WEEK 1 Terms & Definitions:

Engineering Economy: General Accounting

- Discipline concerned with the economic Cost Accounting

aspects of engineering.
Accounting Data - primarily concerned with
- Involves the scientific evaluation of the costs past and current financial events; data are often
and benefits of proposed technical projects. used to make projects about the future

- Analyze alternative uses of financial resources, General Accounting - is a source of much of the
particularly in relation to the physical assets and past financial data needed for estimating future
the operation of an organization. financial conditions.

Alternatives - An alternative is a stand-alone Cost Accounting - also known as management

solution for a given situation. Every situation accounting is subset of accounting that is of
has at least two alternatives. In addition to the particular importance because it is concerned
one or more formulated alternatives, there is principally with decision making and control in
always the alternative of inaction, called the do- action.
nothing (DN) alternative. This is the as-is or
Accounting - also a source of data for analyses
status quo condition.
of how well the results of a capital investment
Principle of Engineering Economy: turned out compared to the results that were
predicted in the engineering economic analysis.
1. Develop the alternatives - Identification
of alternatives and defining for Objectives of Modern Cost Accounting:
subsequent analysis.
 Determine the cost of products or
2. Focus on the differences - Only the
services.
differences in expected future
 Provide a rational basis for pricing
outcomes among the alternatives are
goods or services
relevant to their comparison and should
 Provide a means of controlling
be considered in the decision.
expenditures.
3. Use a consistent viewpoint -
 Provide information on which operating
Prospective outcomes of the
decisions may be based and the results
alternatives, economic and others,
evaluated.
should be consistently developed from
a defined viewpoint or perspective. (ex. Time Value of Money
Viewpoint of the customer should be
adopted in decision) It is often said that money makes money. The
4. Use a common unit of measure - Using statement is indeed true, for if we elect to
a common unit of measurement to invest money today, we inherently expect to
enumerate as many of the prospective have more money in the future. The change in
outcomes as possible will make easier the amount of money over a given time period
the analysis and comparison of the is called time value of money; it is the most
alternatives. important concept in engineering economy. The
5. Consider all relevant criteria price of any commodity or product will depend
6. Make uncertainty explicit - Uncertainty largely on the market situation. The following is
is inherent in projecting or estimating a tabulation of the different market situations:
the future outcomes of the alternatives
and should be recognized in their
analysis and comparison.
7. Revisit your decisions. - Improved
decision-making results from an
adoptive process; projected outcomes
of the selected alternative should be
compared with actual results achieved.

Engineering Economy Studies

Provide information on which current

decisions pertaining to the future operation of
an organization can be based.
Perfect Competition (also known as atomistic Generally, low supply and high demand increase
competition) refers to the market situation in price. In contrast, the greater the supply and
which any given product is supplied by a very the lower the demand, the price tends to fall.
large number of vendors and there is no Therefore, the relationship between price and
restriction against additional vendors from supply is that they are directly proportional, i.e.
entering the market. the bigger the selling price, the more the
supply; and the smaller the selling price, the less
Perfect competition is a type of market
is the supply.
situation characterized by the following:
Types of Cost
A. Many sellers and many buyers
Costs of engineering products can broadly be
B. Homogenous products
grouped under DIRECT COST or INDIRECT COST.
C. Free market-entry and exit
Direct Costs - are the costs of those factors
D. Perfect Information which can be directly attributed to the
manufacture of a specific product. These are
E. Absence of all economic friction the costs of material and labor.
This market situation provides an assurance of Material Cost is the cost of that material which
complete freedom on the part of both the goes into the finished product and includes all
vendors and the buyers though the latter the waste which has been cut away from the
benefits more from the reduced prices brought original bar, casting, etc.
about by the perfect competition while more
and better services are afforded by the vendors Labor Cost will be the product of the number of
or players in the industry. pieces produced and the piecework rate (in the
case of a simple incentive scheme) or the
Monopoly is the opposite of perfect product of the time spent in manufacturing the
competition. This market situation is product.
characterized by the following:
Indirect Costs - are the costs of those factors
A. One seller and many buyers which can only be indirectly attributed to the
B. Lack of substitute products manufacture of a specific product. They are
sometimes called OVERHEADS or ONCOSTS.
C. Blockaded entry
They can be subdivided for convenience under
There exists a perfect monopoly if the single three headings:
vendor can prevent the entry of all other
vendors into the market. The monopolist is in a. Works Overheads. These consist of the cost
the position to set the market price. of the wages of works of superintendents,
foremen, inspectors, storekeepers, etc., cost of
Demand is the need, want or desire for a cutting oil, depreciation of machines, lighting,
product backed by the money to purchase it. In rents, rates, etc.
economic analysis, demand is always based on
“willingness and ability to pay” for a product, b. Office overheads. These consist of the cost of
not merely want or need for the product. The the wages of all office staff, postage, legal
demand for a product is inversely proportional expenses, depreciation of office equipment, etc.
to its selling price, i.e. as the selling price is c. Sales Overheads. These consist of the cost of
increased, there will be less demand for the the wages of all sales staff, advertising, sales
product; and as the selling price is decreased, commissions, etc.
the demand will increase.
Therefore, it can be seen that indirect costs are
Supply is the amount of a product made the total costs running the organization less the
available for sale. If the selling price for a direct material costs and the direct labor costs.
product is high, more producers will be willing
to work harder and risk more capital in order to
reap more profit. However, if the selling price Sales Price = Direct Cost + Overheads + Profit
for a product declines, capitalist will not
produce as much because of the smaller profit
they can obtain for their labor and risk. The law
of supply and demand is a theory that explains
the interaction between the supply of a
resource and the demand for that resource.
Cost may be more conveniently grouped under Principal – is called the sum received by the
fixed costs and variable costs. borrower on the origin date; also called as
“Present Worth or Present Value.”
Fixed Costs are those costs which are
independent of the quantity of the product Maturity Value – is called the sum of the
manufactured. These include preparation costs principal and the simple interest that the lender
such as the cost of tooling, setting up, etc. and receives from the borrower; also called the
also interest cost and depreciation cost. future worth.
Obviously, the more products that are made,
Ordinary Interest – is called when the loan term
the less will be the fixed cost per piece.
is expressed in days (D) using 360 days for
Variable Costs are those costs which vary as the ordinary year, also called as approximate
quantity of products made varies. Usually, interest; assume 30 days per month.
variable costs increase proportionally as the
Exact Interest – is called when the loan term is
number of products made increases and
expressed in days (D) using 365 days per year
includes the direct labor and material costs.
and 366 days for leap year.
Cost of Product = Fixed Cost + Variable Cost
Actual Time – is obtained by counting every
Segregate the fixed cost and the variable cost of day, except the origin date, within the term of
running a motor car for one year. the loan.

Fixed Cost (independent of distance covered in Approximate Time – is obtained by assuming

the year) that every month contains 30 days.

Variable Cost (varies proportionally to distance 4 different time factors which are possible
covered in the year) whenever simple interest is involved.

1. Actual Time/360 3. Approximate time/360

2. Actual Time/365 4. Approximate time/365

WEEK 2 When “Actual Time/360 is used, the interest

obtained is referred to as” Ordinary Interest by
Cash flow diagrams are, in general, used in the
Banker’s Rule” This is to be used whenever the
teaching and practice of engineering economic
problem does not specify which time factor to
analysis to evaluate present and future worth
use.
receipts and disbursements of investment
alternatives. Periodic receipts and payments Discount Interest – is an amount paid for
usually occur in five different series: uniform (or borrowing money; is charged at the time the
equal) amount series, single present or future loan that has been negotiated or executed.
receipt, arithmetic gradient series, geometric Whereas simple interest is paid on the maturity
series, and irregular series. date when it is added to the amount of the loan
applied for on the origin date, discount interest
Interest - is called to the benefits of the lender
is charged in advance and is taken from the
by receiving a fee for letting the Borrower use
amount of the loan applied for on the origin
the money, the borrower benefits, too, by
date.
availing of money he could use for investment,
production of goods or even consumption. Promissory Notes – a written commitment by a
Designated as “I or r” as the current simple person or business (called the drawer) to pay a
interest rate or referred to as “money’s worth” certain sum to another person or business
(called the drawee) within a specified time; it is
Origin Date – is called to the date on which
also called simply a “note”
borrowed money is received by the borrower.
Discounting Notes – is called to the discount
Maturity Date – is called to the date on which
that a drawee will give to the buyer of the note
the loan is to be completely repaid; also called
in case he will sell it to a bank or an individual
“Repayments”
prior to the maturity date; this happens when
Term of the Loan – is called to the length of the drawee needs money prior to its maturity
time between the origin and the maturity dates. date. This discount is equivalent to the advance
interest. In such a case, the buyer is said to have
Simple Interest – is called the interest that is rediscounted the note.
computed only on the amount received by the
borrower on origin date and that is added to
this amount on maturity date.
Some of the terms related to cash flow diagram 2. Discounts
are:
• A jacket priced at P695.00 is marked “40%
1. Time Scale - is called to the horizontal line, off”. How much does it cost?
with progression of time moving left to right.
Solution:
2. Arrows - signify cash flows and are placed at
Multiply P695 by (1 − 0.4) = 0.6
the end of the period.
0.6 × 695 = 417
3. Cash Outflows - are represented by an arrow
downward to connote expenses; also called as Forty percent off means you must pay 60
negative cash flows. percent of the original price.
4. Cash Inflows - are represented by an arrow 3. Sales Tax
upward to connote receipts; also called as
positive cash flows. • If the sales tax is 6.5%, what is the final price
of a DVD player that is marked P1179.98?
5. Cash Flows - are usually placed at the end of
the period Solution:

6. Net Cash Flow - is called to the difference Multiply 1179.98 by (1+.065) = 1.065:
between the total cash flows (receipts) and cash 1.065 × 1179.98 = 1256.6787
outflows.

7. Cash Flow Diagram - is a diagram that shows

what is involved when flows of money occur at
various times dependent on the point of view/ WEEK 3
viewpoint. Help visualize and simplify problems
having diverse receipts and disbursements. INTEREST - It is the manifestation of the time
value of money and it essentially represents
“rent” pain for use of the money.

SIMPLE INTEREST - Is called when the interest

earned at a cut of date is automatically
reinvested to earn more interest.

FORMULA: Interest = end amount – original

amount

Simple Interest:

I=PNi

F = P (1 + N I)

where:
N = No. of Interest Period
F = Future Worth or Maturity Value
I = At interest rate/interest period
P = Present Worth or Principal
F = Maturity Value or Future Worth
N = No. of Interest Period or term of the loan

I = Interest Rate per interest period

Sort of a Review:
For Exact Interest: N = D/365 days for ordinary
1. Percent – A percent means “so many per year & D/366 for leap year
hundred.” Thirty percent, 30% is 30 out of 100
For Approximate Interest, N = D/ 360 days;
Fifty percent is 50 out of 100 assume 30 days per month

50% = 50/100 = ½

Note: You need to be careful when you see

expressions like 0.04 percent. This is not the
same as 4 percent, which equals 0.04. You must
divide by another hundred:

.04% = .04 / 100 = .0004

Discount Interest: Nominal Rate – is called when the interest is
compounded more than once a year.
F = P + Id
Effective Rate – is the rate that, when
Where;
compounded annually, produces the same
Id = Discount Interest = F (dt) or F(iN) amount each year as the nominal rate i
compounded m times a year.
P = F - Id d = discount Interest rate; equivalent
to I expressed in %

t = term of the loan; equivalent to N

F = Maturity Value of the Loan; the amount of

the loan applied for on the origin date

P = Amount received by the borrower on the

origin date or proceeds of the loan; equivalent
to principal
Interest rate is used for i, that is (1.01)3 – 1 =
P = F (1 – dt ) 3.03%, then the n time unit I 4 quarters,
Rate of discount, d = Interest / Original Principal Alternatively, it is always correct to determine
the effective i per payment period.
Rate of Interest, i = Interest / Actual Principal
COMPOUND INTEREST - Is called when the
i = d / (1-d) interest earned at a cut of date is automatically
reinvested to earn more interest.
Promissory Notes:
- Interest may be compounded annually,
A type of promissory note is the simple interest
quarterly (4 times a year), monthly (12 times a
note in which:
year), or even daily.
1. the note is drawn on the origin date.
Compounded annually – means that the
2. the note is redeemed on the maturity date. interest earned in 1 year is added to the
principal to earn additional interest for the next
3. the stated value of the note – the face value-
year.
corresponds to the principal; and
FORMULA:
4. the face value plus the interest, is the
maturity value.

Two Types of Interest

Simple interest is computed on the original

principal only. At an annual rate of 4.5%, the
accrued simple interest on a principal of P1000
after three years will be 3 × 45 = 135. With
Compound interest, the bank pays you interest
on the interest you made in the first and second
years.

Simple Interest:

The formula for simple interest is very simple.

Variables:

r = annual interest rate

t = number of years

P = original principal

F = amount accumulated after t year

F = P (1 + r t)
The formula for compound interest with
periodic interest conversions per year is:

Variables:

j = annual interest rate

m = number of interest periods per year

t = number of years

P = original principal

F = amount accumulated after t years

F = P (1 + r / m) mt

Monthly versus Yearly:

At 4.5% annual interest, the amount accrued in

your account after 30 years with P10,000.00 is?

Yearly? P37, 453.20

Monthly? P38, 476.98