Engineering Economy

Chapter 2: Fundamental
Cost Concepts
Page 42 Sullivan Books
( Cost Concepts and Design Economics)

Copyright ©2012 by Pearson Education, Inc.

Engineering Economy, Fifteenth Edition
Upper Saddle River, New Jersey 07458
By William G. Sullivan, Elin M. Wicks, and C. Patrick Koelling
All rights reserved.
 The objective of Chapter 2 is to present
various of costs categories in an
engineering economy analysis.

Copyright ©2012 by Pearson Education, Inc.

Engineering Economy, Fifteenth Edition
Upper Saddle River, New Jersey 07458
By William G. Sullivan, Elin M. Wicks, and C. Patrick Koelling
All rights reserved.
 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

Copyright ©2012 by Pearson Education, Inc.

Engineering Economy, Fifteenth Edition
Upper Saddle River, New Jersey 07458
By William G. Sullivan, Elin M. Wicks, and C. Patrick Koelling
All rights reserved.
 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.

Copyright ©2012 by Pearson Education, Inc.

Engineering Economy, Fifteenth Edition
Upper Saddle River, New Jersey 07458
By William G. Sullivan, Elin M. Wicks, and C. Patrick Koelling
All rights reserved.
• 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

Copyright ©2012 by Pearson Education, Inc.

Engineering Economy, Fifteenth Edition
Upper Saddle River, New Jersey 07458
By William G. Sullivan, Elin M. Wicks, and C. Patrick Koelling
All rights reserved.
Example 1 : Refer Sullivian’s book

Classify each of the following cost items as mostly fixed

or variable.

Raw materials Administrative salaries

Direct labor Insurance
Depreciation Office rent
Supplies Utilities
Services & Maintenances Property taxes

Copyright ©2012 by Pearson Education, Inc.

Engineering Economy, Fifteenth Edition
Upper Saddle River, New Jersey 07458
By William G. Sullivan, Elin M. Wicks, and C. Patrick Koelling
All rights reserved.
Example 1 : Refer Sullivian’s book

• 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

Copyright ©2012 by Pearson Education, Inc.

Engineering Economy, Fifteenth Edition
Upper Saddle River, New Jersey 07458
By William G. Sullivan, Elin M. Wicks, and C. Patrick Koelling
All rights reserved.
 Copyright ©2012 by Pearson Education, Inc.
Engineering Economy, Fifteenth Edition
Upper Saddle River, New Jersey 07458
By William G. Sullivan, Elin M. Wicks, and C. Patrick Koelling
All rights reserved.
Example 2 : Refer Rosnah Mohamad Sirin’s book

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 m 3 of concrete

mixed in a day.

Copyright ©2012 by Pearson Education, Inc.

Engineering Economy, Fifteenth Edition
Upper Saddle River, New Jersey 07458
By William G. Sullivan, Elin M. Wicks, and C. Patrick Koelling
All rights reserved.
 Solution

a) If FC=100 per day, VC= RM5 per day, if the output is Q m 3 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

Copyright ©2012 by Pearson Education, Inc.

Engineering Economy, Fifteenth Edition
Upper Saddle River, New Jersey 07458
By William G. Sullivan, Elin M. Wicks, and C. Patrick Koelling
All rights reserved.
 Example 3: Refer Rosnah Mohamad Sirin’s book

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.

Copyright ©2012 by Pearson Education, Inc.

Engineering Economy, Fifteenth Edition
Upper Saddle River, New Jersey 07458
By William G. Sullivan, Elin M. Wicks, and C. Patrick Koelling
All rights reserved.
 Solution:

(a) TC 1 =350, Q 1 =10

TC2 =600, Q 2 =20

TC1 =FC+aQ1 TC2 =FC+aQ2

350=FC+a(10)…..(1) 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

Copyright ©2012 by Pearson Education, Inc.

Engineering Economy, Fifteenth Edition
Upper Saddle River, New Jersey 07458
By William G. Sullivan, Elin M. Wicks, and C. Patrick Koelling
All rights reserved.
Example 4: Refer Rosnah Mohamad Sirin’s book

Untuk memproses 1 kg kopi memerlukan kos berubah

sebanyak RM5 dan kos tetap sehari ialah RM300

(a) Terbitkan persamaan linear kos pengeluaran kopi

(b) Kira kos pengeluaran bagi 1000kg kopi yg diproses
dalam sehari.
(c) Jika kopi dijual dengan harga Rm10/kg. Kira titik pulang
modal
(d) Kira jumlah keuntungan atau kerugian jika kilang kopi
mengeluarkan 100kg/hari dan 50kg/hari.

Copyright ©2012 by Pearson Education, Inc.

Engineering Economy, Fifteenth Edition
Upper Saddle River, New Jersey 07458
By William G. Sullivan, Elin M. Wicks, and C. Patrick Koelling
All rights reserved.
 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)
Copyright ©2012 by Pearson Education, Inc.
Engineering Economy, Fifteenth Edition
Upper Saddle River, New Jersey 07458
By William G. Sullivan, Elin M. Wicks, and C. Patrick Koelling
All rights reserved.
• 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)

Copyright ©2012 by Pearson Education, Inc.

Engineering Economy, Fifteenth Edition
Upper Saddle River, New Jersey 07458
By William G. Sullivan, Elin M. Wicks, and C. Patrick Koelling
All rights reserved.
 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)

Copyright ©2012 by Pearson Education, Inc.

Engineering Economy, Fifteenth Edition
Upper Saddle River, New Jersey 07458
By William G. Sullivan, Elin M. Wicks, and C. Patrick Koelling
All rights reserved.
• 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?

Copyright ©2012 by Pearson Education, Inc.

Engineering Economy, Fifteenth Edition
Upper Saddle River, New Jersey 07458
By William G. Sullivan, Elin M. Wicks, and C. Patrick Koelling
All rights reserved.
• 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.

Copyright ©2012 by Pearson Education, Inc.

Engineering Economy, Fifteenth Edition
Upper Saddle River, New Jersey 07458
By William G. Sullivan, Elin M. Wicks, and C. Patrick Koelling
All rights reserved.
• 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

Copyright ©2012 by Pearson Education, Inc.

Engineering Economy, Fifteenth Edition
Upper Saddle River, New Jersey 07458
By William G. Sullivan, Elin M. Wicks, and C. Patrick Koelling
All rights reserved.
 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)

Copyright ©2012 by Pearson Education, Inc.

Engineering Economy, Fifteenth Edition
Upper Saddle River, New Jersey 07458
By William G. Sullivan, Elin M. Wicks, and C. Patrick Koelling
All rights reserved.
• 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)

Copyright ©2012 by Pearson Education, Inc.

Engineering Economy, Fifteenth Edition
Upper Saddle River, New Jersey 07458
By William G. Sullivan, Elin M. Wicks, and C. Patrick Koelling
All rights reserved.
Example 1: Refer Rosnah Mohamad Sirin’s book

Q1 (a) Sketch and describe the life circle cost

(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.

Example 2: Refer Sullivan’s book

Q1 A soft drink company with bottling plant automation

software installed incurs an annual fixed cost of $10,000.
Labor is $3.50 per package and material cost is $4.50 per
package. The selling price will be $12.50 per package. What
is the breakevent point in $ and units.

Copyright ©2012 by Pearson Education, Inc.

Engineering Economy, Fifteenth Edition
Upper Saddle River, New Jersey 07458
By William G. Sullivan, Elin M. Wicks, and C. Patrick Koelling
All rights reserved.
 k You
T ha n

Copyright ©2012 by Pearson Education, Inc.

Engineering Economy, Fifteenth Edition
Upper Saddle River, New Jersey 07458
By William G. Sullivan, Elin M. Wicks, and C. Patrick Koelling
All rights reserved.