MODULE 5

Estimating and Costing

Introduction
⚫ Estimating and costing analyses the expenditure involved in
production so as to ascertain the various cost of all products
manufactured by the firm and fix the prices so as to earn profit.
⚫ It also helps in controlling the costs and providing necessary
costing information to management for decision making.
⚫ In short costing can be called as specialized branch of accounting
which deals with classification, recording, allocation and control of
costs etc.
⚫ With the help of estimating and costing, a manufacturer finds out
the total cost of each article he makes and fixes the selling price of
the article in order to make a definite profit.
 Introduction
⚫ Estimation is the assessment of the total cost in
manufacturing a product even before it is manufactured.
⚫ The Chartered Institute of Management Accounts
(CIMA), London has defined costing as “the techniques
and processes of ascertaining costs.”
⚫ Harold Wheldon has defined costing as, "the proper
allocation of expenditure and involves the collection of
costs for every order, job, process, service or unit.”
 Need for Estimating & Costing
1. For determining the cost of production:
It provides reliable data regarding expenditure on materials, wages &
other things which helps in determining the cost of production
precisely.
2. For controlling the costs:
It provides the cost for each product, process, job, department etc.
which helps in identifying profitable and non-profitable areas in the
organization. This guides the management in taking corrective
measures of their unprofitable activities.
3. For fixing selling price:
Costing provides information for fixing the selling price of the
product. The cost of production, volume of production, profit
analysis, break-even analysis serves as a basis for determining the
selling price of the product.
 4. For preparing quotations and submitting tenders:
⚫ Cost accounting principles help immensely in preparing
quotations and submitting tenders.
⚫ A quotation is the information regarding the selling price of a
product or service offered to a prospective buyer.
⚫ A tender is also an information regarding the selling price given to
a prospective buyer, but given in a sealed envelop.
5. For specific managerial decisions:
Costing provides information for taking the managerial decisions.
i. Make or buy
ii. Whether to own fixed assets or to hire them
iii. Whether to replace the existing plant or machinery before its
useful life.
6. For other reasons:
Costing provides information for wage incentive plans, cost control
measures for materials & supplies, budgeting & budgetary
control, standard costing, changes in design of products etc.
 Elements of Product Cost
The total cost of a product is the sum of several elementary
costs that are involved in manufacture.
The major costs in manufacturing a product consists of:
1. Material Cost
a) Direct Material Cost
b) Indirect Material Cost
2. Labour Cost
a) Direct Labour Cost
b) Indirect Labour Cost
3. Expenses
a) Direct Expenses
b) Indirect Expenses or Overheads
1. Material Cost
It is the cost of raw materials and additional materials required for the
manufacture of the product.
a) Direct Material Cost:
It is the cost of materials which are processed through various stages to
form a part of the product or whole product.
Ex. Aluminium ingots for casting, MS rods for making shafts
Direct material costs include the purchase price as well as the associated
charges like transportation, insurance, loading & unloading charges,
import duties etc.
b) Indirect Material Cost:
It is the cost of materials necessary which are essentially needed for
helping the direct materials to be converted into finished product.
Ex. Grease, lubricating oil, coolants, cotton waste etc.
2. Labour Cost
It is the cost of remuneration paid to the employees of an organization. It
includes wages, bonus, compensation, commissions etc.
a) Direct Labour Cost:
It is the cost of wages paid to the workers directly engaged in the
manufacturing of product.
It also includes wages paid to the workers engaged in handling the product
inside the department.
Ex. Wages paid to the workers like machinist, turner, fitter, welder etc.
b) Indirect Labour Cost:
It is the wages paid to the labour who help the direct labour in performing
their duties.
Indirect labour cost cannot be associated directly to a particular job.
Ex. Wages paid to the workers like supervisor, inspector, sweeper,
watchman, helper etc.
 3. Expenses
Apart from material cost and labour cost, there are several other costs
involved in the manufacture of a product. They are known as Expenses.
a) Direct Expenses:
Direct expenses are done for that specific job only and can be identified
and allocated to persons and materials involved in that job.
Example.
i. Cost of preparing design drawings for the manufacture of a particular
product.
ii. Cost of manufacturing jigs and fixtures for a particular product
iii. Cost of special type of patterns, moulding boxes, dies etc.
b) Indirect Expenses or Overheads:
Indirect expenses are those which cannot be charged directly to a particular
product manufactured.
All expenses other than the direct material cost, direct labour cost and direct
expenses are considered as Indirect Expenses .
Indirect expenses are also called as Overheads, On costs or Burden.
Indirect expenses can be classified as.
a) Production or Factory Overheads:
Ex. Costs of indirect materials such as grease, lubricating oil, coolants,
cotton waste etc.; wages paid to indirect labours like supervisor,
inspector, sweeper, watchman, helper etc.
b) Administrative Overheads:
Ex. Salaries of MD, GM, Clerks, typists, personal managers, medical
officers etc.
c) Selling Overheads:
Ex. Salaries of sales manager, sales representative, agents, costs of
advertisement and publicity.
d) Distribution Overheads:
Ex. Packing expenses, transportation expenses, salaries of stores officers,
store keepers and their assistants.
e) R & D Overheads:
Ex. Salaries of R & D Staff, costs of R & D equipments, costs of R & D activities.
 Determination of Selling Price
1) Prime Cost:
It is the sum of all direct costs. It is the cost resulting from the costs spent
within the organization to produce it. It is also known as direct cost.
Prime cost = Direct labour cost + Direct material cost + Direct expenses
2) Factory Cost:
It is the cost of a product spent directly on manufacturing & it includes the
production overheads. It is also known as works cost.
Factory cost = Prime cost + Production overheads
3) Manufacturing Cost:
It is the cost of manufacturing an article. It includes the cost of each item
incurred in manufacturing the finished product, right from purchasing
the raw material to the point when the finished product is ready for sale.
Manufacturing cost = Factory cost + Administrative overheads
4) Total Cost:
It includes all the costs up to the last rupee spent towards producing, selling
the product.
Total cost = Manufacturing cost + Selling overheads + Distribution
overheads
5) Selling Price:
The customers buy the product by paying the price which is called as selling
price.
Selling price = Total cost + Profit
6) First Cost:
It is same as the prime cost.
7) Marginal Cost:
It is nothing but the extra cost incurred for every unit increase in production.
Other Related Costs
1. Fixed Costs:
These costs remain fixed or constant irrespective of the volume
of production. They remains the same whether the production
is smaller, larger or Nil.
Ex. Costs on land, building, salaries to top management,
insurance, depreciation, etc.
2. Variable Costs:
These costs vary with the volume of production. Higher the
production, higher will be the variable costs. Variable costs
become zero when production is stopped. Prime costs are also
known as variable cost.
Ex. Cost of raw materials, labour, transportation of finished
goods, packing costs etc.
Mensuration is concerned with measuring, calculating and
estimating lengths, areas and volumes, as well as the
construction of three-dimensional objects.
⚫ A branch of mathematics that talks about the length, volume, or
area of different geometric shapes is called Mensuration. These
shapes exist in 2 dimensions or 3 dimensions.
⚫ Differences Between 2D and 3D shapes

Sl. 2D Shape 3D Shape

No
1 If a shape is surrounded by three If a shape is surrounded by a no. of
or more straight lines in a plane, surfaces or planes then it is a 3D
then it is a 2D shape. shape.
2 These shapes have no depth or These are also called solid shapes
height. and unlike 2D they have height or
depth.
3 These shapes have only two These are called Three dimensional
dimensions say length and as they have depth (or height),
breadth. breadth and length.
4 We can measure their area and We can measure their volume, CSA,
Perimeter. LSA or TSA.
 Break Even Analysis
⚫ A break-even analysis is an economic tool that is used to determine
the cost structure of a company or the number of units that need to
be sold to cover the cost.
⚫ Break-even is a circumstance where a company neither makes a
profit nor loss but recovers all the money spent.
⚫ The break-even analysis is used to examine the relation between the
fixed cost, variable cost, and revenue. Usually, an organization with
a low fixed cost will have a low break-even point of sale.
Components of Break-Even Analysis
1. Fixed costs
2. Variable costs
Importance of Break-Even Analysis
⚫ Manages the size of units to be sold
⚫ Budgeting and setting targets
⚫ Manage the margin of safety
⚫ Monitors and controls cost
⚫ Helps to design pricing strategy

Uses of Break-Even Analysis

⚫ New business
⚫ Manufacture new products
⚫ Change in business model