ESTIMATED COSTS: CHARACTERISTICS, OBJECTIVES AND EXAMPLES - DUDAS - 2025

The estimated costs are projected the amount of costs that will be incurred for manufacturing a product or build something. This amount comes as part of the capital budgeting process required for a project or as part of a sales quote when trying to sell a product to a customer.

Estimated costs arise from the need to predetermine or calculate production costs in order to be able to set sales prices. They are determined prior to actual production based on specified future conditions, which refer to the quantity of items to be produced.

Reliable cost estimates are necessary for all projects. Without a cost estimate, it would be impossible to prepare a business plan, establish detailed budgets, predict resource requirements, or control the costs of a project.

In a competitive situation, if a company's cost estimate is too low, then you can get an order, but you risk financial loss. On the other hand, if your cost estimates are too high, you are probably not price competitive and lose the order.

characteristics

- To establish the estimated cost, scientific bases are not used, only approximations are used.

- Estimates are expressions based on past experiences, on calculations established on preliminary statistics and on in-depth knowledge of the company and the industry in particular.

- They indicate not what it should cost, but what the product can cost.

- They are used by those companies that follow a historical cost system, for which they are based on real costs from the past.

- They are used as a guide to determine the price and to prepare quotes for clients.

- They are obtained before starting production. It is essential to take into account a certain volume of production in order to determine the unit cost for that quantity.

- The existing variations when comparing the estimated costs and the real costs should always be adjusted to the real thing, reconciling the affected accounts.

Estimated cost system

Estimating total cost requires inputting information into an automated system, such as a manufacturing resource planning (MRP) system.

The system uses labor hours, machine hours, hourly rates for labor and machinery, overhead rates, operational routes, and bills of materials to calculate the estimated cost.

Operational routes are the series of steps required to manufacture products, including work areas and associated hours and fees.

Bills of materials are the items required to assemble or manufacture higher-level products, and estimates of purchased items result from averaging actual costs from previous purchases. A cost system creates estimated costs through accumulated costs.

goals

- Determination of the unit cost of the products, in order to contribute to setting their sales prices in advance and to be able to prepare price quotes to customers.

- Accounting valuation of the production in process and the finished one.

- Determination of the cost of production of the merchandise sold.

- Know the items that can be sold at different prices, according to their profitability, establishing maximum and minimum sales prices, if supply and demand allow it.

- Decide on whether to continue producing or to buy an item that is being manufactured, as well as assessing the feasibility of costs to produce a new item.

- Take into account the market supply and demand, as well as the respective competition, considering current market prices and comparing them with the calculated estimates.

- Because it is obtained prior to production, it leads to the adoption of correct standards in the production, purchase and distribution functions.

- Facilitate having safe estimates when changing the design of a product or its manufacturing procedure.

- Serve as a tool for internal and preventive control.

- Help in making managerial decisions to plan and visualize difficulties on the horizon.

Examples

First example

Profitability is vulnerable and deserves to be protected by a good estimate of costs. Managing a project that has been underestimated in its costs can be a terrible experience; it can be demoralizing, as all cost predictions made will only serve to assess the magnitude of an impending loss.

The goal should be to reduce the number of unknown variables or risks as much as possible.

Consider a project that was sold for a price of $ 1,000,000, taking into account an estimated total cost of $ 850,000. The budgeted return was $ 150,000, 15% of the sale price.

Now suppose that the project actually cost $ 910,000 instead of the estimated $ 850,000. This $ 60,000 cost variance represents an estimation error of approximately 7%.

Some might think that this is a small mistake, and the project manager would be delighted with such a result. However, a cost estimate error of 7% causes a significant reduction in profitability.

In this example it has been reduced from the planned $ 150,000 to just $ 90,000, with a reduction not of 7%, but of 40%; the expected profitability has been reduced by almost half. This is how company management and other stakeholders would view this result.

Second example

The basis for incorporating the estimated costs into the accounting of the company lies in the following data:

Calculation of the estimated cost per unit sheet

- Raw material: $ 200.

- Direct labor: $ 300.

- Manufacturing expenses: $ 150.

Total estimated product costs: $ 200 + $ 300 + $ 150 = $ 650

It is recorded in the accounting of the period according to the quantity produced:

- Production in process of 300 units based on estimated costs: $ 650 x 300 = $ 195,000.

- Finished production of 200 units at estimated costs: $ 650 x 200 = $ 130,000.

- Cost of merchandise sold at estimated costs: $ 650 x 200 = $ 130,000.

- Record of the actual cost items total of the product: $ 850.

- Cost of merchandise sold at actual costs incurred: $ 850 x 200 = $ 170,000.

Compare the cost of merchandise sold (CMV) with estimated costs versus actual costs:

- CMV Estimated Costs = $ 130,000.

- CMV Actual Costs = $ 170,000.

Determination of the variations between the actual cost and the estimate, generating the accounting adjustment: $ 170,000 - $ 130,000 = $ 40,000.

Adjust the sheet of estimated costs per unit for the following period by $ 200 ($ 850 - $ 650).

References

1. Steven Bragg (2017). Estimated cost. AccountingTools. Taken from: accountingtools.com.
2. Bob Turek (2017). How to Calculate Total Estimated Cost. Bizfluent. Taken from: bizfluent.com.
3. John Freedman (2018). Cost Estimation Methods in Accounting. Small Business - Chron.com. Taken from: smallbusiness.chron.com.
4. Accounting-Management (2018). Distinction Between Standard Cost And Estimated Cost. Taken from: accountlearning.blogspot.com.
5. Greves &: B. Schreiber (2018). Engineering Costing Techniques in ESA. European Space Agency. Taken from: esa.int.
6. Dennis Lock (2018). Estimating Project Costs. Chapter 4 of Project Management. Taken from: gpmfirst.com.