ESTIMATION AND COSTING

Introduction to Estimating and Costing

Estimating

Definition: When we think of about estimation, estimation means estimating the

manufacturing cost of the product before it is actually gets manufactured. Estimation is
an art of calculating the probable cost of a product before the start of its production. It
helps us to decide about whether a particular product is to be purchased from the market
or to be manufactured within.
Estimation is an art of finding the probable cost of the product, which is likely to
be incurred during the manufacturing of the product, before it is actually being
manufactures, i.e. it is the process of calculation of a probable cost of the product before
start of manufacturing. It also includes the predetermination of a statement of the
quantities of materials required, the amount of time involved in production, labours
required, the procedure to be followed in placing an order etc.
Importance of Estimating
In all organizations, before starting actual production or filling up of tenders,
estimation is done. Thus, a very accurate estimation is necessary to withstand the market
competition and make sure that, whether manufacturing of a particular product will be
profitable or not. Both over and under estimation are very dangerous.
Over estimating leads to increase the cost of a product and product will not get
response from the market and under estimating of a product may lead to heavy losses.
Hence, accurate estimating is very essential and therefore, staff of the estimating
department must be well qualified, experienced and trained.
For example, some ABC company wants to start the manufacturing of some X
product. From the market survey the company finds that the price of the product X in the
market is Rs.1000/-. But the estimated price of the product by the company is more than
the market price, and then the design of the product X may be sent back to the design
department and asks them to redesign the product X, so that the price of the product X
may be reduced. If the alternative design of the product and hence reduction in the cost of
the product is not possible, then the idea of manufacturing a product X should be
dropped, otherwise it leads to heavy losses to the company.
Aims of Estimating
The main aims/objectives of estimating are as follows –
1. To help the owner of the factory to decide about the manufacturing and selling
prices.
2. To determine the wage rates of workers.
3. It will help the owner to decide whether a particular product should be purchased
from the market or to be manufactured.
4. It will help in improving the design, which may reduce the cost of production.
5. To decide the amount of overheads, this helps in comparing and checking the
actual overheads of the factory.
6. It will helps in filling up of tenders, so as to estimate the profit.
Functions of Estimating:
The important functions of estimating are as follows-
1. To determine the materials cost, taking into consideration of different allowances
given for different manufacturing operations.
2. To determine the cost of materials to be purchased from outside.
3. To determine labour cost, considering labour time and with the help of wage
rates.
4. To determine the cost of equipment, tools, jigs and fixtures etc. to be purchased
from outside
5. To calculate overhead charges associated with product. The different overhead
charges are selling, administration, packing and distribution etc.
6. To conduct motion and time study.
7. To keep in contact with the various departments, regarding methods of operation,
quality of material and product etc.
8. To find most economical procedure for manufacturing of the product.
9. To calculating the selling price of the product including profit.
10. To keep control over the selling expenses, with the help of sales manager.
 11. To intimate estimated price of the product to the sales department for deciding the
selling price of the product.
12. To help in modification of the design.
13. To keep the records of all estimating in a systematic way for the future reference.
Estimator:
A person who carries out, cost of estimation of all the products in an organization
is called estimator. In an organization estimator is a trained person. The main function of
the estimator is to estimate the cost of the product.
The estimator who estimates the cost of the product in an organization should possess
some of the qualities. The different qualities of the estimator are-
1. He must be able to read and understand drawings and blue prints very well.
2. He must have a good knowledge of different machines, operations and operating
times for the product being manufactured.
3. He should have a good knowledge of proper use of special tools, jigs and fixtures
etc.
4. He must have good knowledge of the market prices of different materials required
during manufacturing.
5. He must have good knowledge of the wage rates of all types of workers.
6. He should have good knowledge of the different allowances of time, such as
personal allowance, fatigue allowance etc.
7. He must co operate with all other departments, such as Design, Planning and sales
department.
8. He must be familiar with the time and motion study procedures.
9. He must have good knowledge of official accounting procedures.
10. He must be well - qualified, trained person and he must be able to suggest new
methods of production to reduce the cost of production.
Functions of estimator:
The main functions of the estimator are-
1. To prepare estimation from the request of sales/production department.
2. To consult all the departments regarding the new product and get the necessary
information required for correct estimation of the product.
 3. To collect information about the cost of material needed, production time and
overheads.
Procedure for Estimation:
The estimating procedure can be grouped into mainly three parts –
a. Finalizing the design, accuracy and finish
b. Deciding the selling price of the product by the estimating/sales department
c. Check the existing load from the production department.
The detailed estimating procedure of the product is as follows-
1. Production planning department decides the requirements and the
specifications of the product, type and qualities of material required. Then
the design department design and prepare the drawings, then production
department decides about the method and the sequence of operations,
machines to be used etc.
2. Deciding the amount of accuracy and finish required.
3. Prepare the list of components of the product.
4. Decide about components that are to be manufactured within the
organization and components that are to be manufactured outside the
organization.
5. Determine the weight of the material, considering the various allowances
and determine the cost of the material by considering the market price.
6. Determine the time required for various operations by using method and
motion study and by adding suitable allowances.
7. Determine the labour cost, considering wage rate for different class of
workers and from the performance time of the workers.
8. Determine the prime cost by adding direct material cost, direct labour cost
and direct expenses.
9. Determine the factory overheads including depreciation, insurance etc.
10. Determine the administration overheads by considering the factory policy.
11. Determine the package, delivery charges etc.
12. Calculate total cost.
 13. Decide the amount of profit want to make, adding to the total cost, to fix
the selling price. The selling price should be competitive in the market.
14. Decide the percentage of discount allowed to the distributor.
15. Decide the delivery time in consultation with the sales and production
department.
16. Prepare estimate form.
Errors in Estimation:
During estimating the cost of the product there are certain types of errors that may occur.
These errors may be mainly classified into two types, they are-
A. Unavoidable errors
B. Avoidable errors
A. Unavoidable errors
These are those types of errors, which cannot be avoided during estimating the cost of
the product. They are-
1. Machine break down
2. Power failures, rise in power purchase rates
3. Drop in the efficiency of the workers
4. Lockout and strikes
5. Drop in the efficiency of machines and tools
6. Accidents
B. Avoidable errors
These are those errors, which can be avoided by the estimator while preparing the
estimates. These errors may occur due to
1. Less experience,
2. Carelessness,
3. Hurry in preparing estimation
4. Poor analysis
5. Omission of essential factors, which changes the picture of the estimation
6. Not considering the up to date data
7. The same factors are considered frequently which are unnecessary
These errors can be avoided by the estimator by careful observations, eliminating the
hurry and with due experience.
Constituents of Estimation (Principle factors in estimating)

The main principle factors in a cost estimating of a component are –

1. Design time and cost
2. Drafting time and cost
3. Time study, motion study, production planning control time and cost
4. Design and arrangement of special items
5. Experimental work
6. Labour cost
7. Material cost
8. Allowances of time
9. Overheads

1. Design time and cost

It is the time required to design a particular product. During estimating, the wages and
other expenditures to be paid in designing a product are also considered. For this purpose,
the cost can be estimated on the basis of similar product designed previously. It also also
includes

2. Drafting time and cost

Methods of Costing

Costing can be defined as the technique and process of ascertaining costs. The
principles in every method of costing are same but the methods of analyzing and
presenting the costs differ with the nature of business. The methods of job costing are as
follows:

1. Job Costing

The system of job costing is used where production is not highly repetitive and in
addition consists of distinct jobs so that the material and labor costs can be identified by
order number. This method of costing is very common in commercial foundries and drop
forging shops and in plants making specialized industrial equipments. In all these cases,
an account is opened for each job and all appropriate expenditure is charged thereto.

2. Contract Costing

Contract costing does not in principle differ from job costing. A contract is a big job
whereas a job is a small contract. The term is usually applied where large-scale contracts
are carried out. In case of ship-builders, printers, building contractors etc., this system of
costing is used. Job or contract is also termed as terminal costing.

3. Cost Plus Costing

In contracts where in addition to cost, an agreed sum or percentage to cover overheads

and fit is paid to a contractor, the system is termed as cost plus costing. The term cost
here includes materials, labor and expenses incurred directly in the process of production.
The system is used generally in cases where government happens to be the party to give
contract.

4. Batch Costing

This method is employed where orders or jobs are arranged in different batches after
taking into account the convenience of producing articles. The unit of cost is a batch or a
group of identical products instead of a single job order or contract. This method is
particularly suitable for general engineering factories which produce components in
convenient economic batches and pharmaceutical industries.

5. Process Costing

If a product passes through different stages, each distinct and well defined, it is desired to
know the cost of production at each stage. In order to ascertain the same, process costing
is employed under which a separate account is opened for each process.
This system of costing is suitable for the extractive industries, e.g., chemical
manufacture, paints, foods, explosives, soap making etc.

6. Operation Costing

Operation costing is a further refinement of process costing. The system is employed in

the industries of the following types:

a. The industry in which mass or repetitive

production is carried out
b. The industry in which articles or components have
to be stocked in semi-finished stage to facilitate the
execution of special orders, or for the convenience of
issue for later operations

The procedure of costing is broadly the same as process costing except that in this case,
cost unit is an operation instead of a process. For example, the manufacturing of handles
for bicycles involves a number of operations such as those of cutting steel sheets into
proper strips molding, machining and finally polishing. The cost to complete these
operations may be found out separately.

7. Unit Costing (Output Costing or Single Costing)

In this method, cost per unit of output or production is ascertained and the amount of
each element constituting such cost is determined. In case where the products can be
expressed in identical quantitative units and where manufacture is continuous, this type
of costing is applied. Cost statements or cost sheets are prepared in which various items
of expense are classified and the total expenditure is divided by the total quantity
produced in order to arrive at per unit cost of production. The method is suitable in
industries like brick making, collieries, flour mills, paper mills, cement manufacturing
etc.

8. Operating Costing

This system is employed where expenses are incurred for provision of services such as
those tendered by bus companies, electricity companies, or railway companies. The total
expenses regarding operation are divided by the appropriate units (e.g., in case of bus
company, total number of passenger/kms.) and cost per unit of service is calculated.

9. Departmental Costing

The ascertainment of the cost of output of each department separately is the objective of
departmental costing. In case where a factory is divided into a number of departments,
this method is adopted.
10. Multiple Costing (Composite Costing)

Under this system, the costs of different sections of production are combined after finding
out the cost of each and every part manufactured. The system of ascertaining cost in this
way is applicable where a product comprises many assailable parts, e.g., motor cars,
engines or machine tools, typewrite$, radios, cycles etc.

As various components differ from each other in a variety of ways such as price,
materials used and manufacturing processes, a separate method of costing is employed in
respect of each component. The type of costing where more than one method of costing is
employed is called multiple costing.

It is to be noted that basically there are only two methods of costing viz. job costing and
process costing. Job costing is employed in cases where expenses are traceable to specific
jobs or orders, e.g., house building, ship building etc. In case where it is impossible to
trace the prime cost of the items for a particular order because of the reason that their
identity gets lost while manufacturing operations, process costing is used. For example,
in a refinery where several tons of oil is being produced at the same time, the prime cost
of a specific order of 10 tons cannot be traced. The cost can be found out only by finding
out the cost per ton of total oil produced and then multiplying it by ten.

It may, therefore, be concluded that the methods of batch contract and cost plus costing
are only the variants of job costing whereas the methods of unit, operation and operating
costing are the variants of process costing.