INTRODUCTION TO COST ESTIMATION

1. 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

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. 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
7. Multiple cost method

22. 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

23. 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

24. 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

25. 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.
Estimated cost of an item
=
Material cost of the item being estimated
Material cost share of item being estimated (in %)

26. 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

27. • 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

28. 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.,

29. (i) 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).

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

31. 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.

32. 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.,

33. 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

34. 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.

35. 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

36. 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

37. 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

38. 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

39. 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

40. Indirect expenses - Selling and distribution expenses
• his 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

41. Methods of Estimating
• Conference method
• Comparison method
• Detailed analysis method

42. 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

43. 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

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

45. 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 lists of parts to be manufactured within the
plant and parts to be purchased outside the plant

46. Step 5: Estimate the materials cost for the parts to be
manufactured in the plant
Material cost =
Weight of the
material
×
Material cost per
unit weight
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.,

47. Step 8: Estimate the machining time for each operations listed in
the manufacturing process plan
Step 9: Determine the direct labour cost
Direct labour cost =
Total operation
time
×
Labour
wage rate
Step 10: Determine the prime cost by adding direct expenses,
direct material cost, and direct labour cost
∴ Prime cost =
Direct
labour
cost
+
Direct
material cost
+
Direct
expenses
COST ESTIMATING PROCEDURE
Contd.,

48. 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.,

49. 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
Total Cost
=
Prime
Cost
+
Factory
overheads
+
Administrative
expenses
+
Selling and
distribution expenses
COST ESTIMATING PROCEDURE
Contd.,

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

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

52. 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

53. BLOCK DIAGRAM

55. ESTIMATION OF LABOUR COST
i) Set up time
ii) Operation time
a) Handling time
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

56. ALLOWANCES IN COST ESTIMATION &
CALCULATION OF STANDARD TIME
Allowances :
Allowance is an amount of time added to
the normal time to provide for personal delays,
unavoidable delays and fatigue of the operator.

57. TYPES OF ALLOWANCES
1. Relaxation allowances
a) Personal need allowances
b) Fatigue allowances
2. Contingency allowances
3. Process allowances
4. Interference allowances
5. Special allowances

58. 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= Normal time + Allowances
Normal (or basic) time= observed time x rating
factor
Rating factor= (observed time/ normal time) x 100

59. 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.

62. 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.

65. 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.

70. ESTIMATION OF MATERIALS COST
Procedure
• Study the given drawing carefully. Then 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
• Material cost =
Weight of the
material
×
Material cost per
unit weight

71. Example

74. METHODS OF ALLOCATION OF
OVERHEAD EXPENSES

75. 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.

76. CAUSES OF DEPRECIATION

77. METHODS OF DEPRECIATION