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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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Budgeting, Costing and Estimating for the Injection Moulding Industry
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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Budgeting, Costing and Estimating for the Injection Moulding Industry
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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Budgeting, Costing and Estimating for the Injection Moulding Industry
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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Budgeting, Costing and Estimating for the Injection Moulding Industry
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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Budgeting, Costing and Estimating for the Injection Moulding Industry
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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Budgeting, Costing and Estimating for the Injection Moulding Industry
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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Budgeting, Costing and Estimating for the Injection Moulding Industry
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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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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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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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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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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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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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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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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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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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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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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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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Suchanoperationisaprimecandidateforthestandardcostingmodelsince:
onlyonemouldingmaterialisbeingusedforthemouldingoperations;
themouldingmachinecostsshouldbewellknownasrelativelyfewmouldtools
arebeingused;and
alltheotheroperatingcostsandmaterialcostswillbeaccuratelyknownthrough
continual reassessment.
Frequently,companieswilldeveloptheirowncustomcostingmethodsthatconsist
ofacombinationofthemethodspreviouslydiscussed.Costingsystemswillnaturally
evolvetosuitthetypeofbusinessandthemarketseachcompanyisserving.As
markettrendschange,costingsystemsmayhavetochangetostayintunewiththat
particularmarket.