CCE Chapter 1

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Chapter 1

Cost Elements
1
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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 costi.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
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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 companys code of accounts is configured to support the recording of
cost data in the general ledger.
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Cost Accounting:
Definition
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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Cost Accounting:
Definition
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 package
Level 5
Level Of Effort
It 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
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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.
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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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