em302 lec 1-4 2014

8/11/2019 EM302 Lec 1-4 2014

1/25

ENGINEERING MANAGEMENT 302 - 1 -

2nd Semester, 2014

ENGINEERING MANAGEMENT 302LECTURES 1-4

BASIC PRINCIPLES of MANAGEMENT

N O T E: So m e d e f i n i t i o n s a n d d e s c r i p t i v e m a t e r i a l a r e t a k e n f r o m t h e W e b a n d o t h e rs o u r ce s t o m a i n t a in c o n s i s t e n cy w i t h t h e t e r m s i n l i n e w i t h t h e b u s in e s s an dm a n a g e m e n t d i s c ip l i n e s . T h e y a r e r e f e r e n c e d a p p r o p r i a t e l y .

M a n a g e r is person controls and administers all or part of an organisation. Managers achievegoals through other people.

M a n a g e m e n t is getting people together to achieve goals and objectives of an organisationeffectively within the available resources.

O r g a n i z a t i o n s : A consciously coordinated social unit functioning to achieve common goals.

Functions of managers

According to Henry Fayol managers:

Forecast: Work out the necessary steps Plan : defining goals, establishing strategy, and coordinate activities Organise : determine and allocate tasks, report, open communication channels, and

make decisions. Staffing : make sure tasks are executed Lead : motivate, determine directions, resolve conflicts, and set examples. Control Monitoring activities to ensure that they executed as planned, accomplished on

time, and deviations are corrected.

http://www.youtube.com/watch?v=yhcrOLQjAFI

P o w e r : the capacity of a person to influence the behaviour of others so that others do things

they would not normally do. Power is attained through the control of important resources.T y p e s o f p o w e r : FRENCH and RAVEN argue that there are six types of power

1. Reward: based on positive benefits2. Legitimate: based on the formal position, experience and status3. Coercive: based on fear4. Persuasive: based on the ability to allocate symbolic rewards5. Expert: based on the ability to control unique and valuable information6. Referent: based on admiration

P o w e r t a c t i cs are the translation of power basis to specific action. There are seven commonlyused tactics

Legitimacy: imposing organisation policies and rules Persuasion: presenting positive argument

8/11/2019 EM302 Lec 1-4 2014

2/25


Consultation: seeking support Exchange: target mutual benefits Assertiveness: use of direct and forceful approach, ordering, enforcing compliance Coalition: getting the support of others Sanctions: punishment denying the rights of persons, and so on.

MOTIVATION

M o t i v a t i o n : The willingness to exert high level of efforts towards organisational goals.

Motivation and Hierarchy of Needs

MASLOW formulated the theory of motivation as hierarchy of needs in five stages, Figure 1.1:

Figure 1.1 Maslows hierarchy of needs

Self-actualisation: creative and challenging work Esteem: self-respect, autonomy, recognition, responsibility Social: affection, belongingness, acceptance, and friendship Safety: protection from physical and emotional harm, job security, compensation Physiological: physical comfort, reasonable work hours

Other theories such as motivation-hygiene theory, cognitive evaluation theory, etc.

Motivation and Personality

McGREGOR proposes X-type (-ve) or Y-type (+ve), known as the theory X and theory Y.

X-types are:1. People inherently dislike work and whenever possible they avoid it2. Since they dislike work they must be coerced, and controlled3. They will avoid responsibilities and seek formalities whenever possible

Y-types are:

1. Employees view work as a natural part of their living and exercise self-direction and control3. They accept and seek responsibility4. They seek innovative ideas.

Physiological needs

Social/Affiliation needs

Safety/Security needs

Esteem needs

Self-actualisation

8/11/2019 EM302 Lec 1-4 2014

3/25


http://education-portal.com/academy/lesson/henri-fayols-management-principles-managing-departmental-task-organization.html

http://education-portal.com/academy/lesson/managerial-skills-how-good-managers-promote-productivity.html

http://education-portal.com/academy/lesson/theory-x-theory-y-two-types-of-managers.html

http://education-portal.com/academy/course/principles-of-management-course.html

Business 101

TEAM DEVELOPMENT

Team consists of two or more individuals to achieve some goals.

Stages of team formation: has five stages, known as the f i v e - st a g e g r o u p m o d e l

1. Forming: teams are formed to accomplish a shared purpose. There are uncertaintieson purpose, structure and leadership.

2. Storming: there is resistance to constraints imposed on individuals. Disagreements onmission and approaches.

3. Norming: Close understanding and relationships develop for cohesiveness. The groupstructure solidifies. There is common expectation about members behaviour.

4. Performing: Group structure is fully functional. The group energy is diverted toexecute the task in hand.

5. Transforming or Ending: tasks are completed.

Team Development Situational Leadership

There is close link between success of the team and leadership, shown in Figure 1.2 .

Figure 1.2 the situational leadership chart

(

Hi gh

) S u p p or t i v

e B

e h a vi o

ur L

o w )

Low Directive Behaviour Hi h

High Directive&LowSupportive

Low Supportive&Low Directive

High Directive&

High Supportive

High Supportive&Low Directional

Delegating

Coaching

Directing

Supporting

8/11/2019 EM302 Lec 1-4 2014

4/25


Personality characteristics of team members: team productivity is influenced by moraleand cohesiveness of the members. Other traits such as sociability, self-reliance, independence,willingness to contribute, responsiveness and respect to the rights of others are essential.

ORGANISING TEAMS

Teams have structure that shapes the behaviour of members by having leadership, roles,norms, team status and size, and composition.

Leadership : Every team tend to have a leader, such as department managers, supervisors,foremen, project leader, committee chair, and so on. There are many different typesof leaderships. Participative leadership appears to be more effective than autocratic leadership.

Roles: A role is defined as a set of expected behaviour patterns attributed to someoneoccupying a given position. Roles are shaped by r o l e id e n t i t y , which is described bycertain attitudes and behaviours consistent with a role.

Despite the role identity individuals have their own r o l e p e r c e p t i o n . That is, anindividual's view of how he or she is supposed to perform. Role perceptions are shapedby personality, traits of individuals, and environment.

R o l e e x p e c t a t i o n : is how others believe a person should act in a given situation. Forexample, a football coach is generally expected to be aggressive, dynamic andinspiring, although the opposite appears to work equally well.

There is an unwritten p s y c h o l o g i c a l c o n t r a c t among team members amongthemselves, and management. For example, manager should treat team members

justly, provide good conditions, and communicate clearly. Team members areexpected to demonstrate good attitude, follow directions, and perform as required.

R o l e c o n f l i c t can arise if a member is confronted with divergent role expectations. Insome situations, the roles may be mutually contradictory among the members.

Norms: Acceptable standards of behaviour within a team, shared by all. Fo r m a l n o r m s arewritten by the organizations. I n f o r m a l n o r m s are set the by teams telling memberswhat they can (cannot) do. Norms can:

Facilitate team survival

Increase predictability of member behaviour Decrease conflict Allow members to express core values.

Norms develop gradually as members learn what behaviours are necessary foreffective operations. In some cases, teams may have to make e x p l i ci t s t a t e m e n t s about expected norms.

Size: the size of team can affect the overall behaviour. For example, smaller teams cancomplete a task quicker; lager ones can have diverse inputs.

Size of team creates S o c i a l L o a f i n g : "the tendency of team members to do less than

their individual capability, resulting in an inverse relationship between team size andindividual performance". There are many reasons for social loafing, such as:http://www.youtube.com/watch?v=Oww-ozL6I_c http://www.youtube.com/watch?v=zgvBae4AWvk

8/11/2019 EM302 Lec 1-4 2014

5/25


Belief that other members are not doing enough Seeing others (or being) lazy and inept Dispersion of responsibilities Non-measurability of contributions each member makes.

Composition: Most groups require variety of skills. A heterogeneous group will have diverseabilities, opinions, personalities, skills, and information, hence can be more effective

http://www.youtube.com/watch?v=FJVS__j_lio&list=PL20A54F1DF4CCC2AD http://www.youtube.com/watch?v=EJNWE6PDqak

http://www.youtube.com/watch?v=Kj9hw0ngPJU

COMMUNICATIONS MANAGEMENT

Communication fundamentals are illustrated in Figure 1.3 .

Elements of communication management are:

1. Communications planning: assembling , distributing, and updating information2. Information distribution: must be timely and effective3. Performance reporting: current status , progress made, and forecasting

Figure 1.3 Communication fundamentals

ORGANIZATIONS

Organizations: A coordinated social entity with collective goal linked to external environment.

Organizations types: Governments and non-governmental organizations International organizations Corporations

COMMUNICATION PROCESS

Idea Encoding

Idea

Decoding Meaning

EncodingDecodingMeaning

Messageinitiated

Messagefeedback

Shared experiences

Distraction, interference, words,

culture, judgements, emotions,personalities, interests, values,

8/11/2019 EM302 Lec 1-4 2014

6/25


Non-profit corporations Partnerships Cooperatives Public sectors

ORGANIZATIONAL STRUCTURE

Organisational structures are defined by: Complexity, formalisation, and centralisation

1. Complexity is the degree of vertical , horizontal , and spatial differentiation 2. Formalisation is how processes are standardised. High formalisation can give

consistent and uniform outputs. Low formalisation can give greater freedom.3. Centralisation: In centralised organizations decisions are made by top management.

In decentralised organizations decisions can be taken locally by teams.

There are four basic types of structures: Departmentalised and Pyramid structures (bureaucratic and hierarchical) Organic and Matrix structures (no bosses or multiple bosses) Ecologies (competition within the organisation) Committees (formed by peers)

DEPARTMENTALISED STRUCTURES: Classical theorists argued that activities in anorganization are grouped into departments.

Fu n c t i o n a l d e p a r t m e n t a l i s a t io n : is based on group activities by functions performed, e.g.,engineering, accounting, manufacturing, HR, etc., in Figure 1.5 . This can lead to e c o n o m i e so f s c a l e by placing people with common skills in groups.

Figure 1.5 Departmentalisation by functions

O R G A N I C S TR U C T U R ES has low complexity and formalisation and it is decentralised.Communication sideways is effective. It involves participation of many in making decisions.

Departmentalised structures High horizontal differentiationRigid hierarchical relationshipFixed dutiesFormal communicationCentralised authority

Organic structures Low horizontal differentiationEasy collaborationFlexible dutiesLow formalisationInformal communicationDecentralised decision authorit

PlantManager

Human resourcesManufacturingAccountingEngineering

8/11/2019 EM302 Lec 1-4 2014

7/25


Figure 1.6 Organization structures

ORGANISATIONAL SPAN OF CONTROL

Span of control is the number of subordinates a manger can control.

Figure 1.4 Span of control

Classical theorists prefer small span, no more than 6. Wider or larger the span the more

efficient the organization becomes economically, as illustrated in Figure 1.4 .

Note: Research indicates that in many cases jobs may be highly technical and specialised. Thismay create a gap between the authority and employee. Since managers may not becompetent in these jobs they rely on authority to exercise their power, which can result in lesssatisfied employees.

http://www.youtube.com/watch?v=STED8sSHJU8

http://www.youtube.com/watch?v=wtMORWO5h9Y

http://www.youtube.com/watch?v=R-m8grawp1k

ORGANISATIONAL CHANGES

Organisations select structures and implement changes for:1. Strategy2. Organization size3. Technology4. Environment5. Power-Control

STRATEGY

CHANDLER suggests that as the organization grows they get more ambitious and theirproducts diversify, thus making periodical restructuring essential. Strategy theory suggeststhat organizations go through restructure for three reasons:

1

4

1664

256

1,024

4,096

1

8

64

512

4,096

Span of 84,096 Operatives585 Managers

Span of 44,096 Operatives1,365 Managers

8/11/2019 EM302 Lec 1-4 2014

8/25


1) Innovation2) Cost minimisations3) Imitation

1. Innovation IS the introduction of major new products and services. Organic structureis suitable since it is flexible, low division of labour, and low formalisation.

2. Cost minimisation emphasizes tight cost control. Departmentalised structure issuitable since it has tight control and high formalisation.

3. Imitation strategy emphasizes to move into new products or new markets only aftertheir viability has been already proven.

ORGANIZATION SIZE

The number of people employed in an organization can determine the type of structure.

TECHNOLOGY

Organizations transfer inputs to outputs by: unit production , mass production , and process production .

Management in unit production has low vertical differentiation; low horizontal differentiation,and low formalisation, therefore organic structure is suitable.

Management in mass production has moderate vertical differentiation, high horizontaldifferentiation, and high formalisation, therefore mechanistic structure is suitable.

Management in process production has high vertical differentiation, low horizontal

differentiation, and low formalisation, therefore organic structure is suitable.

ENVIRONMENT

Environmental factors inside and outside of an organisation strongly affect its performance.

EMERY and TRIST identify four kinds of business environments

1. Placid-randomised environment in which demands are randomly distributed andchanges occur slowly such as the farming organisations.

2. Placid-clustered environment in which changes occur slowly but threats occur inclusters such as the mining industry. Organization must have long range strategic plan

and centralised decision making.3. Disturbed-reactive environment in which environment is dominated by one or morelarge organizations. Examples are computer industries, automobile industry, etc .

4. Turbulent-field environment in which environment changes constantly such as thestock exchange, most electronics and software industries.

http://www.youtube.com/watch?v=3Jk6clmMycI

ETHICS

Ethics is a general term for what is often described as the "science (study) of morality". Inphilosophy, ethical behaviour is that which is "good" or "right." The Western tradition of ethics

is sometimes called moral philosophy. This is one part of value theory (axiology) the otherpart is aesthetics one of the four major branches of philosophy, alongside metaphysics,epistemology, and logic

8/11/2019 EM302 Lec 1-4 2014

9/25


( http://www.google.com.au/search?hl=en&defl=en&q=define:ethics&sa=X&oi=glossary_definition&ct=title )

Values are those things that really matter to each of us ... the ideas and beliefs we hold asspecial. Caring for others, for example, is a value; so is the freedom to express our opinions."

"Ethics deals with what we believe to be good or bad and with the moral obligations that thesebeliefs imply. Ethics involves the rules for deciding right and wrong and the code of conductthat is based on our decisions. While there are some things that not everybody sees eye-to-eye with in this area, there are a whole lot more that we do agree about. For example, to stealis wrong, for most of us. So too is physical assault. Most of us don't think it is right to cheat inschool; many of us think it is injustice to punish someone who didn't do anything wrong. As anidea, ethics is simple, but the consequences re profound!"( http://www.ethicscommittee.ca/definition-of-ethics.php )

Responsibilities of Engineers

Engineers have a responsibility to act in an ethical and responsible manner in all theirprofessional dealings. Essentially we are required to act in a rational and objective mannerthat is transparent and easily defendable

Ethical & Philosophical Dilemmas

Many projects involve subjective decision making that may result in an outcome that is notconsistent with a persons own values, but which protect the companies interests. Thesedecisions can best be viewed in three categories:

Environmental Dilemmas e.g., pollution Social Dilemmas, e.g., adverse impacts on local communities Commercial / Contractual Dilemmas

Different Countries Different Ethical Values

AUSTRALIA Companies operating in Australia must comply with Australian laws and regulations, on:

Environmental Management issues, and Social Responsibilities

Australian Companies operating abroad Obey the local laws

Avoid potential abuse of powerConclusions for ethical behaviour in Engineering

Engineers must act in a rational, objective, transparent, and defensible manner Engineers engaged in Project Management must understand ethical issues and make

judgements objectively Reputable companies do not place Engineers in ethically compromising situations

IEEE Code of Ethics (2006)

We, the members of the IEEE, in recognition of the importance of our technologies in affectingthe quality of life throughout the world, and in accepting a personal obligation to our

profession, its members and the communities we serve, do hereby commit ourselves to thehighest ethical and professional conduct and agree:

8/11/2019 EM302 Lec 1-4 2014

10/25


1. To accept responsibility in making decisions consistent with the safety, health and welfareof the public, and to disclose promptly factors that might endanger the public or theenvironment;

2. To avoid real or perceived conflicts of interest whenever possible, and to disclose them toaffected parties when they do exist;

3. To be honest and realistic in stating claims or estimates based on available data;

4. To reject bribery in all its forms;

5. To improve the understanding of technology, its appropriate application, and potentialconsequences;

6. To maintain and improve our technical competence and to undertake technological tasksfor others only if qualified by training or experience, or after full disclosure of pertinentlimitations;

7. To seek, accept, and offer honest criticism of technical work, to acknowledge and correcterrors, and to credit properly the contributions of others;

8. To treat fairly all persons regardless of such factors as race, religion, gender, disability,age, or national origin;

9. To avoid injuring others, their property, reputation, or employment by false action;

10. To assist colleagues and co-workers in their professional development and to support themin following this code of ethics.

Download a copy of the IEEE Code of Ethics (PDF)

Source: http://www.ieee.org/portal/cms_docs/about/CoE_poster.pdf

http://www.youtube.com/watch?v=n9A8-FjhArE

http://www.youtube.com/watch?v=r4HrtcSwpVE

8/11/2019 EM302 Lec 1-4 2014

11/25


BASIC PRINCIPLES of ENGINEERING ECONOMICS

DEFINITIONS

Ec o n o m i c s is a social science that deals with the production, allocation, and use of goods andservices. www. wordnet.princeton.edu/perl/webwn

There are many different ways to look at economics: classical economics, Keynesianeconomics, political economics, labour economics, evolutionary economics, and many others.In this course we will largely be dealing with microeconomics.

M a c r o e co n o m i cs : the study of the entire systems of economics. It deals with growth,inflation, unemployment, monetary and fiscal policies, national income, and long termeconomic considerations http://www.investopedia.com/terms/m/microeconomics.asp .

M i c r o e c o n o m i c s: the study of individual units that make up the whole economy. It studieshow individual markets and industries organised, patters of competition, and economicefficiency. It concentrates on consumers, households, and firms; how prices are determined;price/production relations; distribution, and the use of goods and services.

S u p p l y : the amount of goods or services available at a given price at any time.

D e m a n d : how many consumers desire to consume the goods or services that are in supply.

G o o d s : can be described as tangible items for consumption. There are many types: consumergoods; producer goods e.g., raw materials; capital goods e.g., machinery.

S e r v i c e s : helpful or professional activities performed as duties or work for others, such aseducation, health, communications, transportation, banking, social services, and tourism.

I n d u s t r y : a sector of economy made up of different categories of businesses. Examples are:Aerospace, health care, automobile, entertainment, defence, technology, manufacturing,farming, tourism, energy, finance, and building and construction.

G r o s s d o m e s t i c p r o d u c t , G D P: the dollar value of all the final value of goods and servicesproduced in a country. If the real GDP goes down, we say economy is in state of recession.Severe recession is depression.http://en.wikipedia.org/wiki/List_of_countries_by_GDP_(nominal)

http://en.wikipedia.org/wiki/List_of_countries_by_past_and_future_GDP_(nominal)_per_capita

Ec o n o m i c p o l i cy is concerned with finding solutions to economic problems. It is based oncultural, social, legal, and political issues. Major economic policies are: price stability,employment, economic growth, environmental standards, economic freedom, tax burdens,income distribution, and balance of trades.

I n f l a t i o n is a continuing general rise in prices.

M o n o p o l y is a market structure in which entire market for a good or service is supplied by asingle seller or firm. In this case a firm is said to have monopoly power if it is able to set priceswith no close possible substitutes in the market.

O l i g o p o l y is a market condition dominated by a few large firms.

P er f e c t c o m p e t i t i o n is a condition that many firms compete in the market.

8/11/2019 EM302 Lec 1-4 2014

12/25


BRIEF HISTORY of ECONOMIC THEORY

Economics went through many phases throughout the history. First structured ideas abouteconomics started during the ancient Greek civilisation. Todays ideas and practices are basedon studies and theories of many well-known economists, such as

Adam Smith s were ideas expressed in book The Wealth of Nations 1776. This started themodern economic outlooks.

Thomas Malthus (19 th century) expressed that population would always advance faster thanscience and technology.

David Ricardo (19 th century) put forward ideas about wages and labour relationship. To beelaborated by Karl Marx and others.

John Stuart Mill (19 th century) talked about cooperatives and labour unions, and competition.

John Maynard Keynes (early 20 th century) wrote about business cycles. His ideas welcomed bygovernments to exercise more controls on their economies.

Milton Friedman (late 20 th century) put forward theories on the money supply, which is themost important influence on todays economy.

http://www.bloomberg.com/video/77542270-author-frank-discusses-economic-theory.html

SUPPLY AND DEMAND

The supply and demand model describes how prices vary as a result of the balance betweenavailable products and the demand for them as in Figure 1.1 .

Figure 1.1 The Supply and Demand curve

D e m a n d is the quantity that all prospective buyers would be prepared to purchase at eachunit price of the goods and services. The law of demand asserts that the lower the pricecharged for a good the larger the demand. There a many determinants of demand, such as the

price of all other goods, household incomes, expectations, tastes and the numbers of buyers.Changes in any of these will result a shift in the demand curve to go up or down, right or leftas in Figure 1.1.

Quantity

P r

i c e

Q1 Q 2

P2P1

D1 D 2 S

8/11/2019 EM302 Lec 1-4 2014

13/25


S u p p l y is the relationship between the quantity of a goods and/or services that producers arewilling to bring into the market. Supply is determined by: the prices of resources, technology,number of suppliers, and supplier expectations.

Changes in supply and demand, represents by shifts in curves that will upset the equilibrium.This sets in motion competitive price bidding which eventually results in a new equilibrium. Thebasic supply and demand curve in Figure 1.1 gets much more complex as other factorsaffecting the economy comes into play.

Economy also depends on other factors such as consumer confidence, spending and profits,prices, investments, income, and future expectations. Keynes pointed out that the economyneeds to have continuous investment for growth - otherwise a Depression, like the one in early1930s, will take place. The 1930s depression is depicted in Figure 1.2 .

Figure 1.2 Reasons and effects of 1930s economic depression

http://www.youtube.com/watch?v=2YyJWEzY0vo http://www.youtube.com/watch?v=nyAZGqFtVjw

ENGINEERING ECONOMICS

En g i n e e r i n g e c o n o m i c s is a branch of economics for the application of economic methods inthe engineering operations, projects, supply of goods and services. It is related tomicroeconomics but macroeconomics involved.

Some other topics of engineering economics are: financial statements, accounting, inflation,depreciation, resource depletion, taxes and effects of taxes, cost estimation and behavior,capital financing, time value of money, money management, cash flow , etc. In addition thereare non-economic considerations such as product safety, environmental factors, public image,etc. www.answers.com/topic/ engineering -economy

Engineers are involved in decision making process related to engineering economic. Thereforeall engineers should be aware of how the businesses are run, how the decisions are taken aswell as implications of those decisions for the present and future operations of the companies.

The successes of companies are also shaped by many internal and external factors as shown inFigure 1.3 .

Stock Market Crash on29 th Oct 1929:

Consumerconfidence

Down 25% in 2 days Down 40% in 2 months

Wealth

Spending &profits

Prices

Futureexpectations ofprices & profits

Investment

Income

In 2.5 years the USS&P Index lost 89% adding further fuel tothe Depression

8/11/2019 EM302 Lec 1-4 2014

14/25


Figure 1.3 Importance of engineering economics

Many companies need to take up new projects and require large sums of upfront investment,which are difficulty in forecasting revenues and costs. An investment process is depicted inFigure 1.4 .

http://www.youtube.com/watch?v=UMYLvEuzYUI

ACCOUNTING

Accounting is a process of recording, summarizing, and allocating all items of income andexpense of a company and analysing, verifying, and reporting the results.

Accounting is required to measure how well the economic objectives in an organization areachieved. It provides data to indicate financial performance and assessing future directions.

Economic objective of many companies is to maximize the profit, that is:

Purpose of Accounting

Internal reporting for cost planning , control and performance evaluation

Internal reporting for recourse allocation and pricing Internal reporting for decisions , long term plans , new products , and investments External reporting to shareholders, creditors, and governments

Investment

Design &Planning

MarketingProduct

Manufacturing Profit

Figure 1.4 Investment process

Profit = Revenue - Expenses

Innovations &production

Dynamic businessenvironment

Investments & valueof dollar

Technology andadvancements

Risk management &measuring

Social & externaldemands & constraints

EngineeringEconomics

8/11/2019 EM302 Lec 1-4 2014

15/25


Ethical Aspects of Accounting

Accounting requires good Ethical practices, such as:

Integrity, sincerity and honesty Objectivity and impartiality Confidentiality and independence without conflict of interest Professional conducts and high competency

TYPES OF ACCOUNTING

Financial Accounting (for external purpose)Managerial Accounting (for internal purpose)

Cost Accounting (management accounting + financial accounting)1. Financial Accounting

Financial Accounting is a way of reporting of the financial position and performance of acompany through financial statements issued periodically.

Financial Accounting reports are used by shareholders, banks, regulators, etc. It is pastoriented and constrained by law. It must be accurate.

2. Managerial Accounting

It uses both historical and estimated data in providing information for management. It is usedin daily operations, and planning future operations. It helps developing business strategies.

It is less accurate compared to financial accounting. It uses data deemed to be relevant forinternal use and decision making by managers. It is generated either regularly or ad hoc basisto estimate near or long term future performance and revenues.

3. Cost Accounting

Cost accounting is used for estimating, tracking and controlling product and service costs. It ispracticed for internal reporting for cost control, performance evaluation, and profitability. Thereports may be used for external reporting such as financial statements, shareholders, bankreports, and taxation office.

COST ACCOUNTING

CLASSIFICATION

Costs can be classified as

1. Assignment of costs to a cost objecta. Direct costsb. Indirect costs

2. Profit determinationa. Capitalised costs: expenses in financing fixed assetsb. Product costsc. Overhead costs

8/11/2019 EM302 Lec 1-4 2014

16/25


3. Changes in cost driversa. Variable costsb. Fixed costs

Example// Manufacturing industry will have: direct material costs, direct manufacturing labourcosts, manufacturing overhead costs.

COST TERMINOLOGY

Cost accumulation: is the collection of cost data in an organised manner.

Cost assignment: is the assignment of accumulated cost to cost objects.

Cost Object: is a tangible input for a product/service.

Direct cost: is a cost that can be directly traced to specific products/services.

Indirect cost: is any cost incurred for common objectives and therefore cannot be directlycharged to any single cost objective. Indirect cost is also termed overhead or burden cost .

Value Chain is adding value through various processes . Value added through R & D, design,production, distribution, and customer services.

Prime cost is the total cost of direct materials, direct labour and direct expenses.

Conversion cost is the cost to process material in a single stage, from one type to another.

Marginal Revenue is the extra revenue that an additional unit of product will generate.

Marginal Cost is the change in total cost when one extra unit is produced.

Sunk Cost is the cost incurred in the past, and is not relevant for to future decisions. Insoftware engineering, digital products usually have significant sunk costs in the form of R&D,

Direct material costBeginning $11,000New purchases 73,000

Cost of material available 84,000Ending material 8,000

Direct material used 76,000

Direct manufacturing labor 17,500

Manufacturing overhead costsIndirect labor 4,000Other supplies 1,000Electricity 2,000Depreciation of plant 1,500Depreciation equipment 2,500Miscellaneous 500 11,500

Total manufacturing cost 105,000

8/11/2019 EM302 Lec 1-4 2014

17/25


intellectual property, patents, etc. If the product is not successful, the costs associated withthat product cannot be recovered.

Opportunity Cost is the potential benefit given up as by an alternative course of action.

Inventory is a complete listing of the type amount and value of assets owned by a companyat a point in time (e.g. July 1). Inventory is the tangible finished products waiting to be soldand/or direct materials to be processed. There are three major types of inventories:

Raw materials inventory Work in process inventory Finished goods inventory

In the inventory stage, the manufacturing costs are treated as assets. Inventory becomes anexpense only when sold once sold they are treated as costs of goods sold.

There are two fundamental ways of accounting for inventories:

1. Perpetual inventory based on continuous monitoring on real-time.2. Periodic inventory accounting for inventory at the end of a specified period.

Costing System is an accounting system for monitoring a company's costs. Bycollecting data, cost assignment, tracing, and allocation of costs by the following steps:

Step 1 The costs are recorded as assets when costs incur. The costs are recorded asexpenses when the revenue is generated associated to that cost.

Step 2 Product costs are determined. Products are considered as assets until they aresold. After selling they become expenses.

Step 3 Period costs are deducted as expenses in a relevant period. The period costs canbe: Administration costs, marketing costs, advertising and distribution costs, etc.

COST DRIVERS

Cost Driver is any activity that causes costs to incur. There are two types:

1. Structural cost drivers are due to: strategic choices of an organization, its structure,

size, complexity, and technology used.

2. Executional cost drivers are due to execution activities, capacity utilization, plantlayout, and work-force involvement.

Cost behaviour is the sensitivity of costs to changes in production. It is influenced by:

1. Fixed costs2. Variable costs3. Mixed costs

Fixed Costs is the cost that stays constant over the relevant range, including the rent,

insurance, salaries, depreciation, property taxes, buildings, machinery, and so on. Averagefixed cost per item is reduced by increasing the number products produced, but the total costremains fairly constant.

8/11/2019 EM302 Lec 1-4 2014

18/25


Average Fixed Cost (AFC) is the total fixed costs (TFC) divided by number of units produced.

When number of units produced increases, AFC decreases, known as Ec o n o m i e s o f S ca l e .

When companies expand to increase their outputs, the TFC may increase (Figure 1.5) due to:additional supervision, machinery, buildings, bigger warehouses, and so on. This expansiondepends on company policies, market potential, competitors, and availability of finances.

Figure 1.5 Total Fixed Costs and Average Fixed Costs

Variable cost is the cost that changes directly proportional to the number of units produced.It includes labour, materials used per unit, sales commission per unit, etc.

Total Variable Cost (TVC) is equal to the number of units produced multiplied by thevariable cost per unit.

Average Variable Cost (AVC) is the cost per unit. AVC is high for low volumes but remainsfairly constant as the number of units increases ( Figure 1.6 ). AVC may be improved byproductivity improvements, new technologies, use of different materials, labor training.

Figure 1.6 Total Variable Cost and Average Variable Cost behavior

Total Cost is sum of the Total Fixed Costs and the Total Variable Costs.

Unit cost is the total cost divided by the number of units produced

The profits are related to cost and revenue, as:

Average Fixed Cost (AFC) = Total Fixed Cost (TFC) / Total Units Produced

Units Produced

Total VariableCost(TVC)

Units Produced

AverageVariable Cost

(AVC)

Units Produced

Total FixedCost (TFC)

Units Produced

Average FixedCost (AFC )

Unit Cost = Total Cost / Number of units produced

Total Cost = Total Variable Cost + Total Fixed Cost

8/11/2019 EM302 Lec 1-4 2014

19/25


Example// Manufacturing salaries and wages:

http://www.youtube.com/watch?v=TLYwPogWdEU&list=PL2D96727267C7FD8E

Contribution Margin is the marginal profit per unit sale. It is calculated as the price of theproduct minus the total variable cost of that unit. Therefore, the contribution margin can bethought of as the fraction of sales that contributes to offsetting fixed costs.

For example if a manager determines that a particular product has a 35% contribution margin.

This figure can then be used to determine whether variable costs for that product can bereduced, or if the price of the end product could be increased for higher revenue.

Unit Contribution Margin is the contribution of each unit sold to cover fixed costs.

Example// Contribution margin:

Break Even Point is the point where the cost is equal to the revenue from products.

M i x e d c o s t s contain both fixed and variable elements such as depreciation of machinery.

Contribution margin = Total revenue Total variable costs

Break Even = Quantity of output where Total revenue equals Total cost (zero profit)

Revenue $200100 units $20,000Variable costs 120100 units 12,000Contribution margin 80100 units 8,000Fixed costs 4,000Profit before tax 4,000Income tax 1,200Net Profit 2,800

Unit Contribution Margin = Price per unit - Av Variable Cost per unit

Direct manufacturing labor $20,000Indirect manufacturing labor 10,000Sales salaries and commissions 15,000Administrative salaries and wages 5,000Total payroll gross 50,000

WithholdingsPAYE tax $15,000Union dues 1,000Private health insurance 4,000

Superannuation contribution 2,000Total withholdings 22,000

Total payroll net 72,000

Profit = Revenue Total costs

8/11/2019 EM302 Lec 1-4 2014

20/25


PROFIT DRIVER TREE

Profit driver tree ( Figure 1.7 ) summarizes expenses and revenues in terms of fixed andvariable costs, and the prices of units.

Figure 1.7 Profit driver tree

INDUSTRY COST / SUPPLY CURVES

Industry cost/supply curves show total numbers of suppliers, the cost, volume, and price ofproducts in a particular marketplace, as in Figure 1.8 .

Figure 1.8 Determination of Costs and Profits for different companies

Each firm chooses the volume of products to produce based on lowest cost point (max profit).

Example// Cost and price curve for alumina production in the world, Figure 1.9a, b and c.

Max (Profit)

Ave Price / Quantity Sold

FixedCosts

Overhead

Marketing

Administration

VariableCosts

+

Average Variable Cost /Quantity Produced

Quantity Produced

Revenue

Expenses

Quantity Sold

+

x

-

+

x

Material ($/unit)

Labour ($/unit)

Mfg Overhead($/unit)

+

+

Average Variable Costper Quantity Producedremains fairly constantover a given range ofoutput levels

Total Fixed Cost remains fairlyconstant for a large range ofQuantity Produced

NOTE: Engineers are traditionally moreinterested in expense, or cost, behaviour NOTE: Its assumed th at Quantity Produced i s

the only driv er of cost, or Volume Index

Quantity Produced

% Produced sold

x

Requires understanding fromMarketing & Economics notcovered in this course

Units Produced

AverageFixedCost

(AFC)

Units Produced

AverageVariable

Cost

(AVC)

Firm 1:+ =

Units Produced

AverageTotalCost

(ATC)

AFC AVC

ATC

Price

Profit

Units Produced

AverageFixedCost

(AFC)

Units Produced

AverageVariable

Cost

(AVC)

Firm 2:+ =

Units Produced

AverageTotalCost

(ATC) AFC

AVC

ATC

Price

Profit

+

+

.

.

.

=

Priceis thesame

Industry Supply Curve:

ATC 2

ATC 1

Q1

Q2

AverageTotalCost

(ATC) &Price

Price

And so forth, to includeall firms in industry

Units Produced

ATC 1 ATC 2

Firm 1Firm

2

Q2Q1

8/11/2019 EM302 Lec 1-4 2014

21/25


Figure 1.9 setting the price of alumina. (Newer refineries enjoy economies of scale andimproved technology thus pushing costs lower).

BREAKEVEN ANALYSIS

Breakeven: the income is equal to expenditure, neither profit nor loss.

Breakeven analysis helps to make decisions on overtimes, expansions, new methods,modifications, outsourcing, and distribution and marketing of their product. It can affect newand on-going projects.

Breakeven Analysis can be done by a number of methods:

1. Equation methods2. Contribution margin methods3. Graphical methods

Price range

Alumin a Indus tr y Cos t Curv e (1997)*

* Costs based on pre expansions in the mid to late 1990s, which have consequently improved cost positions** Although Worsley OPEX is lower than Alcoas facilities, their CAPEX was significantly higher ($A1,100/t vs $A500/t from industry interviews)Source: Australian alumina producer, MacQuarie Equities

Opex (US$per tonne)

Annu al pr odu cti on (000t)Worsl ey** Pi nj arr a Wagerup Kwi nana

Newer and larger refineriesare at the lower end of theindustry cost curve

Uneconomical

All WA Refineri es

Profit

Refinerysize

0

50

100

150

200

250

300

0 10,000 20,000 30,000 40,000 50,000

8/11/2019 EM302 Lec 1-4 2014

22/25


At Breakeven point, if the number of units sold is QBE, then

In breakeven analysis, Fixed and Variable Costs are used to determine the volume of goods tobe produced and to predict the expected profits for a given quantity sold, as in Figure 1.10.

Figure 1.10 Cost and revenue behavior

Example// A mechanical repair shop pays $2,000 for rental (Fixed Cost), conducts repairscosting $120 (Variable Cost), and charges $200 per unit. Calculate the breakeven point. ( Ans:25 ). To make a profit of $1,200 how many units need to be repaired? ( Ans: 40 )

Solution/ Calculate breakeven points if the landlord gives the following options: $2,000 fixed rent, or $1,400 rent + 5% of revenue ( Ans: 20 ), or Nil fixed rent + 20% of revenue.

http://www.youtube.com/watch?v=2cbbWOnH42Y

PRODUCT MIX

Organisations produce many different products. This complicates the break-even andsensitivity analysis since contribution of different products to the profit becomes different.Managers often attempt to increase those products that contribute highest profit.

EFFECT of INCOME TAX

Income tax reduces the net profit, but does not affect breakeven point (30% in Australia).

COSTING SYSTEMS IN MANUFACTURING SECTOR

Costing systems varies from one sector to another as well as from industry to industry.

Fixed Costs

VariableCosts

Profit R e

v e n u

e

T o t a l C o s

t

$

QuantitySold

$ Breakdown atgiven Quantity Sol

Break-EvenPoint

BreakevenVolume

Breakeven Volume = QBE = Total Fixed Cost / (Price per unit - Ave Variable Cost per unit)

Price QBE = TFC + AVC QBE

Total Revenue =Total CostTR = TFC + TVC

8/11/2019 EM302 Lec 1-4 2014

23/25


M a n u f a c t u r i n g is the conversion of raw materials into finished goods. Cost of manufacturingcan be traced as: manufacturing costs and non-manufacturing costs.

M a n u f a c t u r i n g c o s t s are:1. Direct material cost 2. Direct labour cost such as assembly-line workers, machine operators, welders3. Manufacturing overhead cost such as indirect labour and material, maintenance.

N o n - m a n u f a c t u r i n g c o s t are:1. Overhead heat, light, property taxes, depreciation, and administrative costs2. Marketing advertising, shipping, sales, clerical, management cost3. Administrative functions executive compensation, general accounting, public relation

M a n u f a c t u r i n g / j o b co s t i n g s y s t e m is used for unique or separately identifiable jobs. Costfor each item is allocated with minimum averaging.

Example// Job costing of purchase and installation rural area telephone network

M a n u f a c t u r i n g / p r o c e ss Co s t i n g Sy s t e m is used for many similar mass-produced items.During the manufacturing process:

1. Units may be fully completed, or2. Some units are still in the process and are incomplete

http://www.youtube.com/watch?v=sP_CR8zR8f8

COSTING SYSTEMS IN SERVICE & MERCHANDISING

Companies use two basic types of costing systems:

1. J o b c o s t i n g s y s t e m : costs are assigned to individual jobs2. P r o c e ss c o s t i n g s y s t e m : costs are assigned to whole process

ACTIVITY BASED COSTING

Activity based costing (ABC) focuses on activities as the cost objects. There are two types Products and services: products are ranked for profitability Customers are classified and ranked for profitability

Example 1/a) Basic raw materials used in production (VARIABLE COST)b) Property taxes on administrative buildings (FIXED COST)

c) Emergency maintenance on machinery and equipment (VARIABLE COST)d) Repair (VARIABLE COST) and maintenance of delivery trucks (FIXED COST)e) Sales commission (VARIABLE COST)f) TV advertisement of a product (VARIABLE COST)

Direct cost:Direct materials 24,000Direct labour 32,025 56,025

Indirect cost:Overhead 20,170

Total job cost $76,195

8/11/2019 EM302 Lec 1-4 2014

24/25


g) Electricity for machinery and equipment in the plant (VARIABLE COST)h) Property taxes on factory building (FIXED COST)i) Salaries of design engineers (FIXED COST)

j) Wages paid to temporary workers (VARIABLE COST)k) Heat and air-conditioning in the plant (FIXED COST)l) Annual maintenance on machinery and equipment (FIXED COST)m) Factory fire insurance (FIXED COST)

Example 2/The Evergreen Associates employs 150 professionals each working 2,000 h pa, 1,250 hours ischargeable for clients. What is the charging rate in 2011 and 2012? ( Ans: $125 )

Example 3/Costs of electronic items are given below. Calculate direct, conversion and total cost per unit.( Ans: $165, $85, $250 )

EVERGREEN ASSOCIATES Profit and Loss Statement (000)2011 2012

Revenue $21,544 $23,437

Operating costs:Professional labour 11,250 12,000

Other employee costsProfessional indemnity insurance 561 600Clerical staff 840 800Information systems staff 240 300Administrative staff 300 320Others 292 2,233 322 2,342

Non- labour operating costs:Computing hardware and software 460 448Rent/leasing 1,400 1,500Phone/fax/ photocopying 1,330 1,122Travel 718 1,052Other 275 4,183 286 4,408

Total operating costs 17,666 18,750

Profit $3,878 $4,687

Direct material (5,000 units) 825,000Conversion costs (5,000 units) 425,000

Total cost to account for (5,000 units) 1,250,000

Direct material cost per unit ?Conversion cost per unit ?

Manufacturing cost per unit ?

8/11/2019 EM302 Lec 1-4 2014

25/25

Example 4/Costs of electronic items are: Direct material $825,000 and conversion cost is $475,000 for5,000 items. 4,500 items have been completed but the remaining items are half way throughthe conversion process. Calculate to cost per unit.

Direct material cost 825,000Cost per unit (5,000 units) $165

Conversion cost 475,000Cost per unit (5,000 units) $85

Assignment of costs:Completed and transferred out (4,500 units) $1,125,000

Work in progress:Direct material cost (500 units) $ 82,500

Conversion cost (250 units) $ 21,250

Total work in progress $103,750

Total cost accounted for $1,228,750

em302 lec 1-4 2014

Documents