CCE Chapter 1

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Chapter 1

Cost Elements

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• Cost is a fundamental attribute of activities and assets

* Cost is one of the three fundamental attributes associated

with performing an activity or the acquisition of an asset.

(1)price (cost)

(2) features (performance)

(3) availability (schedule).

- What are the elements that make up cost?

- How are these cost elements categorized?

- How do they relate to one another?

- Why is it important to collect and account for costs as they

relate to specific activities and assets?

- How do we apply these cost elements and categories to the

insight for managing activities and assets?

This chapter will provide you with a basic understanding of these cost

fundamentals and will give you the insight and background you will need as

you study

Introduction

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LEARNING OBJECTIVES

After completing this chapter, the reader should be able to:

• Understand what makes up cost—i.e. the basic resources (material,

labor, etc.) that are needed to perform an activity or create an asset;

• Understand the distinction between cost elements that are directly

applied to an asset and those that are indirectly applied;

• Relate the cost elements to the life cycle of the asset: acquisition, use,

and disposal;

• Use the understanding of cost elements to further understand how

cost is measured, applied, and recorded to arrive at the total activity

and/or asset cost;

• Apply the knowledge gained to solve problems related to cost element

source and definition.

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* Cost is the value of an activity or asset.

* Generally, this value is determined by the cost of the

resources that are expended to complete the activity or

produce the asset.

-Resources utilized are categorized as material, labor,

and “other.”

- Although money and time are sometimes thought of

as resources, they only implement and/or constrain the

use of the physical resources just listed

* Structuring the cost elements into:

1) Direct costs

2) Indirect costs

3) Fixed costs

4) Variable costs 4


Example 1:- John decides to build a deck on the back of his house.

He draws up plans for the project, gets the building permit from the city,

buys the material, hauls it home, and constructs the deck.

The cost elements and categories associated with building this asset

are shown

Notice that some of these cost elements are not part of the physical

deck, but are necessary in order to complete the project.

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* Direct Costs - Direct costs are those resources that are expended solely to complete

the activity or asset.

- In other words, “Any cost that is specifically identified with a particular

final cost objective, but not necessarily limited to items that are

incorporated in the end product as material or labor”.

- Thus, the direct cost of a foundation for a house includes trenching for

the footings, the wooden forms (if not reusable), the concrete, and the

labor to place and finish the concrete.

- Direct costs for making a metal bowl would be the metal sheet stock

and the stamping machine operator labor cost.

- The material cost for manufacturing the bowl would include the scrap

from the stamping process less any salvage value.

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* Indirect Costs - Indirect costs are those resources that need to be expended to

support the activity or asset but that are also associated with

other activities and assets.

- In other words, “Any cost not directly identified with a single final cost

objective but identified with two or more final cost objectives …”.

- Consequently, indirect costs are allocated to an activity or asset based

upon some direct cost element, such as labor hours, material cost or

both.

- Indirect costs also may be referred to as “overhead costs” or “burden

costs.”

- Indirect costs are general administrative activities associated with

operating the business, costs for providing and maintaining

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* Fixed Costs - Fixed costs are those cost elements that must be provided

independent of the volume of work activity or asset production

that they support.

-These can be either direct or indirect costs.

-The tool used to stamp the metal bowl is a direct fixed cost that is

incurred whether 100 or 1,000 items are produced.

- The tools used to finish the concrete foundation are an indirect

fixed cost since they can be reused on other concrete finishing

work.

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* Variable Costs - Variable costs are those cost elements that must be provided

and are dependent on the volume of work activity or asset

production that they support.

-Again, these can be either direct or indirect costs.

An example of:

A direct variable cost is the material used to form the metal bowl since

the amount varies with the quantity produced.

An indirect variable cost would be the electricity used to operate the

stamping machine since it also varies with the quantity produced but is

considered to be an overhead cost.

Example 2:-

John tries to better understand the costs associate

with building the deck? Can You Help Him!

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Cost Accounting: Definition

• Cost accounting is defined as the historical reporting of disbursements,

costs and expenditures on a project.

• Recording of cost information is nothing more than the mechanical

gathering of data in a routine manner.

• Become familiar with the Code of Accounts structure. Every business enterprise has an established approach for classifying and summarizing

costs that is organized around their business practices.

This approach is called a “code of accounts” by which all recorded cost elements are

classified.

A code of accounts (sometimes referred to as a chart of accounts) is a systematic numeric

method of classifying various categories of costs incurred in the progress of a job; the

segregation of engineering, procurement, fabrication, construction, and associated project

costs for accounting purposes.

A company’s code of accounts is configured to support the recording of

cost data in the general ledger.

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• Activity Based Costing assigns resources to activities. While classifying costs in accordance with the general ledger breakout is a

common practice, this approach does not generally provide the visibility needed

to manage the work or to make informed forecasts of the cost of new jobs.

An alternate method of cost element classification is called activity-based

costing (ABC).

In the ABC approach, resources that are used are assigned to activities that are

required to accomplish a cost objective.

ABC makes cost accounts understandable and logical, and much more useful

for the cost engineer.

This method of collecting and summarizing cost elements reveals which

resources and activities are the most significant contributors (drivers) to the cost

of the cost objective.

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• Work Breakdown Structure WBS can be used with Code of

Accounts. Be familiar with the WBS.

- Another approach to classifying costs that is similar to ABC accounting is using

a work breakdown structure (WBS) to group cost elements.

-It has become a common practice for a WBS to be a required project

management tool on most contracts.

-Not only does a WBS provide a framework for planning and controlling the

resources needed to perform the technical objectives, but it facilitates a summary

of project data regarding the cost and schedule performance.

-Next is an example WBS for a study project wherein the deliverable item is an

intellectual product documented in technical publications.

- When used to classify and record costs, the WBS becomes the cost element

structure (CES), as well.

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Work Breakdown Structure

Level 1

Level 2

Level 3

Total program

Project

Task

Level 4 Sub task

Work packageLevel 5

Level Of EffortIt can be used to provide the basis for:

• The Responsibility Matrix

• Network Scheduling

• Costing / Estimating

• Risk Analysis

• Control

For most companies, however, the differences between projects make it almost

impossible to standardize the top levels of the WBS

80 Hrs.

• Staffing

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Regardless of how cost elements are classified and grouped, it is important

that this is done in a manner that is consistent with the way future work is

estimated and budgeted.

Historical cost records represent the way a company conducts its business

and can be analyzed to determine whether improvements have been made

and how costs may trend in the future.

Therefore, the integrity of the cost accounting system

is essential to developing a project cost baseline 16


Example 3:- John recognizes that the deck he is building is an improvement to

his home that would be considered a capital investment.

He decides that he needs to structure his cost accounts to provide

data for future maintenance estimates.

Can you help him in code of accounts he is trying to develop?

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COST MANAGEMENT

We will consider four of the most common methods of how

cost information is applied to cost management.

These are:

Cost Estimating

Cost Trending

Cost Forecasting

Life Cycle Costing

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Cost Estimating

Cost Estimating predicts the quantity and cost of resources

needed to accomplish an activity or create an asset.

The building blocks of a cost estimate are :

• a well-defined scope (what we are trying to estimate),

• a cost element structure (how we organize the

information),

and

• historical cost data (data from cost accounting records

and/or “experience” of knowledgeable people).

Key questions to ask regarding a cost estimate always

include “What cost data was used?” and “How can we

reduce the cost of x?” Therefore, cost element data and its

structure are paramount ingredients of a sound cost

estimate. 19


Cost trends are established from historical cost accounting

information.

Cost management questions may focus on how

expenditures are trending relative to physical

accomplishments.

“How much are we spending for pipe fitters and how

much piping has been installed during the last six

months?”

or “What has been our monthly cost for steel this last year

and how many bowls have we produced?”

Cost Trending

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Cost Forecasting

• Forecasts are much like estimates.

• Whereas an estimate is always for future activities and

assets, forecasts are predictions of the cost at completion

for cost elements in progress.

• Therefore, a sound cost forecast will be based on cost

element data from inception of the work to the date of the

forecast, the cost trend of that data compared to

accomplishments, and a cost estimate of the work remaining

to be completed.

• Cost element history in the proper activity structure is

essential for realistic cost forecasts.

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Life Cycle Costing

• Life-cycle costs (LCC) are associated with an asset and

extend the cost management information beyond the

acquisition (creation) of the asset to the use and disposal of

the asset.

• Asset acquisition consists of the design/development

phase and the production/construction phase.

• Generally, cost elements are segregated into these

phases because design/development costs are often

recovered over more than one asset.

For example,

- design and development cost of a new airplane is

amortized over the production.

- The design of a housing project is recovered through

sales of the houses built.

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Once the asset is created, it enters the operation and support (O&S)

phase, sometimes called operations and maintenance (O&M).

A new set of cost elements and CES is applicable to this phase and cost

data must be collected to support cost management efforts.

The final phase is disposal of the asset with another unique set of cost

elements. see how John might group cost elements of the deck project to reflect its LCC.

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