Module 2 Cost Concepts For Decision Making

Chapter 2.
COST CONCEPTS
FOR DECISION
MAKING
©2017 Batangas State University
1
Introduction
We observed that the word cost has many meanings in different

contexts, and the type of cost notion employed in a given
situation is determined by the circumstances/requirements of that
particular case. Actual costs are recorded by financial
accountants. Costs are classified for the purposes of decision
making and control based on their relevance to the various types
of decisions and control functions. Relevant costs, rather than
real costs, are evaluated while making business decisions.
Relevant costs are a realistic basis for decision making that
differs from the historical cost approach.
2 ©2017 Batangas State University
Learning Objectives
Analyze short-term alternative when the time

of value money is not a factor
Analyze problems using economic
breakeven analysis and present
economy studies.
Discuss the general economic environment
and the different cost terminologies.
.

COST CONCEPTS
• There are a variety of costs to be considered in an engineering

economic analysis.
• These costs differ in their:

– Frequency of occurrence
– Relative magnitude
– Degree of impact on the study

COST CONCEPTS
FIXED / VARIABLE COSTS

 If costs change appreciably with fluctuations in business
activity, they are “variable.” Otherwise, they are “fixed.”
 A widely used cost model is:
• Total Costs = Fixed Costs + Variable Costs

COST CONCEPTS
FIXED / VARIABLE COSTS
 Some examples of fixed costs: Insurance, taxes on facilities,

administrative salaries, rental payments and initial setup or
installation costs.
 Some examples of variable costs: direct labor, direct
material, per unit transportation.

COST CONCEPTS
 Fixed Costs
• Fixed costs are those unaffected by changes in activity level
over a feasible range of operations for the capacity or
capability available.
• Typical fixed costs include insurance and taxes on facilities,
general management and administrative salaries, license fees,
and interest costs on borrowed capital.

COST CONCEPTS
 Fixed Costs
• Of course, any cost is subject to change, but fixed costs tend to
remain
constant over a specific range of operating conditions.
• When larger changes in usage of resources occur, or when
plant expansion or shutdown is involved, fixed costs can
be affected.

COST CONCEPTS
 Variable Costs
• Variable costs are those associated with an operation that
varies in total with the quantity of output or other measures of
activity level.
– For example, the costs of material and labor used in a
product or service are variable costs, because they vary in
total with the number of output units, even though the costs
per unit stay the same.

COST CONCEPTS
 Incremental Costs
• An incremental cost (or incremental revenue) is the
additional cost (or revenue) that results from increasing the
output of a system by one (or more) units.
• Incremental cost is often associated with “go–no go” decisions
that involve a limited change in output or activity level.

COST CONCEPTS
 Incremental Costs ……
• For instance, the incremental cost per mile for driving an
automobile may be $0.49, but this cost depends on considerations
such as total mileage driven during the year (normal operating
range), mileage expected for the next major trip, and the age of the
automobile.
• Also, it is common to read about the “incremental cost of
producing a barrel of oil” and “incremental cost to the state for
educating a student.” As these examples indicate, the incremental
cost (or revenue) is often quite difficult to determine in practice.
COST CONCEPTS
 Recurring/Nonrecurring Costs
• If costs are repetitive and occur when an organization produces
goods or services on a continuing basis, they are “recurring.”
• Otherwise they are “nonrecurring.”
• Variable costs are recurring since they repeat with each unit of
output.

COST CONCEPTS
 Direct/Indirect Costs
• If costs can be reasonably measured and allocated to a specific
output, they are “direct.”
• Otherwise they are “indirect.”

COST CONCEPTS
 Direct Costs
• Direct costs are costs that can be reasonably measured and
allocated to a
specific output or work activity.
• The labor and material costs directly associated with a product,

service, or construction activity are direct costs.
• For example, the materials needed to make a product specific

packaging would be a direct cost.
COST CONCEPTS
 Indirect Costs
• Indirect costs are costs that are difficult to allocate to a specific
output or work activity.
• Normally, they are costs allocated through a selected formula

(such as proportional to direct labor hours or direct material
cost) to the outputs or work activities.
• For example, the costs of common tools, general supplies, and

equipment maintenance in a plant are treated as indirect costs.
COST CONCEPTS
 Overhead Costs
• Overhead consists of plant operating costs that are not direct
labor or direct material costs.
• In this course, the terms indirect costs, overhead, and burden are
used interchangeably.
• Examples of overhead include electricity, general repairs, property
taxes, and supervision.
• Administrative and selling expenses are also usually added to
overhead costs to arrive at a unit selling price for a product or
service.
COST CONCEPTS
 Standard Costs
• Standard costs are planned costs per unit of output that are
established in advance of actual production or service delivery.
• They are developed from anticipated direct labor hours,

materials, and overhead categories.
• Because total overhead costs are associated with a certain level

of production, this is an important condition that should be
remembered when dealing with standard cost data.
COST CONCEPTS
 Standard Costs
• Standard costs play an important role in cost control and other
management functions. Some typical uses are the following:
1. Estimating future manufacturing costs

2. Measuring operating performance by comparing actual cost
per unit with the standard unit cost
3. Preparing bids on products or services requested by customers
4. Establishing the value of work in process and finished
inventories
COST CONCEPTS
Cash Cost
• A cost that involves payment and actual transfer of funds e.g. in
form of cash, cheque, wire-transfer, etc. is called a cash cost
(and results in a cash flow)
Book Cost - Reflected only in the accounting system.

• It is a cost that does not involve a cash transaction and is
reflected in the accounting system as a non-cash cost.
• This non-cash cost is often referred to as a book cost.

COST CONCEPTS
Book Cost ……
• Book costs are costs that do not involve actual payments.
• The most common example of book cost is the depreciation
charged for the use of assets such as plant and equipment.
• In engineering economic analysis, only those costs that are cash
flows or potential cash flows from the defined perspective for
the analysis need to be considered.
• Depreciation, for example, is not a cash flow and is important in
an analysis only because it affects income taxes, which are cash
flows.
COST CONCEPTS
 Sunk Cost
- Past costs that are unrecoverable and may not be
relevant for decision making purposes.
 Thus, a sunk cost is common to all alternatives, is not part

of the future cash
flows, and can be disregarded in an engineering economic
analysis.
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.©2017 Batangas State University
COST CONCEPTS
• Suppose the heating, ventilating and air conditioning (HVAC) system in
your home has just experienced a major failure. You immediately call the
Air Comfort Company for an estimate to replace your system. Their
price is $4,200 and you gladly sign a contract and write a check for the
required $1,000 down payment.
• At this point the weather warms and the urgency for replacement of
your defunct system eases somewhat.
• You then get a second estimate for a new HVAC system. It is $3,000. You
call Air
Comfort back and they inform you that the $1,000 down payment is not
refundable!
• What should you do? Explain.
COST CONCEPTS
Opportunity Cost
 It is the cost of forgoing the chance to earn profit on
investment funds.
• Question: “ A retired person is living with his son, and he
has rented his former home, valued at about $185,000, for
$400 per month. Is it in his best interest to keep his home
because it is all paid for? ”

COST CONCEPTS
Opportunity Cost
 It is the cost of forgoing the chance to earn profit on investment funds.
• Question: “ A retired person is living with his son, and he has rented his former home, valued at
about $185,000, for $400 per month. Is it in his best interest to keep his home because it is all
paid for? ”
• Answer: There is little reason for the person to continue owning his
former home as a rental. To see this, consider the opportunity cost,
i.e., the return you are giving up, of ownership. The same $185,000
invested in another profitable business can bring a profit rate of 7%
or more thus providing almost $13,000 in yearly income. This is
many times what is obtained from continual rental.
Thus opportunity cost of keeping the house is: $13,000 - $400 x 12 = $8,200/-
COST CONCEPTS
Example 1 (Fixed, Variable & Total Costs)
 In connection with surfacing a new highway, a contractor has a choice of

two sites on which to set up the mixing plant equipment.
 The contractor estimates that it will cost $1.15 per cubic meter per km to
haul the asphalt paving material from the mixing plant to the job site.
 If site B is selected, there will be an added charge of $96 per day for a
watchman
 The job requires 50,000 cubic meters of mixed asphalt paving material. It
is estimated that four months (17 weeks of five working days per week)
will be required for the job
COST CONCEPTS
Cost Factors Site A Site B

Average hauling distance 6 km 4.3 km
Monthly rental of site $1,000 $5,000
Cost to setup and remove equipment $15,000 $25,000
Cost of watchman Nil $96/ day
Transportation expense $1.15 / m3/km $1.15 / m3/km
a. Compare the two sites in terms of their fixed, variable, and total costs.
b. For the selected site, how much profit can be made if paid $8.05 per
cubic meter delivered to the job site?
COST CONCEPTS
Example 1 contd…
Fixed Costs Site A Site B

Monthly rental of site $1,000x4 = $4,000 $5,000x4 = $20,000
Cost to setup and remove $15,000 $25,000
equipment
Watchman wages 0 $96 x 85 = $8,160
Total Fixed Costs $19,000 $53,160
Variable Costs Site A Site B
$1.15 / m3/km x 6 km x $1.15 / m3/km x 4.3 km x
Transportation expense
50,000 m3 = $345,000 50,000 m3 = $247,250
Total Variable Costs $345,000 $247,250
Total Costs Site A Site B
Fixed + Variable $364,000 $300,410

COST CONCEPTS
Example 1 contd…
Profit = Revenue - Total Cost

Total cost = $300,410
Revenue = $8.05 / m3 (50,000 m3) = $402,500
Profit = $402,500 - $300,410 = $102,090

COST CONCEPTS
Life Cycle Cost (LCC)

 Owners, users and managers need to make decisions on the
acquisition and use of many different assets including items of
equipment and the facilities to house them.
 The initial capital outlay cost is usually clearly defined and is
often a key factor influencing the choice of asset given a
number of alternatives from which to select.

COST CONCEPTS

 The initial capital outlay cost is, however, only a portion of the
costs over an asset’s life cycle that needs to be considered in
making the right choice for asset investment.
 The process of identifying and documenting all the costs
involved over the life of an asset is known as Life Cycle
Costing (LCC).

COST CONCEPTS
 The total cost of ownership of an asset is
often far greater than the initial capital outlay
cost and can vary significantly between
different alternative solutions to a given
operational need.
 Consideration of the costs over the whole life
of an asset provides a sound basis for
decision-making.
COST CONCEPTS
 General Formula:
LCC = Investment Costs + O&M Costs
+ Replacement Costs + Energy Costs
+ Disposal Costs - Salvage Value (if
any)

COST CONCEPTS

COST CONCEPTS
 A life cycle cost analysis involves the analysis of the costs of a system or a
component over its entire life span.
 Typical costs for a system may include:

• Investment / Acquisition costs (or design and development costs)
• Operating costs
• Maintenance costs
• Replacement costs
• Disposal costs
COST CONCEPTS
Investment costs:
 The investment cost is the capital required for most of the
activities in the acquisition phase.
 In simple cases, such as acquiring specific equipment, an
investment cost may be incurred as a single expenditure.
 On a large, complex construction project, however, a series of
expenditures over an extended period could be incurred.
 This cost is also called Capital Investment.
COST CONCEPTS
Operating costs:
 Operation and maintenance cost (O&M)
includes many of the recurring annual
expense items associated with the operation
phase of the life cycle.

COST CONCEPTS
Operating costs:
 The direct and indirect costs of operation associated with the
five primary resource areas - people, machines, materials,
energy, and information - are a major part of the costs in this
category, which includes:
• Cost of failures
• Cost of repairs
• Cost for spares
• Downtime costs
• Loss of production
COST CONCEPTS
Maintenance costs:
 Cost of corrective maintenance
 Cost of preventive maintenance
 Cost for predictive maintenance

COST CONCEPTS
Disposal costs:
 Disposal cost includes those nonrecurring costs of shutting down
the operation and the retirement and disposal of assets at the end
of the life cycle.
 Normally, costs associated with personnel, materials,
transportation, and one-time special activities can be expected.
 These costs will be offset in some instances by receipts from the
sale of assets with remaining market value.
COST CONCEPTS
Disposal costs:
 A classic example of a disposal cost is that

associated with cleaning up a site where a
chemical processing plant had been located.

COST CONCEPTS
 The best opportunities to
achieve significant cost
reductions in life cycle costs
occur during the early concept
development and design phase
of any project.
 At this time, significant changes
can be made for the least cost.
 At later stages of the project
many costs have become
“locked in” and are not easily
changed.
COST ESTIMATION
Example 2
 Consider the following cost and production data and
develop Cost Estimating Relationship (CER) equation
between produced units and total cost, and estimate the
cost for production capacity of 2100 units.
Month (n) 1 2 3 4 5 6 7
Produced units (x) 1000 850 1500 900 450 690 1150
Total cost (y) 7000 6550 8500 6700 5350 6070 7450

COST ESTIMATION
Least Squares Normal Equations
CER: y = a + bx
y = total cost a = fixed cost
b = unit variable cost x = produced units
n = Number of production cycles

COST ESTIMATION
Example 2

GENERAL ECONOMIC ENVIRONMENT
 There are various general economic concepts that must be

considered in engineering studies.
 In broad terms, economics deals with the interactions between

people and wealth, and engineering is concerned with the cost-
effective use of scientific knowledge to benefit humankind.
 Some of these basic economic concepts will be introduced now

and we will look at how they effect engineering studies and
managerial decisions.
Consumer and Producer Goods and Services
 The goods and services that are produced and utilized maybe divided
conveniently into two classes.
 Consumer goods and services are those products or services that are
directly used by people to satisfy their wants.
 Food, clothing, homes, cars, television sets, haircuts, opera, and medical
services are examples.
 The providers of consumer goods and services must be aware of, and are
subject to, the changing wants of the people to whom their products are
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sold.

 Producer goods and services are used to produce
consumer goods and services or other producer goods.
 Machine tools, factory buildings, buses, and farm
machinery are examples.

 The amount of producer goods needed is determined
indirectly by the amount of consumer goods or services that
are demanded by people.
 However, because the relationship is much less direct than for
consumer goods and services, the demand for and production
of producer goods may greatly precede or lag behind the
demand for the consumer goods that they will produce.

Measures of Economic Worth
 Goods and services are produced and desired because they have
utility - the power to satisfy human wants and needs.
 Thus, they may be used or consumed directly, or they may be
used to produce other goods or services.
 Utility is most measured in terms of value, expressed in some
medium of exchange as the price that must be paid to obtain the
particular item.

Measures of Economic Worth
 Much of our business activity, including engineering, focuses on

increasing the utility (value) of materials and products by changing
their form or location.
 Thus, iron ore, worth only a few dollars per ton, significantly increases
in value by being processed, combined with suitable alloying
elements, and converted into razor blades.
 Similarly, snow, worth almost nothing when found high in distant

mountains, becomes quite valuable when it is delivered in melted form
(water) several hundred miles away to dry regions.
Necessities, Luxuries, and Price Demand
 Goods and services may be divided into two types:
necessities and luxuries.
 Obviously, these terms are relative, because, for most goods and
services, what one person considers a necessity may be
considered a luxury by another.

 For example, a person living in one community may find
that an automobile is a necessity to get to and from work.
 If the same person lived and worked in a different city, adequate
public transportation might be available, and an automobile
would be a luxury.

For all goods and services, there is a
relationship between the
price that must be paid and the
quantity that will be demanded or purchased.
 This general relationship is depicted in

Figure.
 As the selling price per unit (p) is

increased, there will be less demand (D)
for the product, and as the selling price is
53 decreased, the demand will increase.
 For all goods and services, there is a relationship between
the price that must be paid and the quantity that will be
demanded or purchased.
 This general relationship is depicted in Figure.
 As the selling price per unit (p) is increased, there will be less
demand (D) for the product, and as the selling price is
decreased, the demand will increase.

 The relationship between price and demand can be expressed as the linear
function:
where a is the intercept on the price axis and −b is the slope.
 Thus, b is the amount by which demand increases for each unit decrease
in p. Both a and b are constants.
 Therefore, we can say, that:

Competition:
 Because economic laws are general statements regarding the
interaction of people and wealth, they are affected by the
economic environment in which people and wealth exist.
 Most general economic principles are stated for situations in
which perfect competition exists.

Perfect Competition:
 Perfect competition occurs in a situation in which any given
product is supplied by a large number of vendors and there is
no restriction on additional suppliers entering the market.
 Under such conditions, there is assurance of complete freedom
on the part of both buyer and seller.

Perfect Competition:
 Perfect competition may never occur in actual practice, because
of a multitude of factors that impose some degree of limitation
upon the actions of buyers or sellers, or both.
 However, with conditions of perfect competition assumed, it is
easier to formulate general economic laws.

Monopoly:
 Monopoly is at the opposite to perfect competition.
 A perfect monopoly exists when a unique product or service is
only available from a single supplier and that vendor can
prevent the entry of all others into the market.
 Under such conditions, the buyer is at the complete mercy of
the
supplier in terms of the availability and price of the product.

Monopoly:
 Perfect monopolies rarely occur in practice, because:

1. Few products are so unique that substitutes cannot be used
satisfactorily.
2. Governmental regulations prohibit monopolies if they are
unduly restrictive.

Monopoly:
 Perfect monopolies rarely occur in practice, because:

1. Few products are so unique that substitutes cannot be used
satisfactorily.
2. Governmental regulations prohibit monopolies if they are
unduly restrictive.

BREAK-EVEN ANALYSIS
►Evaluation method employ to determine the point where
revenues and expenses are equal which serve as an
indicator for businessman/investors/financiers to know at
what level of business activities they will be able to recover
their capitals.
Assumptions for Break-even analysis
 All units produced are sold at a constant price per unit.
 There is no income other than that from operations.
 The variable costs are directly proportional to production rate from

zero to 100% capacity.
 Fixed costs are constant regardless of the number of units produced.

Break-even Point (BEP) Formula

𝐶𝐹
𝑄 𝐵𝐸𝑃 =
𝑝 − 𝑐𝑣
where:
QBEP = production quantity (volume) at
which break-even will occur
CF = fixed costs
p = selling price per unit
cv = variable cost per unit
Sample Problem
A firm has the capacity to produce 1,000,000 units of a product per year. At
present, it is able to produce and sell only 600,000 units yearly at a total
revenue of Php720,000. Annual fixed costs are Php250,000 and the variable
costs per unit are Php0.70.
▪ Calculate the firm’s annual profit or loss for this production.
▪ How many units should be sold annually to break-even?
▪ If the firm can increase its sales to 80% of full capacity, what will its
profit or loss be, assuming that its selling price and variable cost per unit
remain constant?
▪ Draw a break-even chart indicating the above results on the chart.
Problem Details & Computation
b) Computing for p =
c. At 80% capacity (800,000 units per year)
Profit = Total revenue – Total costs
Profit = (800,000 x Php1.20/unit) – [Php250,000 +

(Php0.70/unit x 800,000)]
Profit = Php960,000 – Php810,000
Profit = Php150,000
An engineering consulting firm measures its output in terms of standard service hour unit,
which is a function of the personnel grade levels in the professional staff. The variable cost
is Php62 per standard service hour. The charge-out rate is Php85.56 per hour. The
maximum output of the firm is 160,000 hours per year and its fixed cost is Php2,024,000 per
year. For this firm,
a. What is the break-even point in standard service hours and in the percentage of total
capacity?
b. What is the percentage reduction in the break-even point if fixed costs are reduced by
10%?
c. What is the percentage reduction in the break-even point if the variable costs per hour
is reduced by 10%?
d. What is the percentage reduction in the break-even point if the selling price per unit is
increased by 10%?
CF 20, 240, 000

a. QBEP    85,908.32 hours
p  cv 855.60  620
85,908.32 hours
% capacity =  0.5369
160, 000 hours
Or their BEP is 53.69% of their annual capacity.
Review Questions
1. A manufacturer produces certain items at a labor cost per unit of Php315,
material cost per unit of Php100, variable cost of Php3 each. If the item has a
selling price of Php995, how much units must be manufactured each month for
the manufacturer to break-even even if the monthly fixed cost is Php461,600.
2. General Electric Company which manufactures electric motor has a capacity

of producing 150 motors a month. The variable costs are Php4,000 per month,
the average selling price of the motor is Php750 per motor. Fixed costs of the
company amount to Php78,000 per month which includes all taxes. Determine
the number of motors to be produced per month to break-even.
Review Questions
3. A telephone switchboard 100 pair cable can be made up with either enameled
wire or tinned wire. There will be 400 soldered connections. The cost of
soldering a connection on the enameled wire will be Php1.65, on the tinned
wire, it will be Php1.15. A 100-pair cable made up with enameled wire cost
Php0.55 per lineal foot and those made up to tinned wire cost Php0.75 per lineal
foot. Determine the length of cable run in feet so that the cost of each
installation would be the same.
Review Questions
4. The purchase of one of two 500 hp motors A and B is better considered.
Motor A costs Php10,000 and Php2,000 to install. Motor B costs Php12,000
and Php3,000 to install. Motor A is 90% efficient, with Php100 annual
maintenance. Motor B is 92% efficient with Php200 annual maintenance.
Fixed charges are 15% and energy cost Php7.46 an hour to run the less
efficient motor. Fixed charges are based on installed cost of motors. Determine
the break-even point in hours of use per year. If the actual hours of use per year
is estimated as 3000, which motor would you recommend?
Market competition often creates pressure to lower the

breakeven point of an operation; the lower the
breakeven point, the less likely that a loss will
occur during market fluctuations.
Also, if the selling price remains constant (or increases),

a larger profit will be achieved at any level of operation
above the reduced breakeven point.

PRESENT ECONOMY
 Involves the analysis of problems for manufacturing a product
or rendering a service based on present or immediate costs.
 Usually occur when the effects of time such as interest and

depreciation are negligible.
 Employed when the alternatives to be compared will provide the

same result and the length of time involved in the study is
relatively short.
PRESENT ECONOMY
Rules:
1. When revenues and other economic benefits are present and
vary among alternatives, choose the alternative that
maximizes overall profitability based on the number of
defect-free units of a product or service produced.
2. When revenues and other economic benefits are not present
or are constant among all alternatives, consider only the costs
and select the alternative that minimizes the total cost per
defect-free unit of product or service output.

PRESENT ECONOMY
Applications of Present Economy
• Selection of Material
• Selection of Method
• Site Selection
• Comparison of Proficiency of Workers
• Economy of Tool and Equipment Maintenance
• Economy in the Utilization of Personnel

PRESENT ECONOMY
Selection of Material
• A diesel engine uses Type A filter and high-grade lubricating oil
costing Php5.50 per liter. With this filter, the oil and the filter
have to be changed every 500 hours of operation, and 5 liters of
oil have to be added every 100 hours. This filter costs Php148 a
piece. Eighty liters of oil fill the engine. Another type, filter B,
costing Php120 may be used with a lower grade of oil costing
Php4.80 per liter. However, if this filter is used, the oil and
filter have to be changed every 300 hours and 10 liters are
added after each 150 hours the engine is used. Which type of
filter and oil would you recommend?
PRESENT ECONOMY
Details of the Problem:
Filter A Filter B
Oil Cost Php 5.50/lt. Php 4.80/lt.
Maintenance Oil & filter must be Oil & filter must be
Provision changed every 500 hours of changed every 300 hours of
operation and must add 5 operation and must add 10
liters of oil every 100 hours liters of oil every 150 hours
of use. of use.
Filter cost Php148 each Php 120 each
Initial Oil 80 liters 80 liters
Requirements
PRESENT ECONOMY
Costing:
Filter A (500 hours) Filter B (300 hours)
Filter cost Php 148 Php 120
Initial Oil Cost (80)(5.50) 440 (80)(4.80) 384
Maintenance Cost (4)(5)(5.50) 110 (1)(10)(4.80) 48
Total Cost Php 698 Php 552
Lifespan (hours) 500 300

Cost per hours Php 1.3960 Php 1.84
Filter A is recommended
PRESENT ECONOMY
Selection of Method
• A manufacturer has a contract to produce 5,000 units of a certain device.
The device can be made by highly-trained workmen working
individually. The device can also be made by less-skilled workmen
working together if they are given specialized equipment and proper
supervision. The highly-trained workmen are paid Php20.00 per hour,
and each can produce one unit every 2 hours, on the average. The
specialized equipment can be placed in operation at an original cost of
Php60,000 and it will be worthless at the time all the 5,000 units are
manufactured. With this equipment, four men, paid at Php15.00 each per
hour, and a foreman, paid at Php25.00 per hour, can do the work. All the
five men working together can finish one unit in 15 minutes. Determine
83 the
©2017gain orUniversity
Batangas State loss if the specialized equipment is used
PRESENT ECONOMY
Required no. of production: 5,000 units
Option A: Highly Skilled Workers
Labor Cost = Php20/hr.
Output Rate = 1 unit/2 hours
Option B : Less Skilled Workers + Specialized Equipment

No. of workers = 4
Labor Cost = Php15/hr
Foreman (1) Labor cost = Php25/hr/
Specialized Equipment Cost Php60,000 (worthless after producing the
5000 units the device)
PRESENT ECONOMY
Costing:
Option A

PRESENT ECONOMY
Costing:
Option B

Gain in favor of Option B of Php33,750
PRESENT ECONOMY
Site Selection
A certain masonry dam requires 200,000 cu.m. of gravel for its construction.
The contractor found two possible sources for the gravel with the following
data: Source A Source B
Average distance (gravel pit to dam 3.0 km 1.2 km
site)
Gravel cost (per cu.m.) - Php10.00
Purchase price of pit Php800,000 -
Road construction necessary Php450,000 -
Overburden to be removed - 90,000 cu.m.
(at Php4.20 per cu.m.)
Hauling cost per cu.m.-km. Php4.00 Php4.00
87
Which of the two sites will give lesser cost?
PRESENT ECONOMY
Costing:
Source A Source B
Pit price Php 800,000 Gravel Cost Php 2,000,000
Road Construction 450,000 Overburden 378,000

Cost
Hauling Cost 2,400,000 960,000
Hauling Cost
Total Cost Php3,650,000 Php3,338,000

Source B will give a lesser cost of Php312,000
PRESENT ECONOMY
Economy Tool and Equipment Maintenance
A machine used for cutting materials in a factory has the following outputs per hour at
various speeds and requires periodic tool regrinding at the interval cited.
Speed Output per hour Tool regrinding
A 200 pieces every 8 hours
B 250 pieces every 7 hours
C 280 pieces every 5 hours

A set of tools costs Php1,800 and can be ground twenty times. Each regrinding costs
Php18.00 and the time needed to regrind and change tools is 1 hour. The machine
operator is paid Php28.00 per hour, including the time the tool is changed. The tool
grinder who also sets the tools to the machine is paid Php25.00 per hour. The hourly rate
chargeable against the machine is Php54.00, regardless of machine speed. Which speed
is the most economical?
PRESENT ECONOMY
Tool Cost = Php1800

Grinding times = 20 times
Regrinding Cost = Php18
Regrinding Time = 1 hr.
Machine Operator Rate = Php28/hr (operator’s hours
includes the time the tool is changed)
Grinder Operator Rate = Php25/hr.
90
Machine Rate = Php54/hr regardless of speed
PRESENT ECONOMY
Costing: Speed A (8 hrs) Speed B (7 hrs) Speed C (5 hrs)
Total Output 1600 pcs 1750 pcs 1400 pcs
Costs: Speed C is more economical to use
Tool Cost Php 90 Php 90 Php 90
18 18 18
Regrinding Cost
M/C Operator 252 224 168
Grinder operator 25 25 25
Machine Cost 432 378 270
Total Cost Php817 Php735 Php571

91 Unit Cost
©2017 Batangas State University Php0.5106 Php0.42 Php0.4078
PRESENT ECONOMY
Economy in the Utilization of Personnel
A contractor has a job which should be completed in 100 days. At
present, he has 80 men on the job and it is estimated that they will
finish the work in 130 days. Of the 80 men, 50 are each paid at
Php220.00 a day, 25 at Php280.00 a day, and 5 at Php350.00 a day. For
each day beyond the original 100 days, the contractor has to pay
Php500.00 liquidated damages.
a. How many more men should the contractor add so that he can
complete the work on time?
b. If of the additional men, 2 are paid Php280.00 a day and the
rest at Php220.00 a day, would the contractor save money by
employing more men and not paying the fine?
PRESENT ECONOMY
Costing:
Yes, the contractor will save

money by employing more men
than paying the fine
Chapter Test
1. An industrial engineer has designed two alternative methods for
accomplishing a production job. Both methods involve the acquisition of the
same working place and other capital equipment to be used for this job only.
Method A calls for a crew consisting of three men each costing P30.00
per hour. This method will result in the production of 10 units per hour of
which two will be reject.
Method B calls for a crew of two men each costing P35.00 per hour and
should result in the production of eight units per hour of which one will be
reject. The cost of the direct material lost in each reject is P20.00. If a certain
total number of units is to be produced, find which method is economical.
Answer: P16.26 ; P12.86 ; Method B is economical

Chapter Test
2. An executive receives an annual salary of P600,000 and his secretary a
salary of P180,000. A certain task can be performed by the executive
working alone in 4 hours. If he delegates the task to his secretary it will
require him 30 minutes to explain the work and another 45 minutes to check
the finished work. Due to the unfamiliarity of the secretary to the task, it
takes her an additional time of 6 hours after being instructed. Considering
salary costs only, determine the cost of performing the task by each method,
if the secretary works 2,400 hours a year and the executive 3,000 hours a
year.
Answer : P800.00 ; P737.50

Chapter Test
3. A cement grinding mill “A” with a capacity of 50 tons per hour utilizes
forged steel grinding balls costing P12,000 per ton, which have a wear rate
of 100 grams per ton cement milled. Another cement mill “B” of the same
capacity uses high chrome steel grinding balls costing P50,000 per ton with a
wear rate of 20 grams per ton cement milled. Determine the more
economical grinding mill, considering other factors to be the same.
Answer : P60/hr ; P50/hr ; Mill B is more economical (because it has lower
production cost than mill A)

Chapter Test
4. A cement kiln with production capacity of 130 tons per day (24 hours) of
clinker has at its burning zone about 45 tons of magnetite chrome bricks being
replaced periodically, depending on some operational factors and the life of the
bricks. If locally produced bricks costs P25,000 per ton and have a life of 4
months, while certain imported bricks costing P30,000 per ton and have a life
of 6 months, determine the more economical bricks and by how much.
Answer : Imported bricks are more economical by P56,250/ month

Chapter Test
5. A manufacturer has been shipping his product (moderately heavy machines),
mounted only on skids without complete crating. To avoid crating he must ship
in freight cars which contain only his machines. To do this he must pay freight
on a car capacity load of 42 tons regardless of whether or not the car is
completely full. In the past he actually has shied only 30 tons in each car. The
car load freight rate is P4.10 per hundred pounds. If the machines are crated so
that they can be shied in mixed car lots, along with other merchandise, they can
be shied at a rate of P4.20 per hundred pounds with the freight bill computed
only on the actual weight shied. The cost of crating would be P25.00 per
machine and would increase the shipping weight from 1,200- 1220 pounds per
machine. Which procedure should be followed? (1 ton= 2,200 lbs.)
Answer: Shipping without crating is cheaper by P404.80
Chapter Test
6. A machine used for cutting materials in a factory has the following outputs
per hour at various seeds and required periodic tool regrinding at the intervals
cited.
Seed Outputs per hour Tool regrinding
A 200 pieces Every 8 hours
B 280 pieces Every 5 hours
A set of tools cost 1260 and can be ground twenty times. Each regrinding costs
54.00 and the time needed to regrind and change tools is 1 hour. The machine
operator is aid 35.00 per hour including the time the tool is changed. The tool
grinder who also sets the tools to the machine is aid 40.00 per hour.
The hourly rate chargeable against the machine is 38.00 regardless of machine
seed. Which seed is the most economical?
99Answer : machine
©2017 Batangas State University B is more economical than machine A by P0.087 per piece.

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Chapter 2.

We observed that the word cost has many meanings in different

Analyze short-term alternative when the time

3 ©2017 Batangas State University

• There are a variety of costs to be considered in an engineering

• These costs differ in their:

4 ©2017 Batangas State University

FIXED / VARIABLE COSTS

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 Some examples of fixed costs: Insurance, taxes on facilities,

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7 ©2017 Batangas State University

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9 ©2017 Batangas State University

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• Otherwise they are “indirect.”

13 ©2017 Batangas State University

• The labor and material costs directly associated with a product,

• For example, the materials needed to make a product specific

• Normally, they are costs allocated through a selected formula

• For example, the costs of common tools, general supplies, and

• They are developed from anticipated direct labor hours,

• Because total overhead costs are associated with a certain level

1. Estimating future manufacturing costs

Book Cost - Reflected only in the accounting system.

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 Thus, a sunk cost is common to all alternatives, is not part

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 In connection with surfacing a new highway, a contractor has a choice of

Cost Factors Site A Site B

Fixed Costs Site A Site B

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Profit = Revenue - Total Cost

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Life Cycle Cost (LCC)

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Life Cycle Cost (LCC)

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 Typical costs for a system may include:

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 A classic example of a disposal cost is that

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 There are various general economic concepts that must be

 In broad terms, economics deals with the interactions between

 Some of these basic economic concepts will be introduced now

Consumer and Producer Goods and Services

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 Much of our business activity, including engineering, focuses on

 Similarly, snow, worth almost nothing when found high in distant

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