1. Engineering Economic Analysis
Chapter 17
Accounting & Engineering Economy
Donald G. Newnan
San Jose State University
Ted G. Eschenbach
University of Alaska Anchorage
Jerome P. Lavelle
North Carolina State University
Neal A. Lewis
University of New Haven
Copyright Oxford University Press 2017

2. Chapter Outline Role of Accounting The Balance Sheet
The Income Statement
Traditional Cost Accounting
Copyright Oxford University Press 2017

3. Learning Objectives
Understand links between accounting & engineering economy
Understand financial transactions, the objectives of accounting, & why they are important
Evaluate firms with financial statements & ratios
Use traditional cost accounting to calculate product costs
Understand concepts of activity–based costing
Copyright Oxford University Press 2017

4. Vignette: A Tale of Three Engineers
Moving Up the Career Ladder. One was quickly promoted to project & then line management
Responsible for justifying engineering decisions & project budgets. Accounting for financial performance & efficiency was required.
Investing for the Future. Second used accounting for personal finances with a budget (income statement) & a balance sheet using Assets = Liabilities + Equity
Student loans paid off, emergency fund established, down payment on house, & now saving for retirement
Copyright Oxford University Press 2017

5. Vignette: A Tale of Three Engineers
Engineering Entrepreneurs. Third engineer is a group of engineering students from University of California, Davis.
After unexpected death of research advisor, they formed a small firm & applied for government funding
Two months later, firm received award letter for over $1M
Key to their success was an innovative idea, a sound technical plan & budget, & the accounting skills to manage the finances & required reporting.
Copyright Oxford University Press 2017

6. Vignette: A Tale of Three Engineers
Questions to consider:
How can you develop accounting or financial analysis skills before entering the workforce?
Accounting & ethics both played large roles in the last fiscal crisis & in many smaller scandals. How can knowledge of accounting help you guard against ethical lapses?
Create annual budgets for next 5 years. Use to connect your current & planned assets, liabilities, & equity.
Copyright Oxford University Press 2017

7. Role of Accounting Accounting data are used To value capital equipment
To decide whether to make or buy a part
To determine costs & set prices
To make product mix decisions
In both private & public sectors
Copyright Oxford University Press 2017

8. Role of Accounting Accounting Eng. Economy Management About past
Analyzing
Summarizing
Reporting
Fin. indicators
Economic trends
Cost acquisitions
Management
About past & future
Capital budgeting
Decision making
Setting goals
Assessing impacts
Analyzing risk
Planning
Controlling
Record keeping
Eng. Economy
About future
Feasibility study
Collect data
Analyze data
Estimate
Evaluate projects
Recommend
Audit
Trade-off & const.
Estimating
Budgeting
Copyright Oxford University Press 2017

9. Accounting for Business Transactions
Accounting function records, analyzes, & reports business transactions
Accounting function also finds, synthesizes, summarizes, & analyzes data
Most accounting is done in nominal or then- current dollars
Accounting function provides data for general accounting & cost accounting
Copyright Oxford University Press 2017

10. Balance Sheet
Balance sheet shows firm's financial position at a specific time = a financial “snapshot”
Fundamental accounting equation:
Assets = Liabilities + Equity (17-1)
Copyright Oxford University Press 2017

11. The Balance Sheet: Assets
Assets are what the company "owns"
Current assets (can be converted to cash within a year)
Cash
Accounts receivables
Securities
Inventories: raw materials, work-in-progress, finished products
Fixed assets
Land
Plant, equipment
Less accumulated depreciation on plant & equipment
Copyright Oxford University Press 2017

12. Balance Sheet: Liabilities & Equity
Liabilities ≡ what firm "owes"
Current liabilities (due within a year)
Expenses, notes, & other payable accounts
Long-term liabilities
Mortgage, bonds, & loans with later due date
Equity
Common stock
Preferred stock
Retained earnings = value that balances assets with liabilities + equity
Copyright Oxford University Press 2017

13. Balance Sheet, Engineered Industries Assets ($1000) on 12/31/2016 (left side of Fig. 17-2)
Current assets
Cash $1940
Accounts receivable 950
Securities (at cost)
Inventories (at lower of cost or market) 1860
(minus) Bad debt provision (80)
Total current assets 8770
Fixed assets
Land 335
Plant & equipment 6500
(minus) Accumulated depreciation (2350)
Total fixed assets
Other assets
Prepays/deferred charges 140
Intangibles
Total other assets
Total Assets $13,815
Copyright Oxford University Press 2017

14. Balance Sheet, Engineered Industries Liabilities & Equity on 12/31/2016 (left side of Fig. 17-2)
Current liabilities
Accounts payable $1150
Notes payable
Accrued expenses
Total current liabilities
Long-term liabilities
Total liabilities 3380
Equity
Preferred stock 110
Common stock 650
Capital surplus 930
Retained earnings
Total equity ,435
Total liabilities & equity $13,815
Copyright Oxford University Press 2017

15. Financial Ratios from Balance Sheet
Working Capital = Current assets – Current liabilities
(17-2)
Liquidity ratios measure firm’s ability to meet short-term obligations
(17-3)
(17-4)
Copyright Oxford University Press 2017

16. If balance sheet a snapshot at a specific time;
is a video over time
Income Statement
Summarizes firm’s financial performance over a period of time (usually a quarter or a year)
(17-5)
Operating Revenues:
Sales revenues – (returns & allowances)
Non-operating Revenues:
Rents
Interest receipts
Operating Expenses:
Cost of goods sold (COGS)
Labor, materials, indirect cost
Selling & promotion
Depreciation
General & administrative
Lease payments
Copyright Oxford University Press 2017

17. Engineered Industries Income Statement for 2017 (top Fig. 17-3)
Operating Revenues Sales $18, (minus) Returns & Allowances −870 Total Operating Revenues 18,030
Operating Expenses Cost of goods sold 13, Labor 6, Materials 4, Indirect cost ,280 Selling & Promotion Depreciation General & administrative 2,160 Lease Payment Total Operating Expenses 17,110
Total Operating Income 920
Copyright Oxford University Press 2017

18. Engineered Industries Income Statement for 2017 (rest Fig. 17-3)
Nonoperating revenues & expenses rents interest receipts (minus) interest payments (120) Total nonoperating income
Net income before taxes 1,120 Income taxes − 390 Net profit
Copyright Oxford University Press 2017

19. Financial Ratios from Income Statement
(17-6)
(17-7)
Copyright Oxford University Press 2017

20. Linking Balance Sheet, Income Statement, & Capital Transactions
Important links to income statement & balance sheet
Overall profit / loss (from income statement)
Equity, starting & ending (from balance sheet)
Acquisition of capital assets
Depreciation of capital assets
Retained earnings
Copyright Oxford University Press 2017

21. Example 17-1
Engineered Industries purchased $400K capital equipment & sold none; paid no dividends;
What changes in 2017 balance sheet due to income statement & this transaction?
Retained earnings increase by $730K profit in 2017
Plant & equipment for 2017 up by $400K
Accumulated depreciation for 2017 increases by $450K depreciation shown on income statement
Fixed asset2017 = Fixed asset $400K − $450K
Copyright Oxford University Press 2017

22. Traditional Cost Accounting
Cost accounting collects, analyzes, & reports operational performance data
Cost accounting data are used
to develop product costs
to determine the mix of labor, materials, & other costs in production
to evaluate outsourcing & subcontracting possibilities
Copyright Oxford University Press 2017

23. Direct & Indirect Costs
From activities directly associated with final product or service
Direct material costs
Direct labor costs
Indirect Costs
Difficult to link to specific projects, products, or services
To allocate indirect costs, various cost drivers are used
Direct labor hours
Material costs
Total direct costs
Copyright Oxford University Press 2017

24. Example 17-2 $850K Indirect Cost Allocation by Labor Cost
Standard
Premium
Total
Annual production (units)
750
400
Unit labor cost
$400
$500
Unit materials cost
$550
$900
Labor cost
$300,000
$200,000
$500,000
Materials cost
$412,500
$360,000
$772,500
Allocate $850,000 by labor cost
Total labor cost = $500,000, so overhead per labor $
= $850,000 / $500,000 = 1.7
Allocation for standard = 1.7(300,000) = $510,000
Allocation to premium = 1.7(200,000) = $340,000
Copyright Oxford University Press 2017

25. Example 17-2 $850K Indirect Cost Allocation by Materials Cost
Standard
Premium
Total
Annual production (units)
750
400
Unit labor cost
$400
$500
Unit materials cost
$550
$900
Labor cost
$300,000
$200,000
$500,000
Materials cost
$412,500
$360,000
$772,500
Allocate $850,000 by materials cost
Total material cost = $772,500, so overhead per material $
= $850,000 / $772,500 = 1.1
Allocation for standard = 1.1(412,500) = $453,750
Allocation to premium = 1.1(360,000) = $396,000
Copyright Oxford University Press 2017

26. Problems with Traditional Cost Accounting
Can distort product cost
Direct labor content is relatively small in automation, high-tech settings
Accounting data “untimely”
Copyright Oxford University Press 2017

27. Activity-Based Costing (ABC) versus Traditional Overhead Allocation
Direct Direct Overhead
Labor Mat’l
Machine Setup Op Order Eng.
Product Cost
Copyright Oxford University Press 2017