Contemporary Engineering Economics, 4 th edition, © 2007 Classification of Costs Lecture No. 29...

Contemporary Engineering

Economics, 4th edition, © 2007

Classification of Costs

Lecture No. 29Chapter 8Contemporary Engineering EconomicsCopyright © 2006



Chapter Opening Story – High Hopes for Plastic Beer Bottles What is the least

expensive way to make a 0.5L PET barrier beer bottle?

Types of Production Method

5-layer 3-layer Internal coating

External coating

Capital investment (20,000 bottles/hr)

Direct Mfg Cost (per 1,000 units)

$10.8M

$59.35

$9.9M

$66.57

$9.2M

$46.90

$7.5M

$55.34

Comments Need a bottle that provides shelf life of over 120 days with less than 15% loss of CO2 and admittance of no more than 1 ppm of oxygen



General Cost Terms

Manufacturing Costs Direct Raw Materials Direct Labor Manufacturing Overhead

Nonmanufacturing Costs Overhead Marketing Administrative Functions



Various Types of Manufacturing Costs



Classifying Costs for Financial Statements Matching Concept: The costs

incurred to generate particular revenue should be recognized as expenses in the same period that the revenue is recognized.

Period Costs: Those costs that are matched against revenues on a time period basis

Product Costs: Those costs that are matched against revenues on a product basis.



Example

Period Costs: General and

administrative expenses Marketing expenses Insurance premiums Income taxes Nonmanufacturing costs

Product Costs: Direct material costs Direct labor costs Manufacturing overhead



How the Period Costs and Product Costs Flow Through Financial Statement



Cost Flows and Classifications in a Manufacturing Company



Product Cost

Period Cost

Example 8.1 Classifying Costs for Uptown Ice Cream Shop

Ice cream (cream, sugar, milk, and milk solids) $0.65Cone 0.05Rent 0.61Wages 0.25Payroll taxes 0.25Sales taxes 0.23Business taxes 0.08Debt service 0.23Supplies 0.09Utilities 0.08Other (insurance, advertising,professional fees) 0.05Profit 0.13

$2.50

Unit Price of an Ice Cream



Cost Classification for Predicting Cost Behavior

Volume index Cost Behaviors

Fixed costs

Variable costs

Mixed costs Average unit costs



Volume Index

Def: The unit measure used to define “volume”

Examples: Automobile – “miles”

driven Generating plant – “kWh”

produced Stamping machine –

“parts” stamped



Fixed Costs

Def: The costs of providing a company’s basic operating capacity

Cost behavior: Remain constant over the relevant range



Variable Costs

Def: Costs that vary depending on the level of production or sales

Cost behavior: Increase or decrease proportionally according to the level of volume



Mixed Costs

Def: Costs are fixed for a set level of production or consumption, becoming variable after the level exceeded.

Cost behavior: Increase or decrease after maintaining a fixed level of expense

1000

2000

3000

4000

5000

6000

05 15 25

Mixed cost behavior

Miles Driven (Unit: 1,000)

Dep

reci

atio

n E

xpen

ses

($)



Average Unit Cost

Def: activity cost per unit basis

Cost Behaviors: Fixed cost per unit varies

with changes in volume. Variable cost per unit of

volume is a constant. Mixed cost per unit of

volume contains both the constant and variable elements



Practice Problem

You have 3000 units to produce. Total labor cost = $20,000 Total material cost = $25,000 Total overhead cost = $15,000 Total fixed cost = $40,000 What is the average cost per unit?

Average cost = ($100,000)/3,000 = $33.33/unit



Future Costs for Business Decisions Differential

(Incremental) cost Opportunity cost Sunk cost Marginal cost



Differential (Incremental) Costs Def: Costs that represent

the differences in total costs, which results from selecting one alternative instead of other

Cost behavior: Increase or decrease with the overall change that a company experiences by producing one additional unit of good



Opportunity Costs

Def: The potential benefit that is given up as you seek an alternative course of action

Example: When you decide to pursue a college degree, your opportunity cost would include a 4-year’s potential earnings foregone.



Sunk Costs

Def:Cost that has already been incurred by past actions

Economic Implications: Not relevant to future decisions

Example: $500 spent to replace brakes last year—not relevant in making a selling decision in the future



Marginal Costs

Def: Added costs that result from increasing rates of outputs, usually by single unit

Example: Cost of electricity—decreasing marginal rate

Contemporary Engineering Economics, 4 th edition, © 2007 Classification of Costs Lecture No. 29...

Documents

Transcript of Contemporary Engineering Economics, 4 th edition, © 2007 Classification of Costs Lecture No. 29...