Chapter 2 Fundamental Cost Concepts PDF

Engineering Economy
Chapter 2: Fundamental Cost

Concepts
Page 42 Sullivan Books
( Cost Concepts and Design Economics)
Engineering Economy, Fifteenth Edition

By William G. Sullivan, Elin M. Wicks, and C. Patrick Koelling
Copyright 2012 by Pearson Education, Inc.

Upper Saddle River, New Jersey 07458
All rights reserved.
The objective of Chapter 2 is to present

various of costs categories in an
engineering economy analysis.


CONTENT
2.1 Introduction
2.2 Cost Terminology
2.3 Fixed Cost, Variable Costs and Total Costs
2.4 Recurring and Nonrecurring Cost
2.5 Direct, Indirect and Standard Costs
2.6 Cash Cost versus Book Cost
2.7 Sunk Cost
2.8 Opportunity Cost
2.9 Life-Cycle Cost


Cost Terminology
Costs can be categorized in several different ways.
Fixed cost: unaffected by changes in activity level over a

feasible range of operations for capacity or capability available.
Typical fixed costs include salaries, utilizes, insurance, taxes and
interest costs on borrowed capital.
Variable cost: those associated with an operation that varies in

total with the quantity of output or other measure of activity
level. For example the costs of service and maintenance, material
and labor used in a product or service are variable costs, because
they vary total with the number of output units.

Total cost : an incremental cost (or incremental revenue) is the

total of cost resulting from fixed cost & variable cost.
TC
=
=
VC + FC
aQ + FC ,
where, Q= output , a variable number


Example 1
Classify each of the following cost items as mostly fixed
or variable.
Raw materials
Direct labor
Depreciation
Supplies
Services & Maintenances

Administrative salaries
Insurance
Office rent
Utilities
Property taxes

Example 1 : Refer Sulivians book pg44
Fixed cost: unaffected by changes in activity level.
Variable cost: vary in total with the quantity of output (or

similar measure of activity)
Incremental cost: additional cost resulting from increasing
output of a system by one (or more) units


Solution


Refer Rosnah Mohamad Sirins book pg3-6

Example 2 :
For mixing 1m3 concrete require variable cost of RM5 and a
fixed cost per day is RM 100.
(a) Produce Linear equations concrete production costs.

(b) Estimated production costs for 1000 m3 of concrete mixed
in a day.



Solution
a) If FC=100 per day, VC= 5 m3 per day, if the output is Q m3 of
concrete per day, while the cost of change is 5Q
TC=FC+aQ
TC=100+5Q
b) Total production 1000 m3 of concrete per day
TC=100+5(1000)
TC=RM5100



Example 3:
The cost to produce 10 shirts is RM350, while RM600 are
required to produce 20 shirts.
(a) Produce Linear equations shirts production costs.
(b) If production increased to 100 pieces shirt for the next
month, calculate the total production for the shirts.



Solution:
(a) TC1=350, Q1=10
TC2=600, Q2=20
TC1=FC+aQ1
350=FC+a(10)..(1)
TC2=FC+aQ2
600=FC+a(20)(2)
250=a(10)
a=25
Replace a into equations (1), 350=FC+25(10)
FC=100
Cost equation, TC = 100+25Q
(b) TC = 100 + 25(100) = RM2600


More ways to categorize costs

Direct: can be measured and allocated to a specific work
activity
(cth : Kos buruh & kos bahan adalah kos langsung bagi sesebuah pembinaan
bangunan dlm kejuruteraan awam)
Indirect: difficult to attribute or allocate to a specific output

or work activity (also overhead or burden)
(cth : Kos baik pulih mesin / jentera yg rosak perlu ditanggung oleh syarikat)
Standard cost: are planned cost per unit of output,

established in advance of production or service delivery
(cth :BQ mempunyai jumlah harga bagi setiap item kerja yang merupakan cost
control dalam kos standard)


Standard costs play an important role in cost control and other

management functions,
i. Estimating future manufacturing costs.
ii. Measuring operating performance by comparing

actual cost per unit with the standard unit cost.
S-curve showed for

site progress (actual
vs progress)


We need to use common cost

terminology.
Cash cost: a cost that involves a payment of cash..cash
voucher
Not involve cash transaction in the accounting system, must
prepare cash voucher
Example 1: payment receive by hand (deposit to buy something
, salaries, bonus, cash & carry etc)
Book cost: a cost that does not involve a cash

payment..payment voucher
Receive payment through company account , must prepare
payment voucher .
Example 1 : payment receive by cheque ( progress payment of
project)

Sunk cost: a cost that has occurred in the past and has no
relevance to estimates of future costs and revenues related to
an alternative course of action.
kos rugi yang telah dikeluarkan sebelum ini dan hangus begitu
shj.
Example 1 pg 46:
Joe College finds a motorcycle he likes and pays $40 as a down payment, which
will be applied to the $1,300 purchase price, but which must be forfeited if he
decides not to take the cycle. Over the weekend, Joe finds another motorcycle he
considers equally desirable for a purchase price of $1,230. for the purpose of
deciding which cycle to purchase, the $40 is a sunk cost and thus would not enter
into the decision, except that it lowers the remaining cost of the first cycle. The
decision then is between paying an additional $1,260 ($1,300 - $40) for the first
motorcycle versus $1,230 for the second motorcycle.
Example 2 :
tender of project by government..RM?


Opportunity cost: the monetary advantage

foregone due to limited resources. The cost of
the best rejected opportunity.
kos peluang yang dapat ditepikan / ditolak secara tersirat
Example 1 pg 47:
Consider a student who could earn S20,000 for working during a year, but
choose instead to go to school for a year and spend S5,000 to do so. The
opportunity cost of going to school for that year is S25,000 ( S5,000 cash outlay
and S20,000 for income foregone .This figure neglects the influence of income
taxes and assumes that the student has no earning capability while in school.
Example 2:
Company must pay for income tax for every year. Cost for reduce tax ex:
entertains client, bonus for staff etc.


Life-cycle cost: the summation of all costs related to a

product, structure, system, or service during its life
span.
2 Phase : Acquisition Phase & Operation Phase

Acquisition Phase Need or wants, prelim design, detailed design.
Operation Phase Construction, O & M, Disposal
Potential for life cycle cost savings - how much total cost budget to
use from start until finish the project.
Cumulative life cycle cost cumulative all cost for the project based
on scheduled


Several basic life-cycle

cost categories
Investment cost capital investment required for most activities in
the acquisition phase.
(kos pelaburan tidak berulang, berlaku sekali sahaja cth kos beli aset tetap spt
pejabat, machine dll)
Working capital funds required for current assets (equipment,

facilities etc) that need to set up and support of operational activities.
Example : cash must be available to pay employee salaries and the
other expenses of operation.
(kos yang dikeluarkan utk sepanjang operasi construction sehingga siap)


Operation & Maintenance (O&M)- expense items in operation

phase. The direct and indirect costs of operation associated with 5
resources area (people, machines, materials, energy and
information)
(kos operasi & senggaraan-berulang sepanjang operasi)
Disposal cost- nonrecurring cost of shutting down or handover

the operation at the end of life cycle. These costs will be offset in
some instances by receipts from the sale of assets with remaining
market value.
(kos pelupusan - kos tidak berulang berlaku hanya sekali shj cth tred in machine)


Rosnah Mohamad Sirin
Exercise Chapter 2:
1. The total cost of repairing the two stores is RM1160. While the 10 stores,
costs improved to RM1800.
(a) Produce linear equations of the store.
(b) Calculate the fixed cost and variable costs of repairing 5 stores.
2.
A company charged RM70 to move a machine at a distance of 15km.

While RM100 is imposed if the distance increased to 25km.
(a) Produce linear cost equation for moving the machine.
(b) Calculate the minimum cost to move this machine?
(c) Calculate the cost per km for moving the machine?


Sullivan
3. The fixed and variable costs for the three manufacturing plant sites for a
product are shown in the following table:

Site
Fixed Cost
Variable Cost
per Year
per Unit
A
RM500
RM10
B
RM1,000
RM8
C
RM1,500
RM6
(a). Write the linear equation for Site A, B and C.
(b). If the production for next year is expected to achieve 500
units, which site will get the highest total cost?
4. (a) Sketch and describe the life cycle cost concept.
(b) If your company decided to buy a new compactor machine that life 6
years, with relevant examples explain the meaning of investment cost,
operation and maintenance cost and also disposal cost.


FINAL EXAMINATION
SEMESTER I
SESSION 2015/2016





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Engineering Economy

Chapter 2: Fundamental Cost

Engineering Economy, Fifteenth Edition

Copyright 2012 by Pearson Education, Inc.

The objective of Chapter 2 is to present

Engineering Economy, Fifteenth Edition

Copyright 2012 by Pearson Education, Inc.

Engineering Economy, Fifteenth Edition

Copyright 2012 by Pearson Education, Inc.

Fixed cost: unaffected by changes in activity level over a

Variable cost: those associated with an operation that varies in

Copyright 2012 by Pearson Education, Inc.

Total cost : an incremental cost (or incremental revenue) is the

Engineering Economy, Fifteenth Edition

Copyright 2012 by Pearson Education, Inc.

Engineering Economy, Fifteenth Edition

Copyright 2012 by Pearson Education, Inc.

Example 1 : Refer Sulivians book pg44

Fixed cost: unaffected by changes in activity level.

Variable cost: vary in total with the quantity of output (or

Engineering Economy, Fifteenth Edition

Copyright 2012 by Pearson Education, Inc.

Engineering Economy, Fifteenth Edition

Copyright 2012 by Pearson Education, Inc.

Refer Rosnah Mohamad Sirins book pg3-6

(a) Produce Linear equations concrete production costs.

Engineering Economy, Fifteenth Edition

Copyright 2012 by Pearson Education, Inc.

Refer Rosnah Mohamad Sirins book pg3-6

Engineering Economy, Fifteenth Edition

Copyright 2012 by Pearson Education, Inc.

Refer Rosnah Mohamad Sirins book pg3-6

Engineering Economy, Fifteenth Edition

Copyright 2012 by Pearson Education, Inc.

Refer Rosnah Mohamad Sirins book pg3-6

Engineering Economy, Fifteenth Edition

Copyright 2012 by Pearson Education, Inc.

More ways to categorize costs

Indirect: difficult to attribute or allocate to a specific output

Standard cost: are planned cost per unit of output,

Engineering Economy, Fifteenth Edition

Copyright 2012 by Pearson Education, Inc.

Standard costs play an important role in cost control and other

ii. Measuring operating performance by comparing

S-curve showed for

Engineering Economy, Fifteenth Edition

Copyright 2012 by Pearson Education, Inc.

We need to use common cost

Book cost: a cost that does not involve a cash

Copyright 2012 by Pearson Education, Inc.

Engineering Economy, Fifteenth Edition

Copyright 2012 by Pearson Education, Inc.

Opportunity cost: the monetary advantage

Engineering Economy, Fifteenth Edition

Copyright 2012 by Pearson Education, Inc.

Life-cycle cost: the summation of all costs related to a

2 Phase : Acquisition Phase & Operation Phase

Engineering Economy, Fifteenth Edition

Copyright 2012 by Pearson Education, Inc.

Several basic life-cycle

Working capital funds required for current assets (equipment,

Engineering Economy, Fifteenth Edition

Copyright 2012 by Pearson Education, Inc.