Ebook Industrial engineering and management: Part 2

Part 2 book "Industrial engineering and management" includes content: Cost accounting and depreciation, replacement analysis and selection among alternatives, value engineering, linear programming and transportation problem, assignment and sequencing models, waiting line theory, principles of management, total quality management, statistical quality control,... and other contents.
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Ebook Industrial engineering and management: Part 2 Chapter         13 Cost Accounting and Depreciation 13.1 Introduction Accounting is a method in which all the costs incurred in carrying out an activity are collected, classified and recorded. This data is then summarized and analysed to determine the selling price (SP). Cost analysis and estimation are slightly difficult due to some unforeseen such as inflation, unpredictable change in technology and the dynamic nature of markets. Cost analysis consists of accumulation, examination and manipulation of cost data for comparisons and projections. Economists and accountants interpret the term ‘cost’ in different ways, but they are related things. Economists define ‘cost’ in terms of the opportunities that are sacrificed when a choice is made. Hence, under the economist’s definition, costs are simply benefits lost. Accountants define ‘cost’ in terms of resources consumed. To distinguish between these two cost concepts, what economists do is referred to as cost estimation and what accountants do is termed as cost measurement. Various combinations of costs are historical and current costs, explicit and implicit costs, incremental and sunk costs, opportunity cost, and long-run and short-run costs. These costs are explained in the following paragraphs: Historical cost vs. current cost: Cost data is known as historical if it is stored for a period of time and then used; and cost data is known as current cost when the cost is paid under prevailing market conditions. It is assumed that current cost exceeds historical cost, but it is not always true. For example, current costs of electronics items are less than their costs 10 years back. Therefore, the current cost for such items is determined by what is referred to as a replacement cost which is defined as the cost of duplication using the current technology. Explicit cost vs. implicit cost: Explicit cost is the amount of money paid by the entrepreneur for purchasing/hiring the services of various production factors to the agencies outside the organization or the persons that are not the part of his organization. This cost is in the nature of contractual payment and may include rent for land, wages to the labour, interest on capital and costs incurred on heads such as raw materials, fuel, power, etc. Implicit cost is more difficult to compute and is likely to be overlooked in decision analysis. Implicit cost is normally computed on the basis of the opportunity cost concept so as to reach an accurate estimate of total cost. Incremental cost vs. sunk cost: Incremental cost refers to change in cost caused by a given managerial decision while sunk cost does not change or vary across decision alternatives. A sunk cost is an expenditure that has been incurred and cannot be recovered. As the sunk cost cannot be recovered, it is irrelevant for decision-making. 270  Industrial Engineering and Management Opportunity cost: The opportunity cost is the value of the alternatives foregone by adopting a particular strategy or employing resources in a specific manner. It is also called alternative cost or economic cost. For example, if an asset is used for one purpose, the opportunity cost is the value of the next best purpose the asset could have been used for. The opportunity cost plays an important role in a decision-making process, but the opportunity cost is not treated as an actual cost in any financial statement. Long-run costs vs. short-run costs: The long run is the hypothetical time period in which there are no fixed factors of production as to changing the output level by changing the capital stock or by entering or leaving an industry. The long-run contrasts with the short run in which some factors are variable and others are fixed, constraining entry or exit from an industry. In the short run, the average total cost (ATC) curve is U-shaped. The short-run average cost (SRAC) curve initially falls and reaches at minimum level and then starts to rise. The reason for the average cost to fall in the beginning of production is that the fixed factors of a firm remain the same. The change takes place only in the variable factors such as raw materials and labour. As the fixed cost (FC) gets distributed over the output with the expansion of production, the average cost begins to fall. When a firm fully utilizes its scale of operation, i.e. capacity, then the average cost is at its minimum level. The firm then operates to its optimum capacity. If the firm in the short run increases its level of output with the same fixed capacity, the economies of that scale of production change into diseconomies and the average cost then begins to rise sharply. In the long-run, all costs of a firm are assumed as variable. The factors of production can be used in varying proportions to deal with an increased output. The firm having a time period long enough can build a larger scale to produce the anticipated output. The long-run average cost (LRAC) curve is also U-shaped but is flatter than the short-run curve as is illustrated in Figure 13.1. The short-run is a period of time during which one or more of a firm’s inputs cannot be changed. In contrast, the long run is a period of time during which all inputs can be changed. Y Average cost SRAC 1 LRAC SRAC 2 SRAC 3 X 0 Z Economies of scale Diseconomies of scale Optimal plant size Figure 13-1: Long-run and short-run aver ...