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P R U P A D H Y A Y

Costing and Finance

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Outline

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• Business & Accountingterminology

• Cost classification &

analysis• Cost-benefit analysis

• Interest & time value ofmoney

• Investment decision

• Risk analysis

• Demand analysis andsales forecasting

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Engineering Economy

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Business & Accounting terminology

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Covered in General Accounting Principles

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Cost

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• Cost is the amount of expenditure, actual ornotional, relating to a specific thing oractivity.

•

The special thing or activity may be aproduct, job, service, process or any otheractivity.

• Cost is expressed in monetary terms.

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Cost classification

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It is the process of grouping costs according to theircommon characteristics.

Cost classification serves the following objectives: Determining product cost

Planning

Decision making

Control

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Different Cost classifications

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On the basis of nature of cost:

Direct material

Direct labour

Direct expenses

Factory/ works overhead

 Administrative overhead

Selling & distribution overhead

 On the basis of behavior of cost: Fixed

 Variable

Mixed (Semi-variable or semi-fixed)

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Different Cost classifications

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On the basis of degree of traceability to the product:

Direct cost

Indirect cost

 On the basis of association with the product: Product cost

Period cost

On the basis of function:

Manufacturing cost  Administrative cost

Selling & distribution cost

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Different Cost classifications

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On the basis of relationship with the accountingperiod:

Capital cost

Revenue cost

 On the basis of decision making and planning: Opportunity cost

Sunk cost

Relevant cost On the basis of controllability: Controllable and uncontrollable cost

Standard cost

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Cost analysis

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Cost analysis is the identification of the costs, as pertheir required classification, for the purpose ofplanning, decision making and controlling.

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Cost-benefit analysis

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It analyses the cost and expected benefit there from.

Helps in decision making relating to level ofproduction.

Following techniques are used: Break-even analysis

Cost-volume-profit analysis

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Interest and time value of money

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Interest is the amount of return of investment inmoney market.

Money has time value therefore specific cash inflow

and outflow are analysed for decision making. To determine the time value of money, following

techniques are used: Discounting

Compounding Equivalence

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Investment decision

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It is fully based on time value of money.

It analyses the feasibility of an investment projectfrom financial aspects.

Following methods are used: Pay back period (PBP)

Discounted pay back period

Net present value (NPV)

Internal rate of return (IRR) Profitability Index (PI)

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Risk analysis

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It focuses on:

identification of risk relating to project or business operation,

assessment of the impact of such risk,

prioritization of risk on the basis of their impact on businessand project; and

using the methods of mitigation or avoidance.

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Demand analysis and sales forecasting

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Demand analysis and sales forecasting try to identifythe expected demand of the product or services to beproduced or delivered and the expected volume ofsales to be made

Helps in determining the level of productionrequired, expenditures to be made and resources to

 be used.

Takes the help of various environmental factors,production capacity and customers behaviors.

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 What is Engineering Economy? 

Economic decision making for engineering systems is called engineeringeconomy.

Engineers are the people who are familiar with all the technicalities ofmachinery and production therefore they are the best judges of the usefullives of an asset and they also have the technical knowledge to calculate the

number of units a proposed plant would produce when operational.

In today’s  competitive world of business it has become essential thatengineers should practice financial project analysis for engineering projectsand make rational decisions.

Engineering economy also includes the study of accounting practices for

manufacturing concerns. Unique features of accounting for manufacturingconcerns are process costing, batch costing, cost allocation.

Engineering economy deals with justification and selection of projects.

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 What is Engineering Economy?

Engineering economy

systematic evaluation of the economic merits ofproposed solutions to engineering problems

Principles:– Develop the alternatives

• Alternatives need to be identified and defined.

– Focus on the difference• Only the differences in expected future

outcomes among the alternatives will effect thedecision.

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 What is Engineering Economy?

– Use a consistent viewpoint

• Prospective outcomes should be developedfrom a consistent, defined viewpoint.

– Consider all relevant criteria– (try to) Use a common unit of measure

– Make uncertainty explicit

• Uncertainty is inevitable. Identify and exploreit in analyses.

– Revisit your decisions

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Engineering Economic Analysis - Seven Steps

1. Recognition and formulation of the problem.

2. Development of the feasible alternatives.

3. Development of the net cash flows (and otherprospective outcomes) for each alternative. 

4. Selection of a criterion (or criteria) for determining thepreferred alternative.

5. Analysis and comparison of the alternatives.6. Selection of the preferred alternative.

7. Performance monitoring and post-evaluation.

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Engineering Economy

Objective – Evaluation

– How to compare the economic value of alternative designoptions?

Basis – Cash Flow Analysis

– One is indifferent between investments with equivalentcash flows

Key issues

– Time value of money– Cash flows occurring at different times

– “Designs” with different durations 

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Thank You

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