DEBRE MARKOS UNIVERSITY

INSITTUTE OF TECHNOLOGY

Manufacturing Engineering

PROCESS PLANNING AND PRODUCT

COSTING
Chapter Four – Manufacturing Cost Elements
& Cost Estimation

By: Mulatu M.(Asst.Prof)

March, 2024
1/10/2023 13 - 1
  Cost is the amount of resource given up in exchange for some goods and
services.

Elements of cost
 The elements of cost are those elements which constitute the cost of the manufacture
of a product.
 Production of goods and services require different factors such as:
 Raw material,
 Human resource,
 Power,
 Machinery and a lot of other elements.
 A firm engaged in production activities have to pay for these entirely different
expenses, which constitute the cost of production.

1/10/2023 13 - 2
 Manufacturing cost is the sum of costs of all resources
consumed in the process of making a product.
 Cont…
 The elements of cost divided into 3 principle elements;
1. Material costs
2. Labor costs
3. Expenses

1/10/2023 13 - 4
 Material’s Cost

Direct Material’s Cost

 It is the cost of those materials which are directly used for the manufacture of
the product and become a part of the finished product.

 The cost of direct material varies according to the level of output.

 For example, Milk is the direct material of Butter.

 Cont…
Indirect material‘s Cost
Indirect materials are necessary in production process,
but its not directly used in the product itself.
It does not become integral part of the product.
The cost associated with indirect materials is called
indirect material cost.
Examples are glue, nails, consumable stores, coolant,
lubricating oil.

1/10/2023 13 - 6
 Labour’s Cost
 Labour cost is the cost of salaries, wages, bonus, commission of the
employees of a company.
Direct Labour
 It refers to the amount which paid to the workers who are directly engaged
in the production of goods. It varies directly with the level of output.

 Examples of the direct labourer are the workers operating lathes, milling
machines or welders, or assemblers in assembly shop.
 Cont…
Indirect Labour
 It represents the amount paid to workers who are indirectly
engaged in the production of goods. It does not vary directly with the
level of output.
 The indirect labour includes supervisors, foreman, storekeeper,
gatekeeper, maintenance staff, crane driver etc.

 The cost associated with indirect labour is called indirect labour

cost.
1/10/2023 13 - 8
 Expenses
 Apart from material and labour cost in each factory there are several other
expenditures such as cost of special layouts, design, etc. hire of special tools and
equipment's; depreciation charges of plants and factory building; building rent; cost
of transportation, salaries and commissions to salesman etc.

Direct Expenses
 Any expenses other than direct material or direct labour incurred on a specific cost unit.
 It refers to the expenses that are specifically incurred by the enterprises to produce a
product.
 Examples of direct expenses are:
 Cont…
Indirect Expenses

 It represents the expenses that are incurred by the organization to

produce a product.
 Examples of indirect expenses are:

1/10/2023 13 - 10
 Overheads Cost

 The aggregate of the cost of

are called as overhead costs.
 These cannot be associated directly with specific products.

1/10/2023 13 - 11
 Cont…

• Production or manufacturing overhead include all indirect expenses

incurred by the concern from the receipt of the production order until it
is ready for dispatch either to the customer or to the finished goods
store.
• Manufacturing or production overheads cost Includes;

1/10/2023 13 - 12
Cont…
 Cont…

 All indirect expenses incurred in;

 Formulating policy,
 Directing the organization,
 Controlling and managing the operations of an undertaking
which
is not directly related with research, development or producing.
Or

1/10/2023 13 - 14
 Cont…

 Selling overhead consists of expenses in order to maintain and

increase the volume of sales by persuading customers to buy.
 Includes all expenses related with selling and marketing.
 Examples are;

1/10/2023 13 - 15
 Cont…

 Distribution overhead covers all expenses connected with

transporting products to customers and storing them when
necessary.

1/10/2023 13 - 16
 • Fixed costs
• Variable costs

 Fixed cost is the cost which does not change in total for a given time period
despite wide fluctuations in output or volume of activity.
 An expense that stays the same every week, month or year.

1/10/2023 13 - 17
 Cont…
 Variable costs are those costs that vary directly and
proportionately with the
output.
 Examples are; direct materials cost and direct labor cost.

1/10/2023 13 - 18
  Process of determining the probable cost of the product before the start
of manufacture.

 Cost estimation is important for

deciding manufacturing and
selling policies.

1/10/2023 13 - 20
 Cont…
 Cost estimation 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 portion of the general administrative and selling
costs.
 Cost estimates are the joint product of the engineer and
the cost accountant.
 Cost estimates are developed for a Varity of different reasons. The
most important reasons are;
1. Cost control
2. Make-or-by decision
3. Determine selling price
4. Check vendor quotes (purchase analysis)

 A job shop (contract shop) will use a cost estimate for cost control
purposes because lot of sizes are small and job shops
seldom/rarely/estimate work standards for what they produce.
 This use of an estimate for this purpose is different from temporary
standards in that it uses the “ meet or beat” philosophy.)
 Cont…
 When a company sets out to produce a new product, many
components in the bill of materials are subject to a make-or-buy
decision.
 A cost estimate is developed for comparison purposes.

 An estimate is used to determine selling price. The estimate is always

a reflection of actual cost.
 In most organizations the marketing department has the responsibility
of establishing a selling price, which can be substantially different
from the cost estimate.

 An estimating function is often established for the sole purpose of

checking vendor quotations on outsourced work.
 One automobile company has an entire department of cost estimators
devoted to this task.
 Cost estimations can be;
exact to the expenses for the
production of goods.

• More than the required expenses, problem with

competitive prices

• Less than the required expenses, will lead to

financial loss.

1/10/2023 13 - 25
Figure: Cost of a product or ladder of costs
1/10/2023 13 - 35
 Cont…
Example1: An isometric view of a work piece is shown in the figure below.
What will be the weight of the mild steel material required to produce it?
The density of the material is 2681kg/m3. Find also the material cost if its rate is
100birr per kg. All dimensions are in mm.
Solution:
 First split up the given workpiece into four portions A,B,C and D, as
shown in the figure.

1/10/2023 13 - 36
 Cont…

1/10/2023 13 - 37
 Or

1/10/2023 13 - 38
  Prime costs , direct costs, are a firm’s expense directly related to the
materials and labor used in manufacturing an item.
 Companies use prime costs to price their products.
 Prime cost is calculated by adding the cost of raw materials to
the cost of labor directly associated with the production
process.
 The formula is as follows;

Prime costs = Direct materials cost +

direct labors cost + direct expenses

1/10/2023 13 - 39
 Cont…
Example 2: Calculate the Prime Cost of a furniture manufacturing
company that incurred the following manufacturing expenses for the
completion of one of its assignments;

 5 Labour worked for 30 days

 Labor charges are 1000Birr per labor per day
 Wood – 100 sheets @ a cost of 1,500Birr per sheet
 Glue – 50 Kg @ a cost of 250Birr per Kg

Prime cost = Raw Material + Direct Labour

=[(100*1,500) + (50*250)] + (1,000*5*30)

= 150,000 + 12,500 + 150,000

= 312,500Birr
1/10/2023 13 - 40
 Cont…
Example 3: ABC Sofa shop in Debre Markos, manufactured 10 sets of
sofas. The labors worked for 200 hours. The incurred the costs shown
below.

1/10/2023 13 - 41
Cont…
 Total cost of the product
Total cost = Prime cost + factory overheads +
administrative expenses + selling + distribution
expenses

Deciding the profit: add the profit to the total cost to fix
the selling price of the part.
Selling price = Total cost + Profit

1/10/2023 13 - 43
 Example 4: Cont…
Find out (a) Prime cost, (b) Factory cost, ( c) Total cost of production, (d)
cost of sales and (e )Selling Price

1/10/2023 13 - 44
 Solution Cont…
(a) Prime cost
����� ���� = ������ �������� ���� + ������ ������ ���� + ������ ��������.
= 105,000 Birr

(b)Factory cost
� � � � � � � � � � � = � � � �� � � � � + � � � �
� � � � � � � � � � � � � � � � = � � � ,� � � +�
� ,� � � = � � � ,� � � �� � �
(c)Total cost of production
���������� ���� = ������� ���� + ����� �������������� �������� = ���, ��� + �,
��� = ���, ��� ����

(d) Cost of sales (selling cost)

������� ���� �� ����� ���� = ���������� ���� + ����� ������� ��� �������������
�������� = ���, ��� + ��, ��� = ���, ��� ����

(e) Selling Price

1/10/2023 ������� ����� = ����� ���� + ������ = ���, ��� + ��, ��� = ���, ��� ���� 13 - 45
Class Work-1
Assignment 1: A factory is producing 1000 bolt and nuts
per hour on a machine. Its material cost is 350 birr, labor
cost 240 birr and the direct expense is 80 birr. The factory
on cost is 150% of the labor cost and office on cost is 30%
of the total factory cost. If the selling price of each bolt and
nut is 1.30 birr, calculate whether the management is
going in loss or gain and by what amount?
Assignment 2: From the following data, find out prime cost, Works/factory cost, production
cost, total cost and selling price. Assume a net profit of 10,000 Birr.
1/10/2023 13 - 49