Cost Estimating

Definition:
Cost estimating may be defined as the 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 the related service facilities such as pattern making, tool making, as well as a portion of the
general administrative 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 as part of his job of planning manufacturing
determines the physical data. The cost accountant compiles and applies the costing data.
Purpose of Cost Estimating
Cost is the background of almost every decision the tool engineer makes in organizing
manufacturing operations and in selecting materials, methods, tooling and facilities. An
understanding of cost determination is essential to ensure that these decisions are based on sound
and dependable estimates of cost.
Estimates of cost must be reasonably accurate if a venture is to be successful (realistic cost estimate).
If a job is overpriced, it is lost to a competitor. If it is underestimated, it results in financial loss.
Detailed cost estimates are prepared to:
1. Determine the selling price of a product for a quotation or contract,
so as to ensure a reasonable profit to the company.
2. Check the quotations supplied by the vendors.
3. Decide whether a part or assembly is economical to be manufactured
in the plant or is to be purchased from outside.
4. Determine the most economical process or material to manufacture a
product.
5. 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.
6. To determine standards of production performance that may be used
to control costs.
Purpose of Cost Accounting
1. To compare the actual cost with the estimated cost to know whether the estimate 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.
5. It helps in determining the discount on catalogue or 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.
Costs can be classified in the following manner :
1. Non-recurring costs. These costs are also called “capital costs” and are one-time costs. These costs consist
of two parts : fixed capital costs and non-depreciated capital costs. Fixed capital costs include depreciable
items such as plant building, manufacturing equipment and tools. Nondepreciated capital cost includes
land.
2. Recurring cost. These costs are a direct function of manufacturing process. These costs are also called
‘operating cost’ or ‘manufacturing cost’.
Another classification of costs is :
(i) Fixed costs. Fixed costs associated with a productive unit are 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 .
(ii) 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’, as explained below : (a) Direct cost. It is that cost
which can be directly assigned to a product. (b) Indirect cost. Indirect costs can not 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 obligations as and when they occur. It consists of : Raw material on hand Semi
finished products in the process of manufacture Finished products in the inventory Accounts receivable Cash in
hand needed for day-to-day operation. The 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 provides a rough estimate of the investment cost of a new product. It is defined as

The turn over ratio for steel industry is about 0.6. In chemical industry, it is nearly 1.0 for many
products.
Elements of cost
The constituents of cost of a product or the “cost elements” are :
Material cost, Labour cost and Expenses.
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.
(i) 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.
(ii) Indirect material
Indirect materials are those which help in the processing of direct materials into the finished
product. These materials don’t form a part of the finished product. Indirect materials include :
Shop supplies such as cotton waste, lubricating oil, cutting fluids, coal, oil, gas, shielding gases
used in Arc welding, Emery paper used for polishing, quenching oils for heat treatment etc.
Indirect materials form the part of oncost or overheads.
Labour cost
Labour which enter into the manufacture of a product is of two categories :
Direct Labour and Indirect Labour.
(i) Direct labour. The operator or operators which actually process the raw materials either on machines or
manually, form the direct labour.
(ii) Indirect labour. All the staff excepting administrative and sales office staff, which help in running the plant
come under the category of indirect labour. Indirect labour includes : Foremen, supervisors, maintenance
staff, stores personnel, time office staff, drawing office staff, etc. Indirect labour forms a part of overheads.
Expenses
Total cost of the product minus the costs of direct material and direct labour constitutes
the ‘Expenses’. Expenses may also be either direct or indirect.
(i) Direct expenses. These expenses like the direct material and direct labour are directly
chargeable to the finished product. These are also known as “chargeable expenses”.
These include : (a) Cost of patterns, jigs, fixtures, dies, drawings or designs specifically
prepared for a particular product which cannot be used for other purposes. (b) Cost of
any experimental work done specially for a particular product. (c) Cost of inward
carriage or freight incurred on supply of special material needed for the particular
product. (d) Hire of special or single purpose tools or equipment for a particular
product.
(ii) Indirect expenses. These are also called “oncosts” “overheads” or “burden”. These
include : cost of indirect material, cost of indirect labour and other expenses that cannot
be conveniently charged directly to a particular job. Indirect expenses may be divided
into : (a) Factory expenses or overheads. (b) Office and Administrative expenses or
overheads. (c) Selling and Distribution expenses or overheads.