Budgeting, Costing & Estimating

7/27/2019 Budgeting, Costing & Estimating

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3Methods of Costing

Having deined and discussed some o the more commonly used costing and

accountancy terms, we are now in a position to investigate the major types o costing

systems used in manuacturing industry.

When a company is deciding the prices it is going to charge or its products, it has

to have a basis on which to compute these. There are three essential requirements

or such a system:

itmustensurethatallcostsarerecovered;

itmustincludetherequiredelementofprot;and

itmustbecompetitive.

Whateversystemisuseditshouldreecthoweasyordifculttheproductistomake

andtakeaccountofanyextrarequirementslikesecondaryoperations(e.g.,hotfoil

stamping/annealing)orspecialpackagingandsoon.

There are several dierent methods o costing and each company will have its

own preerences. The actual method used is not as important as whether the

chosensystemworks.Thesimplerthesystemis,theeasieritwillbetounderstand

and implement.

However,therearefourmaincostingsystemsthatwewillnowexamineindetail:

Standardcosting

Absorptioncosting

Marginalcosting

Machinehourlycosting.


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Budgeting, Costing and Estimating for the Injection Moulding Industry

3.1 Standard Costing

This is arguably the most used costing method or the manuacturing industry. It isbasedonsettingspecicstandardsforeachmanufacturingactivityorprocess.These

standards are agreed between all the interested parties within the company and

representnormal,reasonablyefcientmanufacturingperformance.

It is most important to note that this system is notbased on targets or goals based on

optimum manuacturing perormance that may or may not be achieved.

There are several advantages to using a standard costing system which are summarised

below:

Itmeasurestheexpectedperformanceatalllevelsinthecompany.

It providesa standardisedproduct costing systemthatcanbe used fordirect

product pricing comparison.

Itprovides a system that may beused for non-financialassessment. For

example:

- labourandmanagementperformance;and

- machineandequipmentperformance.

Itgivesastableplatformfortakingmajormanagementdecisionslike:

- productpricingforneworexistinglines;and

- productioncapacityassessment.

Itprovidesastandardisedsystemfordevelopingfuturegrowthplans.

Fornewproducts,theinitialstandardcostwillhavetobebasedonpreviousexperience

withothersimilarproductsandsubsequentlydevelopedandrenedasmoreaccurate

costsbecomeknown.

Itisessentialthateachcompanyhasaclearlydenedmeaningforitsstandardcosting

system and ensures that it is completely understood and implemented properly.

The ollowing guidelines would be typical o a manuacturing business based on

allowableexpenditurefor:

directmaterialcosts;

directlabourcosts;and


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Methods of Costing

productionoverheadcosts(includingdepreciationallowances).

Additionallyitmustbebasedonmanufacturingatastandardlevelofproductionand achieve the ollowing:

therequiredqualitylevel;

therequiredrateofproduction;

thenecessaryfunctionalperformance;and

thedesignatedlevelofefciency(notanoptimumgoal).

Example.Thisexampleillustratesastandardcostinganalysisforatypicalproduct.

Table3.1givestheABCstandardcostingforanindustrialpumpperunit.Fromthistable, the standard costing or this item is 1016p.

I these products were produced in high quantities, small variations in any o the

individualcostscanaffecttheprotabilityoftheprojectquitesignicantly.

This is why it is so important to ensure that all individual cost components accurately

reectrealisticperformance levelsand not targets. Standard costings based on

overoptimistictargets frequentlylead to reduced protability. This effect will be

ampliedinhigh-quantityproduction.

3.2 Absorption Costing

Absorptioncostingisamethodthatensuresthatallthemanufacturingcosts

areabsorbed(orrecovered)bytheproductsproduced.Inotherwords,thecost

o a product will include direct and indirect labour and both the variable and

fixedoverheads.

This method is oten reerred to as a ull costing or complete absorption method. It

ensures that all costs are recovered.

3.2.1 Steps in Introducing an Absorption Costing System

1. Identifyandmakeanaccurateassessmentofallcostsinthebusiness.

2. Classifythesecostsintocostcategories.

3. Alldirectcostsareallocatedtothemanufacturingoutput.


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Table3.1Standardcostingexample

Part

Source

Standard

unittime

(s)

Quantity

per

unit

Material

costper

unit(p)

Labour

costper

unit(p)

O/head

costper

unit(p)

Totalcost

perunit

(p)

Pumpbody

ABC

20

1

20

12

80

112

Pumplid

ABC

15.5

1

16

9

62

87

Seal

Ext

Nil

2

35

Nil

15

50

Leverarm

ABC

18

1

12

5

45

62

Float

ABC

35

1

18

15

20

53

Counter

weight

Ext

Nil

1

55

Nil

25

80

Switch

housing

ABC

17

1

12

8

18

38

Switch

Ext

Nil

2

85

Nil

12

97

Assembly

ABC

185

1

Nil

55

215

270

Packaging

ABC

11

1

27

35

105

167

Totals

301.5

12

280

139

597

1,016

Notes:1.E

ntrieslistedextareboughto

utitemsfrome

xternalsupplie

rsandhencehaveno

labourcontent.However,theyattractanoverheadchargetocoverpurc

hasingandprocessing

costs,etc.2

.Thefollowingactivitieshave

beenincludedinthecosting:designdrawings;

inspectionandqualitycontrol;anallowanceforwastageandrejects;am

ortisedtoolcosts

whereapplicable;plantandequipmentus

ed;purchasingcosts;storagec

osts.3.

Labourcosts

arebasedo

nstandardtimesestablishedthroughworkstudyanalysis.4.

Overheadsusedare

thosealloca

tedpercostcentre.

(Notethatthesecouldalsobebasedonastandardoverall

(global)cos

tallocation.)


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Methods of Costing

4. Allocatealltheindirectcoststoindividualservicedepartments.

5. Re-allocate the costs from production support servicesto productiondepartments.

6. Establish an accurate overhead rate.

7. Absorballdirectandindirectoverheadcostsintoeachproduct.

3.2.2 Absorption Rate

Theabsorptionrate(alsoknownastherecoveryrate)isthemethodofassigning

overheads to a product or service and may be based on:

1. Direct labour hours.

2. Direct material costs.

3. Machineproductionhours.

4. Units o output.

5. Percentage o the product sales prices.

I a company is producing several dierent products then each o these may attract adifferentabsorptionratebecauseeachproductmaymakeagreaterorlesserdemand

onsupportserviceslikepurchasingorhumanresources.

Foreachproduct,allproductioncostsdirectlyassociatedwithitandallrelated

overheads are allocated to this product cost centre.

However, sometimes it is possible to establish an overall relationship between certain

costs or the manuacture o a wide range o dierent products.

Example.Acompanymanufacturesalargerangeofdifferentproductswiththeoverall

production costs given in Table 3.2.

It has been established that there is a close relationship between the material costs or

each product and the overhead cost. In this case the absorption rate would be

Direct material cost 5850.8 80%

Total overhead 730= = =


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Thisrelationshipcannowbeusedtodetermineindividualproductcostings(Table3.3).

In this case, there is a relationship between direct material costs and the manuacturingoverhead cost. However, any other cost may be used as a base or a similar relationship

likethelabourortotalcosts.

Ifaglobalrelationshiplikethiscanbeestablished,itclearlymakesforasimpler

method. I such a relationship cannot be established then each product would include

itsownindividualoverheadallocationaspreviouslyexplained.

Table 3.3 shows the basic absorption o manuacturing overhead costs. This shows

the product costing or manuacturing overheads but there are other overheads that

havetobeaddedtothese.Examplesaresellinganddistributioncostswhichmaybe

amixtureofdirectandindirectcostsandadvertisingcampaignsforspecicproductsorglobaladvertising.Thesenon-speciccostsareusuallyabsorbedinoneofthe

ollowing ways:

asapercentageofthesellingprice;

asarateperunit;and

asapercentageofthemanufacturingcosts.

Table 3.2 Production costs

Cost (000)Direct materials 585

Direct labour 550

Directworksexpenses 175

Total cost 1,310

Total overhead 730

Total works cost 2,040

Table 3.3 Basic absorption costing or three typical products

Category Product A () Product B () Product C ()

Materials 25 35 15

Labour 20 38 12

Expenses 15 12 5

Total cost 60 85 32

Worksoverhead 20(2580%) 28(3580%) 12(1580%)

Total works cost 80 113 44


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Methods of Costing

3.2.2.1 Percentage of the Selling Price

This method is usually used where sales are made through a variety o dierent sales

outlets.Forexample:

adirectsalesforce;

throughnationaldistributors;

throughlocaldealers;

retailchainstores;

onlinesalesviaawebsite;or

throughagents.

Each one o these categories will require a dierent discount rom the nominal

sales or list price. Table 3.4 shows the absorption o selling and distribution costs

or our categories.

Thepublishedlistpriceisrarelychargedoutinfullbutservesasabasegureagainst

whichdiscountedpricesareestablished.Thisexampleshowsthatthecompanywillhavetomanufacturethisproductat48%ofthelistpricetoabsorborachievethe

manufacturingcosts+protmargin.

Thismethodisalsousefulforestablishingtheoptimumexworksorproductioncostof

aproductbyusingthelistpriceofacompetitorsproductandworkingbackwards.

Table 3.4 Absorption o selling and distribution costs

Sales

orce (%)

Local dealer

(%)

National

distributor (%)

Online sales

(%)

List price 100 100 100 100

Discount 12 40 45 30

Total sales revenue 88 60 55 75

Salesanddistribution

costs

40 12 7 27

Productioncost+prot 48 48 48 48


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3.2.2.2 Rate Per Unit

This method allocates a separate proportion o the total overhead costs to eachproduct item so that all the overhead costs are absorbed by the total o all o the

products manuactured.

Fixedcostslikerent,insurance,showrooms,etc.,canbeallocatedbytheturnover

o the product or by product volume. The variable costs can then be allocated on

a rate per item basis. This method is shown in Table 3.5. These results are added

tothemanufacturingcostsperunitplusaprotelementifonehasnotalready

been included.

Table 3.5 Absorption o selling and distribution costs on rate per unit basisCategory Product A Product B Product C

Fixedcosts 10,000 20,000 50,000

Salesvolume 15,000 40,000 100,000

Fixedcostperunit 0.67 0.50 0.50

Variable costs per unit Nil

Packingcosts 0.35 0.30 0.40

Delivery costs 0.25 0.30 0.20

Commissions 0.30 0.30 0.35

Salesanddistributioncostperunit 1.57 1.40 1.45

3.2.2.3 Percentage of the Manufacturing Cost

This system is used where the products are o a similar nature or a similar price. In

thiscaseitshouldberelativelystraightforwardtoestablishaxedpercentageto

add on or administration and selling costs. In Table 3.1, the production cost was

establishedas101.60.Usingthisgure,thenalproductcostcanbearrivedatas

showninTable3.6.Inthiscasethepercentageaddedisthestandardcompanygure

or this product.

Table 3.6 Absorption by adding percentage o the manuacturing cost

StandardcostfromTable3.1 10.16

Distribution costs 3.50

Administrationandsellingcostsat12% 12.19

Total 12.54


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Methods of Costing

3.3 Marginal Costing

Withbothstandardcostingandabsorptioncosting,theallocationofxedandoverheadcostcanbecomplex(butnecessary)toanalyseandapplytoestablish

complete costings.

Costsbehaveindifferentwaysastheproductionorsalesvolumeschange.Inmarginal

costing it is the behaviour o the associated costs that is measured rather than the

origin o the cost. It measures relative eects rather than total costing. It determines

the change in cost that occurs when the output volume changes by one unit. This is

quantiedbythetotalvariablecostforasingleunit.

Tocarryoutamarginalcostinganalysisitisrstnecessarytoidentifythexed

andvariablecostelements.Thefollowingexampledemonstratestheprocedurefor

establishing a marginal costing or a small company producing a single product.

Example. Table 3.7 summarises the procedure or establishing a marginal costing.

Tolookattheseresultsonamarginalcostingbasis,itisnecessarytorearrangethe

guresasshowninTable3.8.

With each product the company sells, it will receive 1.25, and, as this is greater

than the 0.42 variable cost, there will be a contributiontocoverthexedcosts.

Hence, contribution = sales value minus variable costs in this case 0.83 per unit.

Itdirectlyfollowstherefore thatprot= contributionminusxedcosts inthisexample0.17.

Table 3.7 Cost analysis or 160,000 units

Category Total () Fixed costs () Variable costs ()

Sales(160,000units) 200,000

Costs

Direct materials 40,000 Nil 40,000

Direct labour 35,000 19,000 16,000

Production overheads 20,000 20,000 Nil

Salesandmarketing 30,500 22,000 8,500

Development 20,000 20,000 Nil

Administration 15,500 15,500 Nil

Distribution 12,000 9,000 3,000

Total costs 173,000 105,500 67,500

Net proft 27,000


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The results rom this analysis reveal an important point. That is, i more than

160,000productsaresold,theprotwillincreaseasthexedcostscannotchange.

Henceforeachadditionalproductsold,theprotonamarginalbasisisequaltothe

contribution in this case 0.83.

These results can also be demonstrated on a graph that gives a convenient method

for viewing the effect ofvarying different parameters (Figure 3.1). This clearly

demonstrateshowincreasingoutput,andhencesales,increasestheprot.Italso

showsthebreak-evenpoint,whichissimplythepointatwhichthenumberofitems

soldissufcienttomakethesalesrevenueequaltothetotalcosts.

Inthiscasethisgureisaround127,000itemssoldwhichcorrespondsto159,000

ofsales.Ifmoreitemsthanthisaresold,aprotwillresult.Iflessthanthisnumber

issold,alosswillresultwherethecostsexceedthesalesrevenue.

Figure 3.2 shows how the basic graph is constructed.

1. Establish a table similar to Table 3.8 based on yourgures.

2. Drawtheaxesforthesales/costsandnumberofitemsold.

3. DrawalinefrompointAhorizontallyacrossthegraphrepresentingthebudgetedsales in this case 200,000.

4. Draw a line vertically upwards to represent the number o items sold in this

case 160,000.

5. ThesetwolineswillintersectatpointC.

6. DrawalinefromtheoriginthroughpointCandcontinueitalittlefurther.

Table 3.8 Marginal costing or 160,000 units

per unitSales 200,000 1.25

Less variable costs 67,500 0.42

Contribution 132,500 0.83

Lessxedcosts 105,500 0.66

Netprot 27,000 0.17


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Methods of Costing

7. DrawanotherlinehorizontallyfrompointBatadistanceupthesales/costsaxis

representingthetotalcosts(variable+xedcosts)inthiscase173,000.Where

this line intersects the vertical line already drawn we obtain point D.

8. NowdrawalinefrompointFthroughpointDandextenditalittlefurther.

9. Thebreak-evenpointistheintersectionofthesetwolinesatE.

Theguresobtainedfromthegraphgiveareasonableestimatebut,ofcourse,will

dependupontheaccuracywithwhichthegraphhasbeendrawnandinterpreted.For

Figure3.1BreakevengraphfordatainTable3.8


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thosewhopreferamoreaccurategraphicalmethod,aMicrosoftExcelspreadsheetmaybeused(Figure 3.3).Abettervisualresultisobtainedbyalteringtherowand

columnsizestosuitthegureinvolved.

Analternativealgebraicapproachgivesanaccurateresultandcanbeputintoprogram

orm in a computer or added convenience.

Usingbasicalgebra,thebreak-evenpointcanbeestablishedbythefollowingequation

whereallgureshavebeentakenfromTable 3.8:

Figure3.2BasicconstructionofbreakevengraphfordatainTable38


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Methods of Costing

S B V BF

N N

= + (3.1)

where S = sales value, V= variable costs, F=xedcosts,N= number o items sold

and B=numberofitemsrequiredtobesoldtobreakeven.Wecansimplifyand

transpose Equation (3.1) to give

N FB

S V

=

(3.2)

Figure3.3MicrosftExcelgraph

Sales/Costs ()

200,000

190,000

180,000

170,000

160,000

150,000

140,000

130,000

120,000

110,000

100,000

90,000

80,000

70,000

60,000

50,000

40,000

30,000

20,000

10,000

0

10 20 30 40 50 60 70 80 90 100 110 120 130 140 150 160 170 180

Number of units sold

Sales

Break even point

A

B

C

D

E

F

Fixed costs

Variable costs

Profit


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I we now substitute the values rom Table 3.8 in Equation (3.2), we get

whichcorrespondsto127,3961.25=159,245ofsales.

LookingagainatthegraphinFigure 3.1 we can also see that we can determine the

protasthesalesorthenumberofitemssoldincreases.Forexample,if200,000parts

weresoldwecouldexpecttheprottoincreasetoapproximately60,000.

We can similarly arrive at an equation to determine this algebraically:

v vS N V N P F

N N

= (3.3)

where P=protandNv

= dierent number o items sold, chosen or the analysis.

Onsimplicationthisgives:

v( )S V NP F

N

= (3.4)

SubstitutingthevaluesfromTable 3.8 gives:

Note that Equations (3.2) and (3.4) are powerul results allowing other variables to

beestablishedoncethebreak-evenconditionisknown,forexampleestablishingwhat

thevariablecostwillbeforagivenlevelofprot.Anotherusefulresultiswriting:

C S V=

where C is the contribution since C = sales minus variable costs. Hence, Equation

(3.4) may be written as:


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Methods of Costing

vC NP F

N

=

(3.5)

3.4 Machine Hourly Rates

This method o costing is requently used where the majority o production is machine

based.Forexample:

injectionmoulding;

blowmoulding;or

extrusion.

Clearlyitwouldcostmoretorunalargermachinethanasmalleronesince:

thecapitalcostisgreater;

theenergyrequiredtooperateitisgreater;and

themaintenanceandservicingcostsaregreater.

These acts must be refected in the prices charged or manuacturing parts.

Thedifcultyisinestablishingtheamountstochargefordifferentsizemachinesandformachinesofdifferingages.Anumberofmethodshavebeendevelopedfortaking

this into account, including those previously discussed, but by ar the most requently

used is based on the machine rate per hour(ormachinehourlyrate,MHR).

Firstofallwewillexaminewhatwouldhappenifweonlyhadone machine. This

is,ofcourse,veryunlikelyinpracticebutitillustratestheprinciplemoreclearly.We

willthenextendthisprincipletoanynumberofmachines.Thefollowinganalysisis

based on injection moulding but a similar procedure can be adopted or any primarily

machine-basedproductionactivity.

3.4.1 Computation o the MHR

The ollowing analysis applies to an injection moulding operation only, based on

custom moulding or general trade moulding.

Thereisnowayofknowinginadvanceexactlywhatthemixofnewworkwillbe:

whether the parts will be large or small, how many impressions the mould tools will

be, what materials will be required and so on.


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This iswhere analysisof past performance isextremelyvaluable. From such

informationweshouldknow:

theinvoicedsales;

thetotalcostofallmouldingmaterialsused;

theenergycosts;

allotherdirectandindirectcosts.

Infactbyanalysingtheguresfromseveralpreviousyears,atrendcanbeestablished

withouttoomuchdifculty.Forexample,previouslabourcostscanbeprojected

orward, as can energy and several other costs. There may well be a variation romyear to year but these can be averaged out.

Example. To illustratethis we will re-introduceour ctitious injection moulding

company,ABCProductsLtd(ABC).TheboardofABChasdecidedtheperformance

or the orthcoming year:

Invoicedsales:10,000,000.

Protrequired:15%.

ThisisbasedonpreviousyearsguresgiveninTable3.9,inwhichthe materialusage actorisdenedas

Cost of materials used100%

Invoiced sales

Fromthisanalysiswecanestablishtheaverageofthelastthreeyearsmaterialusage

factors:(29+31+28.5)/3=29.5%.

Thedecisionistakeninthiscasetoadopt30%fortheforthcomingyear.Inviewof

this we can establish the ollowing:

Table 3.9 Analysis o previous years fgures

Year 1 Year 2 Year 3

Invoiced sales 6,000,000 7,000,000 8,500,000

Materialsused 1,740,000 2,170,000 2,422,500

Materialusagefactor 29% 31% 28.5%


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Methods of Costing

invoiced sales: 10,000,000

lessprot(15%):1,500,000=8,500,000 lessmaterialsused(30%):3,000,000=5,500,000.

This means that all remaining costs will have to all within 5,500,000

The accountant and production manager have established to support this level o sales

thatallremainingcosts(exceptmaterialcosts)amountto5,000,000.Thisisless

thantheprojectedsurplusof5,500,000andleavesafactorofsafetyof500,000

a10%marginoncostsincasetheactualcostsarehigherthanexpected.

ABCworksa125-hourweek,50-weekyear,givingautilisationof6,250hoursper

yearaUFof74.5%.Fromsimilaranalysesofpreviousyearsperformanceitis

knowntheefciencyfactoris80%.Withthisinformation,wecannowestablishthe

averageMHRforone(virtual)machine.

IfwecanimagineforamomentthatABCdoeshaveonlyonemachine,allthecosts

ofallworkprocessedonitwouldbechargedoutintwobasicparts:

1. The cost or the material.

2. Achargetocoverallothercosts.

Thematerialcostwoulddependonthesizeoftheparts,therunnersystemandtheprice o the material the costs varying rom job to job. Hence, these costs would

have to be charged separately.

The machine charge would have to cover all the remaining costs. In order to do this

we have to predict how many hours per year the machine is going to be actually

producingpartsanddividethisgureintothesecosts.Thisgivesusamachinerate

per hour. Dividing this by 3,600 would give the machine cost per second.

I we then estimate the cycle o a job, we can determine how much we should charge

per shot by multiplying the cycle by the machine cost per second. This gives a machine

costfortheshot.Addingthiscosttothematerialcostfortheshotgivesusthetotal

costforproducingoneshot.Dividingthisgurebythenumberofimpressionsinthe

shot will give the cost per part.

ToillustratethisprocedurewewillestablishtheMHRforonemachineforthe

companyABCasfollows:

Total number of hours worked = 6,250


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Productive hours worked = 5,000 (6,250 80%) per year

Total costs to be recovered = 5,500,000

ThereforeaverageMHR=5,500,000/5,000=1,100.

Clearlyitwouldbeanunderstatementtosayachievingaturnoverof10,000,000

withonemachinewithanMHRof1,100wouldbedifcult!

WewillnowassumethatABChas14machinesrangingfrom25tonnelockto350

tonnelockandthatitspolicyistodepreciateallmachinesoverveyearsonastraight-

line basis. The details o these machines are given in Table 3.10.

AllthatremainsnowistoapportiontheMHRof1,100forthissinglemachine

over all the machines the company has. There are several methods used to achieve

this but we will concentrate on our:

capitalcostmethod;

machinelockmethod;

bookvaluemethod;and

kVA(kilovoltampereseeappendix)ratingmethod.

Table 3.10 ABC machine details

M/C

lock

No. Age

(years)

Original

cost

each ()

Total cost

()

Depreciation

each/year ()

Book

value

()

Total

book

value ()

25 2 2 25,000 50,000 5,000 15,000 30,000

50 1 1 35,000 35,000 7,000 28,000 28,000

50 2 1 40,000 80,000 8,000 32,000 64,000

100 3 3 70,000 210,000 14,000 28,000 84,000

250 1 4 150,000 150,000 30,000 30,000 30,000

250 2 1 210,000 420,000 42,000 168,000 336,000

350 2 2 375,000 750,000 75,000 225,000 450,000

350 1 4 150,000 150,000 30,000 30,000 30,000

Totals 14 1,845,000 1,052,000


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Methods of Costing

3.4.1.1 Capital Cost Method

Thisconsistsofexpressingeachmachinecostasapercentageofthetotaloriginalcapital cost or all machines:

Original capital cost of machineCapital cost MHR 1,100

Total capital cost of all machines=

IfwetaketherstmachinelistedinTable 3.10(25tonnes):

25,000MHR 1,100

1,845,000

15

=

=

3.4.1.2 Machine Lock Method

WiththismethodthemachineMHRsaregroupedbytheirlockingforces.Touse

thismethodwerstneedtoworkoutthetotallockingforceofallthemachines.In

this case we have:

(2 25) (3 50) (3 100) (3 250) (3 350) 2,300 tonnes + + + + =

Theneachlockinggroupisexpressedasafractionofthetotallockingforceofall

the machines added together:

Locking groupMachine lock MHR 1,100

Total locking of all machines=

Takingthe25tonnemachinethisgives:

25MHR 1,1002,300

12

= =

3.4.1.3 Book Value Method (or Depreciation Method)

Asthetermimplies,thebookvalueorwrittendownvalueofthemachinesistaken

as the basis or computation or this method:


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Book value of each machineBook value MHR 1,100

Total book value of all machines

=

Thebookvalueoftherstmachineis15,000.Hence:

15,000MHR 1,100

1,052,000

16

=

=

Table 3.11givesthecapitalcost,machinelockandbookvalueMHRsfor

all machines.

3.4.1.4 kVA Rating Method

As we havealready discussed, theelectrical power requirements for moulding

machinesgenerallyincreaseasthesizesofthemachinesincreaseintermsoftheir

lockingcapacity.Thisisthebasisofthemachinelockmethodofdeterminingthe

MHR.However,itisnotthemostaccuratemethod.

Whilstthereisalooserelationshipbetweenlockingforceandpowerconsumed,it

does not represent the actualpower requirement o each machine. In this respect, thelockingforceMHRmethodcanbestbedescribedasareasonableestimate,although

it will still recover all the costs o running all the machines.

Amoreaccuratemethodis tousethetotalinstalledpowerofeachmachineas a

basisfordeterminingtheMHR.Thetotalinstalledpoweristhemaximumamount

ofpowereachmachinewillconsumeandismeasuredinkilowatts(kW).

Itisunlikelythateveryjobbeingprocessedwillneedthismaximumamountofpower.

Clearly,inpracticetherewillbemanyjobsthatmayonlyrequirehalforlessofthe

available power on every machine on which they run. However, the same reasoningappliestothemachinelockmethodinthesensethatmanyjobswillnotrequirethe

maximumavailablelockingforceofthemachineonwhichtheyrun,andhenceuse

less power.

ThereasonwhythekVAmethodismoreaccurateisthatitusespowerdirectlyas

abasisforcostingratherthanthelockingforcemethodthatusesthemachinelock

capacitytoestimatethepowerconsumption.Sincethepowerusedrepresentsamajor

cost component in running a machine, this is an important actor.


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Methods of Costing

Table3

.11MHRsaccordingtomachinelock,capitalcostandbo

okvaluemethods

No.of

M/C

Lock

Total

lock

Original

co

stper

M/C

Total

original

costper

M/C

Book

value

perM/C

Total

book

valueper

M/C

Depre-

ciation

perM/C

Total

de

pre-

cia

tion

per

M/C

Capital

cost

MHR

Machine

lock

MHR

B

ook

v

alue

M

HR

2

25

50

25,0

00

50,0

00

15,0

00

30,0

00

5,0

00

10,0

00

15

12

16

1

50

50

35,0

00

35,0

00

28,0

00

28,0

00

7,0

00

7,0

00

21

24

29

2

50

100

40,0

00

80,0

00

32,0

00

64,0

00

8,0

00

16,0

00

24

24

33

3

100

300

70,0

00

210,0

00

28,0

00

84,0

00

14,0

00

42,0

00

42

48

29

1

250

250

150,0

00

150,0

00

30,0

00

30,0

00

30,0

00

30,0

00

89

120

31

2

250

500

210,0

00

420,0

00

168,0

00

336,0

00

42,0

00

84,0

00

125

120

1

76

2

350

700

375,0

00

750,0

00

225,0

00

450,0

00

75,0

00

150,0

00

224

167

2

35

1

350

350

150,0

00

150,0

00

30,0

00

30,0

00

30,0

00

30,0

00

89

167

31

14

1425

2300

1,845,000

1,052,000

369,000


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54


Anothercompellingfactoristhatelectricitysuppliersnormallybasetheirchargeson

themaximumkVArequirementforeachfactory.Thisisbecausetheyhavetoensure

theycansupplythemaximumamountofpoweratalltimesincaseitisneeded.

AfurthercaseforthekVAmethodisthatmouldingmachinemanufacturersarenow

marketingmachineswithall-electricdrives,thuseliminatingthetraditionalhydraulic

motordrivenbyapump.Thisisdesignedtoincreasetheoperatingefciencyand

thereore reduce the power requirements substantially. However, the cost o these

machinesis upto50% morethanthecostof theequivalenthydraulicmachines.

Henceitmaytakeseveralyearsbeforethesavingsinpowercostsoffsettheextra

capitalexpenditure.

Were-listinTable 3.12alltheABCmachineswiththeirkWratingstoestablishthe

kVAMHR.ThedifferencebetweenkVAandkWdependsonthepowerfactorofthe

installedelectricalsupplyandisdiscussedintheappendixinfurtherdetail.

Table 3.12 kVA MHR method

Locking orce (tonnes) Rating (kW) MHR ()

25 8 18.57

25 10 23.21

50 15 34.81

50 15 34.81

50 16 37.13

100 18 41.77

100 19 44.09

100 19 44.09

250 50 116.03

250 53 123.00

250 56 130.00

350 63 146.20

350 65 150.84

350 67 155.48

Total 474


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55

Methods of Costing

ThesameprocedureisusedtoestablishtheMHRsforeachmachineasintheprevious

examples.TakingtherstmachineinTable 3.12, we have:

kVA rating of each machinekVA MHR 1,100

Total kVA rating of all machines=

Itcanbeseenfromthisanalysisthattherearesomesignicantdifferencesbetween

themachinelockMHRslistedintable3.11andthoseobtainedusingthekVAmethod

shown in Table 3.12.

3.4.2 Selecting the Best Method

3.4.2.1 Capital Cost Method

Clearly,thismethodweightstheMHRstronglyinfavourofthenewerandmore

expensivemachines.Thelowertheoriginalcostofthemachine,thelowertheMHR

and vice versa.

Iftwomachineshavethesamelockingforcebutonecostmorethantheother,this

isreectedintheMHRandthusthepriceschargedout.

DifferentMHRsforthesamelockingvaluescouldalsobeduetoonemachinebeing

olderthantheother.Alternativelythemachinescouldhavebeenpurchasedatthe

same time, with one being more sophisticated than the other.

This methodhas theadvantageoflower MHRs for older andless sophisticated

machinesandhigherMHRsfornewermachinesandthosewithhigherspecications

and thus capital cost.

3.4.2.2 Machine Lock Method

This is one o the most widely used methods in the injection moulding industry and

isastraightforwardsystemrelatedtothelockingforceirrespectiveoftheoriginalor

written down values o the machines.

Itdoesnot takeaccountof differencesof qualityor ageofmachinesofthesame

lockingforce.ThereforethesameMHRwouldbechargedforanoldbasicworkhorse

asanewhigh-specicationmachineofthesamelock.


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56


3.4.2.3 Book Value Method

ThismethoddoestakeaccountoftheageandvalueofmachinesandclearlyweightstheMHRinfavourofnewermoreexpensivemachines.Oncethebookvalueofa

machinereacheszero,thetheoreticalMHRofthemachinewouldalsobezero.

In practice, o course, a charge would still have be made or such a case since the

machine would still require energy to run as well as possibly more maintenance

and repair.

TheeffectofzeroratinganMHRforafullywrittendownmachineistoincreasethe

MHRsofalltheremainingmachines,whicharestillbeingdepreciated.

Whilst this method is used, it is not as widely used as the capital cost and machinelockmethods.Whereamachinehasbeenfullywrittendown,adecisionhastobe

maderegardingwhatshouldbecharged.InsomecasesaquitelowMHRisusedto

attract very competitive business which otherwise may be lost.

However, once a machine has been ully depreciated or written o, it should be

replaced by using the unds acquired rom the depreciation account which is the

wholepurposeofdepreciationintherstplace.

3.4.2.4 kVA Rating Method

Thisisasimilarbutmoreaccuratemethodthanthemachinelockmethod,butitalso

takesnoaccountoftheageororiginalcostofthemachines.Thismethodisbecoming

morewidelyusedaselectric-drivemachinesareintroduced.

It also has the advantage o allowing the selection o the lowest cost machine to

runajoboninthesamelockinggroup.Forexample,ifajobrequiresthemould

to be run on a 250 tonne machine, Table 3.12 shows which machine would be the

cheapestonwhichtorunit.Bycontrast,themachinelockmethoddoesnotmake

this distinction.

3.5 Adjusting the MHR

Sofar, we have arrived atan MHR bygrouping machines into four categories

or groups:

capitalcostofthemachines;

lockingforce;


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57

Methods of Costing

bookvalueofthemachines;and

machinekVArating.

Aswehavementioned,theactualmethodselectedtousewoulddependuponthe

natureoftheworkacompanyundertakes.

3.5.1 Normal Difculty Work Mix

Forgeneral trademoulding, the usualMHRmethod wouldbe thatbasedonthe

lockingforcegroupingofthemachines.Thiswouldnotreecttheageofmachines

ortheoriginalpricespaidforthem.Acompanymayestimateajobontheirnewest

mostexpensivemachinebutmaynotbeabletouseahigherMHRthantheoldest

leastexpensivemachineinthesamelockinggroup.

This is oten simply because their competitors may estimate on the basis o running

the samejobon alessexpensivemachinewithinthesamelocking groupata

lowerMHR.InotherwordsahigherMHRcannotbechargedbecauseitwould

not be competitive.

Shouldtheoccasionaljobcomealongthatwasmoredemandingthannormalthena

higherthannormalMHRchargeshouldbe made to refect this. In this case a moulder

mayeitherapplyafactorofdifcultyon costtothenormalMHRasdiscussedbeloworuseanisolatedMHRcomputedusingthecapitalcostmethod.

3.5.2 Varied Difculty Work Mix

Iftheworkmixturerangesfromreasonablystraightforwardtoquitecomplexand

technical, a company may have to purchase a range o machines with diering degrees

ofsophisticationbutwithinthesamelockingforcegroups.

Hence i, say, three 100 tonne machines were purchased at dierent prices refectingtheirdifferingqualityandsophistication,theMHRofeachshouldbedifferent.Each

MHRwouldreectthedegreeofdifculty,costofrunningandtheoriginalcostof

each machine.

This situation is a clear candidate or the capital cost method, providing the same

spreadofworkappliedgenerallyoverallmachines.Shouldanextremelydifcult

job occur, a company may decide to apply a degree o difculty actoror that one

job to refect this.


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58


This is oten applied as a percentage on costontopoftheMHR.Forexample,if

thenormalMHRforadifcultjobonthebestmachinewas100,thenforthis

situationanoncostof25%maybewarranted,givinganewMHRof125.Eachcase is considered on its merits and charged out accordingly.

3.6 Discussion

In practice each company will adopt its own customised costing procedure which

reectsthenatureofthetypeofworkitprocesses.Thiscantaketheformof

completelydifferentMHRsystemsfordifferentcategoriesofworkbeingrunonthe

samemachines:forexample,oneMHRforstraightforwardstandardproductsand

anotherforgeneraltradework.

Companiesthatspecialiseinaparticulareldmayapplyawiderangeofmodied

MHRstocoverthevaryingjobrequirementswithinthateld.If,forexample,a

companydoesalargeamountofassemblyworkaswellasmoulding,therunning

costs may well be split into two cost groups: one or the assembly and one or

the moulding.

Each o these groups may have separate hourly charging systems or each process.

Inthesecasesthesameapproachmaybetakenbydividingtheappropriatecostsfor

eachactivitybytheexpectednumberofproductivehours.

3.6.1 Varying MHR System

Somecompanieskeepaveryclosecontrolovercostsandmonitortheseonacontinual

basis. These costs are analysed and projected orward or the remainder o that

nancialyear.ThisenablestheMHRgurestobecontinuallyreviewedandchanged

i necessary.

This gives the company the advantage o being able to oer lower prices when the

predicted costs decrease and increase prices when the predicted costs rise. This systemmaybecombinedwithanyoftheMHRsystemsdescribedabove.

3.6.2 Observation

Although,theexamplespresentedabovearebasedoninjectionmoulding,thesame

approachmaybeusedwithblowmoulding(basedonmachinesize)andwithextrusion

processes(basedonmachinesizeorplasticisingcapacity).


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59

Methods of Costing

3.7 Checking the Calculated MHR

Allthecalculationscarriedoutsofararetheoretical.Theyaremodelledonpredictionsabout turnover and hence costs. These predictions, however, are based on previous

trends and results and represent the best basis we can use in advance o the event.

In view o this, it is important to continuously monitor the actual costs and review

theMHRbeingcharged.

Often,themostvulnerablepredictedcostisthematerialusagefactor.Thiscan

represent upto50%of the totalrunningcostsof acompanyand is, therefore,

highlysignicant.

Onceanewnancialyearhasstarted,itisvitaltoregularlycheckthatthiscostiswithinthebudgetedamount.Ifitissignicantlygreaterthanbudget,thenaction

shouldbetakenimmediatelyasthiscouldleadtoadepletedprotmarginoreven

a loss.

Indeed,allcostsshouldbecarefullycheckedtoensuretheMHRisneithertoohigh

nor too low.

3.8 Observation

MHRguresarerarelycheckedfrequentlyenoughtoguaranteetheiraccuracy.

If each jobmakesa protthere should be an overall protat the endof

the year.

3.9 Summary

3.9.1 Standard Costing

Awidelyusedmethodformanufacturingindustries.

Mustbebasedonrealistic,achievableperformance.

Mustnotbebasedontargetsorgoals.

Cancoverawiderangeoflabour-basedandmachine-basedproduction.Often

used or a combination o both.

Providesastandardtocomparecompanyperformanceandcompetitiveness.


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60


3.9.2 Absorption Costing

Amethodthatensuresthatallthemanufacturingcostsareabsorbed(orrecovered)by the products produced.

Itprovidesastandardorbasesellingpricefordiscountingsalespricestonational

and local distributors and own sales orce.

Theabsorptionrate(alsoknownastherecoveryrate)isthemethodofassigning

overheads to a product or service and may be based on:

- directlabourhours

- directmaterialcosts

- machineproductionhours

- unitsofoutput

- percentageoftheproductsalesprices.

Non-specicoverheadorothercostsmaybeaddedasfollows:

- asapercentageofthesellingprice

- asarateperunit

- asapercentageofthemanufacturingcosts.

3.9.3 Marginal Costing

Marginalcostingmeasuresrelativeeffectsratherthantotalcosting.

Itdeterminesthechangeincostthatoccurswhentheoutputvolumechangesby

oneunit.Thisisquantiedbythetotalvariablecostforasingleunit.

Itisaverygoodmethodforquantifyingtheadditionalprotthatoccursafter

thebreak-evenpointhasbeenreached.

3.9.4 Machine Hourly Rate

Themostcommonlyusedcostingsystemintheinjectionmouldingindustryis

basedontheMHR.

ThebasicMHRisthetotalrunningcost(exceptthematerialcost)dividedbythe


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61

Methods of Costing

numberofproductivehoursworkedinthenancialyear.Thisisfurtherrened

depending on the requirements o each company.

ThemostcommonlyusedMHRsystemsarebasedon:

- capitalcostsofthemachines

- machinelockinggroups

- machinebookvalues

- kVAmachinepowerratings.

MHR systems may vary or be combineddepending onthenature of

the business. WhateverMHRsystemisused,itmustensureallcosts(otherthanmaterialcosts)

are recovered.

TheMHRmustbecheckedfrequentlytocheckitsaccuracy.

Figure3.4showsasummaryofthedifferentMHRmethods.

Alltheaboveanalysesarebasedonchargingoutthematerialcostasaseparatecost

totheMHRduetothewidelyvaryingtypesandcostsnumberofmaterials.

Thereis,however,animportantexceptiontochargingthematerialcostseparately.Ifa company is using a single material only or all its products then it is easier to include

this intheMHR. For example, a companyproducing, say, disposable tableware

comprisingcups,saucers,cutlery,beakersandsoonallinhigh-impactpolystyrene,

thematerialcostwouldbeincludedintheMHR.

3.10 Combined Costing Systems

There are many occasions when a company may choose to operate a number o

dierent costing methods simultaneously. This can occur when a company is producing

a range o standard products that require a number o dierent manuacturing

processes o which the injection moulding process is just one. In this case, it is usual

to adopt a costing system that may include all the dierent costing methods so ar

describedtreatingeachoperationasaseparatecostcentre.Forexample,acompany

manuacturing a hair dryer may have the ollowing production stages:

injectionmouldingtoproducethemainbodyparts;

insertionofmetalinsertsintobodymouldings;


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62


printing;

electricalsubassembly;and

nalassembly.

Inthiscase,thecostingsystemmaylooklikethatshowninFigure 3.5.

Ifacompanyweremakingseveralstandardproductsallofwhichuseinjection

moulded parts made rom the same material, the costing model may change. In such

cases,thecompanywilltrytominimisethenumberofmachinelockinggroupsithas

formaximumversatilityandeconomytoensure:

Figure3.4MHRcostingsummary


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63

Methods of Costing

interchangeability of mouldtools between several machinesin the same

lockinggroup;

purchasingadvantagesinbuyingseveralmachinesofthesamelockinggroupat

thesametime;and

standardisationofsupportequipmentonidenticalmouldingmachines.

Forexample,thisoperationmaybebasedonjustthreelockinggroups,say10of

each o 50, 150 and 250 tonne machines.

With large production volumes, the material would be stored in silos and delivered

automatically to the moulding machines thus eliminating contamination and

labour costs.

Figure3.5Costingmodelforhairdrierproduction


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64


Suchanoperationisaprimecandidateforthestandardcostingmodelsince:

onlyonemouldingmaterialisbeingusedforthemouldingoperations;

themouldingmachinecostsshouldbewellknownasrelativelyfewmouldtools

arebeingused;and

alltheotheroperatingcostsandmaterialcostswillbeaccuratelyknownthrough

continual reassessment.

Frequently,companieswilldeveloptheirowncustomcostingmethodsthatconsist

ofacombinationofthemethodspreviouslydiscussed.Costingsystemswillnaturally

evolvetosuitthetypeofbusinessandthemarketseachcompanyisserving.As

markettrendschange,costingsystemsmayhavetochangetostayintunewiththat

particularmarket.

Date post:	02-Apr-2018
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