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Cost Estimation
and
Indirect Cost Allocation
edintheinitialstage
opedforeitheraprojectorasystem
esphysicalitems,suchasbuilding,manufacturingplant
erationaldesignthatinvolvesprocesses,services,software,an
Cost
blymeasuredandallocatedtoaspecificoutputorworkactivitysm
toattributeorallocatetoaspecificoutputorworkactivitylarger
Costs to estimate
asfirstcostandannualoperatingcost(AOC)alsocalledM&O
costelements.Exampleelementsofthefirstcost:
pmentuse
approach
requiredpricesasanoutputvariableandthecostestimatesasi
lwhencompetitionisnotthedominantfactorinpricing
approachordesigntocost
ecompetitivepriceasaninputvariable
ostestimatesasoutputvariable
whenaccuracyisimportant
Bottom-up approach
Required price
Total cost
Desired
profit
Indirect
cost
Maintenance +
and operations
Cost
component
estimates
Direct
labor
Direct
materials
+
+
Equipment and +
capital recovery
At design stage
Direct cost
Top-down approach
Design-to-cost approach
Competitive price
Target cost
Allowed
profit
Indirect
cost
+
Direct cost
Maintenance +
and operations
Cost
component
estimates
Direct
labor
Direct
materials
+
+
Equipment and +
capital recovery
Before design stage
higher
accuracy
required
Expertopinion
Unitmethod
Costindexes
Factormethod
Costcapacityequations
Unit method
pularpreliminaryestimationtechnique
CT=uxN[15.1]
talestimatedcost,CT,isobtainbymultiplyingnumberofunit
Example 15.1
gaspipeusingandadvancedcentrifugalcastingmethod.Sincea20%estima
Solution
Cost indexes
saratioofthecostofsomethingtodaytoitscostsometimeinthep
= C0 (It/I0)
=estimatedcostatpresenttime
=costatprevioustimet0
=indexvalueattimet
=indexvalueattimet0
[15.1]
andpastcostsformanyofthethingsthat'typical'consumers
ntcostindexChemicalEngineeringplantcostindex(CEPCI
Example 15.2
larcomplexityandmagnitudewascompleted5yearsagoataskill
Cost-Estimating Relationship:
Cost capacity equation
ht,physicalsize)forplant,equipment,andconstructionaredeterm
(CERs)usethesetopredictcosts
[15.2]
costcapacityequationiscommonlyintherange0<x1.
caleprovideacostadvantageforlargersizes
onshipispresent
conomiesofscalepresentinthatalargersizeismorecostlythanth
nethetimeadjustmentofthecostindex(It/I0)fromequation{15.2
x(It/I0)[15.4]
Example 15.4
2010.Estimatethecosttodayforaflowrateof2.0MGD.Theexpo
liabletotalplantcostcanbeobtainedbymultiplyingthecost
[15.5]
lcostfactor
Example 15.5
essplantisexpectedtohaveadeliveredequipmentcostof$2.08m
hcostcomponent
ents,includingindirectcostn
i=1
aldirectcost,onlythedirectcostfactorsareaddedtoobtainh.
I)[15.7]
nts
n
i=1
solution
bothdirectandindirectcostfactorsareappliedtoonlyequipmentc
,951,250
t,andeq[15.7]isusedtoestimatetotalcost
,138,675
Example 15.7
ement,support,etc.,is0.49.Theconstructionfactoris0.53,andthe
tem
ostsofgoodssoldisoneendproductofthissystem
smaterialcosts,laborcosts,andindirectcosts(overheadcost
ystemneedonlyidentifyandtrackthesecosts
ecessarytoallocatethemseparatelytodepartments,processesand
cedepartments,personnel,legal,quality,supervision,purchas
Table 15-7
Commonallocationbases:
Directlaborcost
Directlaborhours
Machinehours
Numberofemployees
Space
Directmaterials
Usingrelation
Indirectcostrate=[ 15.8]
Estimatedtotalindirectcosts
Estimatedbasislevel
Example 15.8
achinesusedtoprocessbeautylotions.Thefollowinginformationwaso
Solution
Applyingeq.[15.8]foreachmachine,theannualratesare:
Machine1rate=indirectbudget/directlaborcost
=$50,000/$100,000
=$0.50perdirectlabordollar
Machine2rate=indirectbudget/directlaborhours
=$50,000/2000=$25perdirectlaborhour
Machine3rate=indirectbudget/materialcost
=$50,000/$250,000
=$0.20perdirectmaterialdollar
Example 15.9
hetotalfactorycostforamonth.Performthecomputationsusingthed
solution
dssold(factorycost)relationgivenbyeq.[B.1]inAppendixB,whichis
directmaterials+directlabor+indirectcosts
t,theratesfromexample15.8areapplied:
(laborcost)(rate)=$2500(0.50)=$1250
(laborhours)(rate)=759($25.00)=$18750
(materialcost)(rate)=$19500(0.20)=$3910
=$23,910
actualmaterialandlaborcostsfromtable158of$31,850andtheindirectcostcha
thethreemachinesrepresentsa91.3%underallocationofindirectcosts.Th
Example 15.10
mponentinhousehasbeenmade.Forthethreedepartmentsinvolved,thean
makealternative,assumingthatamarketrateof15%peryearistheMARR
solution
Ciscomprisedofdirectlabor,directmaterial,andindirectcosts.Usethedataoftab
,000
,000
,000
,000
AOC=$500,000+$300,000+$525,000=$1,325,000
Themakealternativeannualworthis
Awmake=P(A/P,i,n)+S(A/F,i,n)AOC
=$2000,000(A/P,15%,10)+$50,000(A/F,15%,10)
$1,325,000
=$1,721,037
CurrentlythecarafesarepurchasedwithAWof
AWbuy=$2,200,000
Itischeapertomake,becausetheAWofcostsisless
drivers
tion are called cost centers or cost pools. They receive the allocated indirec
ng, maintenance) that generate the indirect cost which are then distributed to
nsumption of a shared resource. Example: number of purchase orders, num
ImplementingABCinvolvesseveralsteps:
Identifyeachactivityanditstotalcost
Identifythecostdriversandtheirusagevolumes
Calculatetheindirectcostrateforeachactivity
ABCindirectcostrate=
Example 15.11
tsEuropeandivision.However,accountssuchasbusinesstravelhaveh
temischosentoaugmentthetraditionalmethodtomorepreciselyallo
otheplantsusingatraditionalbasisofworkforcesizeissufficient.Ift
Solution (a)
ase,eq[15.8]takestheformofablanketrateperemployee
rectcostrate=travelbudget/totalworkforce
=$500,000/29,100employees
=$17.1821peremployee
histraditionalbasisofratetimesworkforcesizeresultsinaplantbyplantall
$17.1821(12,500)=$214,777
e$17.1821(8600)=$147,766
rg$17.1821(4200)=$72,164
na$17.1821(3800)=$65,292
allocatetravelcoststomajorproductlines.Annualplantsupportbudgetsind
lof500travelvoucherswereprocessedbythemanagementofthemajorfive
,25for2
,30for3,30for5
20for4
rline5
ductlinesdrivetravelcostsattheplants
Solution (b)
he4stepproceduretoallocatetravelcoststothefiveproducts
1.Thetotalamounttobeallocatedisdeterminedfromthe
percentageofeachplant'ssupportbudgetdevotedtotravel
Thenumberisdeterminedfromthepercentofbudgetdataasfo
0.5($2,000,000)+....+0.30($500,000)=$500,000
Step2.Thecostdriveristhenumberoftravelvoucherssubmitted
bythemanagementunitresponsibleforeachproductline
ateachplant.Theallocationwillbetotheproductsdirectly,
nottotheplants.However,thetravelallocationtothe
Plantscanbedeterminedafterwardsinceweknowwhat
Productlinesareproducedateachplant.
Step3.Eq.[15.9]determinesanABCallocationrate.
ABCallocationrate=
Total cost of travel
=$500,000/500
Total number of vouchers
=$1000pervoucher
Step4.Table1510summarizesthevouchersandaalocationby
productlineandbycity.Product1($230,000)andproduct
5($170,000)drivethetravelcostsbasedontheABC
analysis.Comparisonofthebyplanttotalintable1510
(farrightcolumn)withtherespectivetotalsinpart(a)
indicatesasubstantialdifferenceintheamountsallocated,
especiallytoParismHamburgandBarcelona.This
comparisonverifiesthepresident'sstatementthatproduct
lines,notplants,drivetravelrequirement