EHS301

ENGINEERING
ECONOMICS AND
MANAGEMENT
Dr. Shabana
Assistant Professor
Department of Mechanical Engineering
Module-II
 Costing: Cost concepts, elements of cost. Methods of
distribution of overhead costs, unit costing, job costing and
process costing; Simple problems.

 Accounts: Preparation of profit and loss account and

balance sheet.
 Today’s topic of Discussion

Cost concepts
 Course objectives
 To analyze the cost concepts and interpret
financial statements.
 Learning Outcomes
 Learning Outcomes:
 At the end of this unit, the student will be able to
 list elements and types of costs. [L1]
 apply cost analysis to determine profit. [L3]
 classify accounts.[L2]
 compose & interpret balance sheet for a given
enterprise. [L3]
 COST
 Cost refers to the amount of expenditure incurred in
acquiring a product.
 The expenditure incurred to produce an output or
provide service.
 Cost can be associated with raw material, labour, other
heads constitute the overall cost of production.
 Output is an important factor which influences the
cost.
Types of Costs

 Explicit Costs: Expenses

of production.
 Implicit Costs: Producer's
efforts and sacrifices
incurred in production.
 Types of costs
 Total
cost/acquisition/outlay
cost,
 Average cost
 Marginal costs.
 Fixed cost
 Variable cost
 Semi-variable cost
 Incremental cost
 Short run and long run
costs
 Opportunity cost
 Direct cost and indirect
costs
 Selling costs
 Life cycle cost
 Sunk cost
 Standard cost
 Recurring and Non-
recurring costs
 Costs
 Fixed costs remain the same
regardless of production
output.
 Ex. of fixed costs include rental lease
payments, salaries, insurance,
property taxes, interest expenses,
depreciation, and potentially some
utilities.
 Variable costs vary based on
the amount of output
produced.
 Ex. of Variable costs may include
labor, commissions, and raw
materials.
 Fixed Costs +
Variable Costs = Total Cost.
 Costs
 Average Cost: The per
unit cost of production
obtained by dividing the
total cost (TC) by the total
output (Q).
 Marginal Costs: It is the
change in the total cost that
arises when the quantity
produced is incremented by
one unit; that is, it is the
cost of producing.
 costs
 Total Cost=f(x)+a--------------------(EQ 1)
 Where a- fixed cost
 X- units produced
 If x=0 it means firm is not employing any variable
factors of production.
 TC=0+a=TFC(even at zero output level the firm has to
incur fixed cost)
 A number of other cost functions may be derived from
equation-(1)
 costs
 Total Cost=f(x)+a--------------------(EQ 1)
 TC=f(x)+a
 = TVC+TFC
 TVC(Total Variable Cost) =f(x)
 AC (Average Cost) = TC/x ={f(x)+a}/x
 AVC (Average Variable Cost) =TVC/x =f(x)/x
 AFC (Average Fixed Cost) =TFC/x = a/x
 MC (Marginal Cost) = dTc/dx
Units of Fixed Variable Total Marginal Average Average Average
output Cost Cost Cost Cost Cost Fixed Variable
Cost Cost
0 176 0
1 176 75
2 176 130
3 176 175
4 176 209
5 176 238
6 176 265
7 176 289
8 176 312
9 176 328
10 176 344
11 176 367
12 176 400
13 176 448
Semi-Variable Cost/ Semi-Fixed Cost
 Incremental Cost
 It refers to the total additional cost associated with the
decision to expand output or to add new variety of
product etc.
 It refers to the difference between two alternatives.
 It refers to the change in the total output as a result of
change in the methods of production or distribution or
use of improved technology or selection of additional
sales channels.
 Opportunity cost
Opportunity cost can be defined as the loss or sacrifice incurred by making a
decision to take one action instead of an alternative action.
Direct cost and Indirect cost
 Selling Costs

In selling costs we include the salaries of sales persons, allowances to retailers to

display the products etc. besides the advertisements. Advertisement expenditure
includes costs incurred for advertising in newspapers and magazines, televisions,
radio, cinema slides etc.
Short run and long run costs
Relationship between short-run costs and long-run costs

https://tinyurl.com/ycsxkxon
 Sunk Cost
 A sunk cost refers to money that has already been
spent and which cannot be recovered.

https://tinyurl.com/y4d4u2ro
 Standard Cost and its significance
 Standard costs are estimates of the actual costs in a
company's production process, because
actual costs cannot be known in advance. This helps a
business to plan a budget.
Recurring and Non-recurring costs

https://tinyurl.com/y2h2hcf7
Elements of Costs
Overheads
 Formulas
 Prime Cost= DMC+DLC+DE(Variable)
 Factory cost= Prime Cost+ FOH(W.O.C)
 Factory Overhead= ILC +IMC+ Other IE
 Establishment Costs= Administrative cost+
Distribution costs +Advertisement costs
 Production Cost (Total Cost) = Manufacturing costs
(FC) +Establishment costs.
 Selling Price= Production costs + Profit
 Problem-I
 1. From the following data find a) Material cost b) Prime cost c) Direct
cost d) Factory cost e)administrative overheads f)cost of production g)
selling and distribution overheads h)Total cost i)selling price. (Assume
the net profit of Rs 10,000/-
 1. Material in hand (April 1st 2019) 60,000 (DMC)
 2. New material purchased 2,50,000 (DMC)
 3. Directors fees 3,500 (AOH)
 4. Advertising 12,000 (SOH)
 5. Depreciation on sales department car 1,200 (SOH)
 6. Printing and stationary charges 300 (AOH)
 7. Plant Depreciation 5,000 (FOH)
 8. Wages of direct workers 70,000 (DLC)
 9. Wages of indirect workers 10,000 (FOH)
 10. Rent on factory building 10,000 (FOH)
 Problem (Contd.)
 11. Postage, telephone and telegraph 200 (AOH)
 12. Water and electricity for factory 1000 (FOH)
 13. Office salaries 2,000 (AOH)
 14. Rent of office 500 (AOH)
 15. Rent of the showroom 1,500 (SOH)
 16. commission on salesmen 2,500 (SOH)
 17. Sales department car expenses 1,500 (SOH)
 18. Material in hand (March 31st 2020) 50,000 (DMC)
 19. Variable direct expenses 750 (DE)
 20. Plant repair and maintenance 3,000 (FOH)
 21. Heating, lighting and water for office use 2,500 (AOH)
 22. Cost of Distributing goods 2,000 (DOH)
 1. Material cost = Cost of material in hand (April 1st)-Cost
of material in hand (March 31st) + Cost of new material
purchased .
= 60,000-50,000+2,50,000=2,60,000.
 2. Prime Cost = DMC+ DLC+DE (variable expenses)
= 2,60,000+70,000+750 = 3,30,750.
3. Direct cost = Prime cost
4. Factory cost= Prime cost +Factory overheads
= 3,30,750+ (7,9,12,20)
= 3,30,750 +5,000 +10,000+5,000+1,000+3,000
= 3,54,750
 5. Administrative overheads (3,6,11,13,14 &21)
 = 3,500+300+200+2,000+500+2,500
= 9,000
6. Cost of Production = Factory cost +administrative
overheads
= 3,54,750+9,000
= 3,63,750
7. Selling and Distribution overhead (4,5,15,16,17 & 22)
= 12,000+1,200+1,500+2,500+1,500+2,000= 20,700
 8. Total Cost = Cost of production+ Selling and
Distribution overheads.
 = 3,63,750+ 20,700
 = 3,84,450
 9. Selling Price = Cost of Sales +Profit (10,000)
 = 3,84,450+10,000
 = Rs 3,94,450/-
 Problem-II
A factory producing 150 electric bulbs a day, involves direct material cost
of Rs 250, direct labour cost of Rs 200 and factory overheads of Rs 225.
Assuming a profit of 10% of the selling price and selling on cost
(overhead) 30% of the factory cost, calculate the selling price of one
electric bulb.

Solution: Factory cost= DMC+DLC+FOH

= 250+200+225
= Rs 675
Total cost = Factory cost +selling overheads
= 675+675(30/100)= 877.50-------------------eq(1)
Also Total Cost= S.P-Profit
S.P- S.P(10/100) ------------------------eq(2)
Equating 1 and 2 equations
S.P= Rs 975/150=Rs 6.5
 Problem-III
 Two molders can cast 25 gears in a day. Each gear weight
3kg and the gear material cost Rs 12.50per kg. If the
overhead expenses are 150% of direct labor cost and two
molders are paid Rs 70per day.
 Calculate the cost of producing one gear.
Solution: Total cost= MC+LC+OH
= (25 x 3 x 12.5)+(70) + (70 x (150/100))
= Rs ___1112.5______
Cost per gear = Total Cost/ No. of gears
( 1112.5 )/ 25
=Rs __44.5________
 Allocation of Overhead Costs
 1. Percentage of Direct Labour cost
 2. Percentage of Direct Material cost
 3. Prime cost percentage rate
 4. Labour hour rate
 5. Machine hour rate
 6. Production unit method.
 Percentage of Direct Labour cost
 Percentage of Direct Labour cost= (FOH for budget
period/ Direct Labour cost for budget period) x 100

 Advantages:
 1. very economical and easy to apply.
 2. Highest degree of efficiency and uniformity in Wage
rates, Skills of workers, Equipment used and work
performed.
 Disadvantages:
 1. Ignores variation in the equipment's used.
Problem
 A fabrication concern had factory overheads of Rs
4,000 and Direct labour cost Rs 12,000.
 A)Find the percentage overhead using percentage of
direct labour cost.
 B) If the production order “X” had a direct labour cost
of Rs 60 find the overhead cost for the production
order.
 Solution: % overhead= (4,000/12,000) x 100= 331/3%
 Overhead cost for the production order “Z” is
 =60 x (331/3)/100 =Rs 20
Percentage of Direct Material cost
 Percentage of Direct Material cost=(Percentage Overhead
for a budget period/ Direct Material cost for a budget
period) x 100
 Pr: A sugar mill had its overheads of Rs 60,000 while it
purchased sugar cane worth 2,40,000. find the percentage
overhead using Percentage of Direct Material cost method.
 If a particular batch had a direct material cost of 30,000.
determine its overheads.
 Solution: % overhead = (60,000/2,40,000) x 100= 25% of
direct material cost.
 Overheads= (25/100) x 30,000= Rs 7,500/-
 Prime cost percentage rate
 Prime cost percentage rate= (Factory overhead for a
budget period/Prime cost for budget period) x 100
 Pr: A fabrication and an assembly shop had its total
overheads of Rs10,000. It used direct material cost
worth Rs 10,000 and paid Rs 15,000 as direct labour
charges. Calculate the % overhead. B)If one product as
its prime cost as Rs 5,000 determine the overheads.
 Solution: % overhead=[10,000/(10,000+15,000)] x 100
 = 40% of prime cost.
 Overhead = (40/100) x 5,000 = Rs 2,000/-
 Labour hour rate
 The rate per hour of direct labour=(Factory overhead
for a budget period/Direct labour hours for budget
period)
 Pr: A fitting and assembly shop had its factory
overheads of Rs 1,20,000 and the production for the
period in terms of direct labour was 24,000hours. Find
the rate per direct labour hour. B) If a particular job
takes 20 labour hours, calculate the overhead applied.
 Solution: The rate per hour of direct labour=
(1,20,000/24,000) =Rs 5
 Overhead= Rs 20 x 5= Rs100
 Machine hour rate
 Machine hour rate= =(Factory overhead for a budget period/ Machine hours for budget period)
 Pr: A machine shop has 10 lathes, 6 drill presses and 2 milling machines. Calculate the machine hour
rate for lathe if the factory expense for a particular period and other data as follows:
 Area occupied by Lathe = 10 sq m
 Area occupied by Drill presses= 3 sq m
 Area occupied by Milling machines= 2 sq m
 Cost of indirect material and labour=1,20,000
 Rent of building= 36,000
 Insurance = 15,000
 Depreciation = Rs 20,000 for Lathes
 = Rs 15,000 for Drill press
 = Rs 20,000 for Milling machines
 Power Consumed= Rs 18,000 for Lathes
 = Rs 6,000 for Drill press
 = Rs 900 for Milling machines
 Repair and Maintenance = Rs 10,000 for Lathes
 = Rs 4,000 for Drill press
 = Rs 4,000 for Milling machines
 Machine hours = 10,000 for Lathes
 = 6,000 for Drill press
 = 2,000 for Milling machines
 Solution: Cost of Indirect material and labour= Rs
 =(1,20,000 x 10)/10+3+2 = Rs 80,000
 Rent of building = (36,000 x 10)/ 10+3+2 =Rs 24,000
 Insurance = (15,000 x 10)/ 10+3+2 =Rs 10,000
 Depreciation =Rs 20,000
 Power consumed =Rs 18,000
 Repair and maintenances= Rs 10,000
 Total overhead = Rs 1,62,000/-
The rate of machine hour = 1,62,000/10,000 = Rs 16/-
 Production unit method.
 Overhead rate per unit =(Factory overhead for a
budget period/Production in terms of units for budget
period)
 Pr: If the estimated overhead costs of a factory making
two head transistor radios is 8,000 in a particular
period and if the transistor radios produced during
that period is 400. calculate the overhead rate per
transistor radio. B) If a production order ‘Z” schedules
making 100 such radios determine the factory
overhead to be applied to produce order “Z”
 Solution: Overhead rate per transistor radio= Rs
8,000/400 = rs 20/-
 Factory overhead for production order “Z”
 =Rs 20 x 100= Rs 2,000/-
References:
 https://tinyurl.com/y6lftv3v
 https://www.economicsdiscussion.net/cost-
accounting/classification-of-overheads/31847
 https://tinyurl.com/ycsxkxon
THANK YOU !