TM 661 Engineering Economics for Managers

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TM 661Engineering Economics for Managers

• Cost Accounting

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Accounting Equation

• Owner Equity Assets - Liabilities
• Owner Equity ownership right of proprietors or
• stockholders
• Assets economic resources owned by a business
  and are expected to benefit future operations
• Liabilities probable future sacrifices of
  economic benefits as result of current
  obligations

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Cost Behavior Flexible Budgeting

• Mixed costs are a function of fixed variable
  costs
• Cost-Volume formula
• Y a bx
• where Y mixed cost to break up
• x a measure of activity (machine hrs)
• a fixed cost component
• b variable rate per unit x

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High-Low Method
Suppose we have the following
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High-Low Method

• X Y
• High 280 2480
• Low 190 2330
• Difference 90 150
• Variable rate 150/90 1.67 per DLH

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High-Low Method

• Fixed Cost Portion
• Total Mixed - Variable 2,480 - 1.67(280)
• 2,012

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High-Low Method

• Fixed Cost Portion
• Total Mixed - Variable 2,480 - 1.67(280)
• 2,012
• Total Mixed Cost 2,012 1.67 X

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Least Squares
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Least Squares
Y 1,900.27 3.054 x
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Flexible Budgeting

• Geared towards a range of activities
• Dynamic rather than static

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Flexible Budgeting

• Geared towards a range of activities
• Dynamic rather than static
• Need to understand rudiments of cost accounting
• Job order costing
• Process costing
• Activity based costing

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Job Order Costing

• K-Corp collects its cost data by the job order
  cost system. For each job, they know the amount
  and material costs. Direct labor costs are 9.50
  per hour. Factory overhead rate is computed at
  4.50 per hour.

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Process Costing

• A Company produces and sells a chemical product.
  During a given month the company purchases 15,000
  gallons of chemicals at a cost of 30,000.
  10,000 gallons are completed and transferred to
  the next department. 5,000 gallons are 20
  complete as to conversion. Factory overhead for
  the month is 20,000.

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Activity Based Costing

• Historically
• direct labor material constitute significant
  elements of cost of goods sold
• Current
• overhead costs dominate the cost of production
• Activity-based costing
• is designed to meet the challenge of a changing
  cost mix by associating manufacturing costs with
  activities which drive them

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ABC Two-Step Process

• Define Cost Pools
• (usually support functions)
• Costs are associated with clearly
  defined elements
• or cost categories such as handling
  costs, energy
• costs, etc.
• Identify Cost Drivers
• (trace costs to the cost pools)
• These are the activities that which are to be
  monitored and controlled under activity based
  costing such as machine hours for energy costs,
  machine hours for tooling and maintenance costs,
  etc.

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ABC Example

• A multinational firm uses traditional accounting
  to allocate manufacturing and management support
  costs. However, travel is typically allocated on
  the basis of employees at plants in France,
  Germany, Italy, and Greece. Consequently, some
  plants are likely generating much more management
  travel than others. The ABC system is chosen to
  more precisely allocate travel costs to major
  product lines.

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ABC Example
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ABC Example
1. Determine Cost Pool
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ABC Example
2. Determine Cost Driver ABC Rate (Total
Travel Cost Pool)/(Total Vouchers)
(500,000)/(500) 1000
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ABC Example
Driver Distribution
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ABC Example
Allocation of Costs
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Value Added

• Examines the difference between the net operating
  profit (after tax) and the cost of capital
• Four ways to create value for shareholder
• increase profit margins without increasing
  capital
• invest in projects that earn more than cost of
  capital
• free-up capital than earns less than cost of
  capital
• use debt to reduce the cost of capital

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Value Added

• Which is the better firm from a shareholders
  point of view?

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Value Added

• Firm B has largest Economic Value Added (EVA)

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Value Added

• Firm B has largest Economic Value Added (EVA)

Maximizing ROI is not the right objective!