
• To check the quotation supplied by the vendors
• To decide whether a part or assembly is economical to be
manufactured in the plant or is to be purchased from outside
• To determine the most economical process or material to
manufacture a product
• To initiate means of cost reduction in existing production
facilities by using new materials which result in savings due to
lower scrap loss and revised methods of tooling and
processing .
• To determine standards of production performance that may be
used to control costs.
 Cost Accountant or Costing
• It is the determination of an actual cost of a component after
adding different expenses incurred in various departments or
it may be defined as system which systematically records all
the expenditures to determine the cost of manufactured
products. The work of cost accounting begins with the pre-
planning stage of the product and ends only after the whole
lot of the product has been fully manufactured.
• Difference between cost estimation and cost accounting:
Cost estimation is determining the anticipated or probable
cost of a job much before the manufacturing of the job is
undertaken, whereas cost accounting is the compilation of
actual cost after the job has been completed.
 Difference between cost estimation and cost
accounting cont.
• Cost estimation gives predicted or standard cost, whereas cost
accounting gives actual or postmortem costs.

• Purpose of cost accounting:

1. To compare the actual cost with the estimated cost to know
whether the estimated cost had been realistic or not
2. Wastages and undesirable expenses are pointed out
requiring corrective measures
3. The costing data helps in changing the selling price because
of change in material cost or labour cost etc.
4. It helps to locate the reasons for the increase or decrease of
loss or profits of a company.
 Purpose of cost accounting cont.

5. It helps in determining the discount on market price of the

product.
6. The actual cost helps the company to decide whether to
continue with the manufacture of a product or to buy it from
outside
7. It helps the enterprise to prepare its budget.
8. The costing data helps to formulate policies and plans for the
pricing of a new job
9. It helps in regulating from time to time the production of a job
so that it may be profitable to the company
 Classification of costs
• Nonrecurring costs: These costs are also called “capital costs”
and are one-time costs. These costs consists of two parts:
fixed capital costs and nondepreciated capital costs. Fixed
capital costs include depreciable items such as plant building,
manufacturing equipment and tools. Nondepriciation capital
cost includes land.
• Recurring cost. This cost is a direct function of manufacturing
process. It’s also called “operating cost” or “manufacturing
cost”
• Fixed costs. Fixed costs associated with a productive unit ,
those costs which are independent of the rate of production
of components. These costs will be there whether the
facilities are being utilized or not
 Classification of costs cont.

• Variable costs: These costs vary with the rate of production. If

there is no production, variable costs will be nil.
• A cost can be termed as “direct cost” or ”indirect cost “
• Direct cost: is that cost which can be directly assigned to a
product
• Indirect cost: can be directly assigned to a product but must
be spread over an entire factory.

• Working Capital. Working capital includes funds over and

above the fixed capital and land investment, to get a facility
started and to provide for the future financial obligation as
they occur.
 Working Capital cont.

• Working capital consists of:

1. Raw material on hand
2. Semi finished products in the process of manufacture
3. Finished products in the inventory
4. Account receivable
5. Cash in hand needed fro day-to-day operation

• Working capital remains tied up during the useful life of the

plant , but it is considered to be fully recoverable at the end of
the life of the facility.
 Turn Over Ratio
• This concept provided a rough estimate of the investment
cost of a new product.

• Turn Over Ration =

• Element of Costing:
The constituents of cost of a product or the “cost element “ are:
1. Material cost
2. Labour cost
3. Expenses
 Element of Costing cont.

1. Material cost. Material is divided into two basic categories

• (a) material for fabricated parts (b) standard purchased parts .
The total cost of these two will give the material cost. Again
there are two kinds of materials which comprise the factory
cost of a product. These are : Direct material and indirect
material
• Direct material. The direct material is the raw material which
is processed in the plant and finally forms the finished
product. Any standard part which also becomes a part of the
finished product will also come under the category of direct
material.
• Indirect material . Indirect materials are those which help in
the processing of direct materials into the finished product.
 Element of Costing cont.

• Indirect materials don’t form a part of the finished product.

Indirect materials include: shop supplies such as cotton waste,
lubricating oil, cutting fluids, oil, shielding glasses used in arc
welding, etc.
2. Labour cost: Labour which enter into the manufacture of a
product is of two categories: Direct labour and Indirect labour
• Direct labour. The operator or operators which actually
process the raw material either on machine or manually form
the direct labour
• Indirect labour: All the staff including sales executives officer,
administrative staff, foremen, maintenance staff etc. come
under indirect labour
 Element of Costing cont.

3. Expenses: Total cost of the product minus the costs of direct

material and direct labour constituted the Expenses or
overhead
Overhead can be grouped into two main categories:
• Fixed overheads or Constant overhead: These are indirect
expenses which remain constant or fixed irrespective of
volume of production. These items include: salaries of high
officer, capital taxes, insurance charges, depreciation on
building, plant machinery, rent of buildings etc.
• Variable or floating overhead: Overheads which vary with the
volume of products such as power, fuel, repairs of machines,
factory lighting , sales officer expenses etc.
 Cost Structure

• Prime cost. Prime cost or direct cost = Direct material + Direct

labour
• Factory cost = Prime cost + Factory expenses
• Manufacturing cost or cost of production = factory cost +
Administrative expenses
• Total cost = Manufacturing cost + Selling cost + Distributing
expenses
• Selling cost = Total cost + Profit
 Data Requirements for Cost Estimating
• The following detailed data are required by the estimator to
arrive at an accurate estimate of a new product:
1. General design specification , i.e. a brief description of the
product, its function, performance and purpose.
2. Quality and rate of product
3. Assembly or layout drawing s
4. List of sub-assemblies of the product
5. Detailed drawings and a bill of material for the product
6. Material release data
7. Operation analysis
8. Standard time data
9. Machine tool and equipment required
 Data Requirements for Cost Estimating

10. Tools, gauge, and special fixtures, jigs or dies required

11. Manufacturing routings
12. Test and inspection equipment and procedures
13. Packaging and transportation requirements
14. Area and building requirements
 Steps in Making a Cost Estimate

• The cost of a new product may be estimated by following the

basic steps given below:
1. Make a complete and thorough analysis of the cost request
to understand it fully
2. Make an analysis of the part or product and separate lists of
standard parts and the parts to be fabricated within the plant
3. Make a manufacturing process plan for the parts to be
fabricated
4. Determine the material costs for the standard and the
fabricated parts
5. Estimate the total production time for each operation listed
in step 3
 Steps in Making a Cost Estimating cont.
6 . Apply the labour and burden rates to each operation
7. Add the material costs step 4 and the labour and burden costs
step 6. This will give the total manufacturing cost
8. Apply the profit factors to arrive at the selling price.
Cost estimate may not be exactly the same as the actual
manufacturing cost. The significant causes for the cost
deviation can be: Fluctuations in material and labour costs,
incomplete design information at the time of estimate,
unexpected delays resulting in premiums paid for overtimes
and materials and the unexpected machining or assembly
problems.
 Example 1
• Calculate the total cost and selling price for a job:
Direct material = N5,500
Manufacturing wages = N3,000
Factory overheads to manufacturing wages = 100%
Non-manufacturing overheads to factory cost = 15%
Profit on total cost = 12%

Solution:
Manufacturing wages (Direct labour) = N3000
Factory overheads = 100% of N3000 = N3000
Factory cost = Direct material + Direct labour + Factory overheads
= N5,500 + N3,000+ N3,000
= N11,500
 Example 1
• SOLUTION CONT.
Non-manufacturing overheads, i.e,
administrative and selling overheads = 15% of N 11,500
= N1725
Total cost = Factory cost + N1725
=N11500 + N1725
= N13225
Profit = 12% of total cost
= 12% of N13225
= N1587
Selling price = Total cost + Profit
= N13225 + N1587
= N14812
 Example 2
From the records of a company, the following data are available:
i Raw materials
opening stock = N20,000
closing stock = N30,000
Total purchases during the year = N170,000
ii. Finished goods
Opening stock = N10,000
Closing stock = N15,000
Sales = N489,500
iii. Direct wages = N120,000
iv. Factory expenses = N120,000
v. Non-manufacturing expenses = N50,000

Find out what price should be quoted for a product involving an

expenditure of N20,000 in material and N30,000 in wages
 Solution
We need to determine the rate of factory expenses, non-
manufacturing expenses and profit from the given data
Direct material cost = opening stock + total purchases during the
year- closing stock = N20,000 + N170,0000 – N30,000
= N160,000
Direct wages = N120,000
Factory expenses = N120,000
Factory cost = N160,000 + N120,000 + N120,000
= N400,000
Non-manufacturing expenses = N50,000
Total cost = N400,000 + N50,000
= N450,000
 Solution Cont.
• Cost of finished goods sold = opening stock + cost of goods manufactured
– closing stock
= N10,000 + N450,000 + N15,000
= N445,000
Total sales = N489,500
Profit = N489,000 – N445, 000
= N44,500

i. Factory expenses(% of direct wages) =

= 100 %

ii. Non-manufacturing expenses to factory cost =

= 12.5%
 Solution Cont.
iii. Profit to cost of sales = = 10%

Now the cost of the product can be quoted as follows:

Direct material = N20,000
Direct wages = N30,000
Factory expenses (100% of wages) = N30,000
Factory cost = 20,000 + 30,000 + 30,000 = N80,000
Non-manufacturing expenses (12.5% of factory cost)

= N10,000
 Solution Cont.

Total cost = N80,000 + N10,000

= N90,000
Profit (10% of total cost) = N9,000
Selling price = N90,000 + N9,000
= N99,000
END