3.

COST CONTROL, MONITORING AND ACCOUNTING

3.1 THE COST CONTROL PROBLEM

During the execution of a project, procedures for project control and record keeping
become indispensable tools to managers and other participants in the construction
process.Cost control can be achieved by selecting the right man for the right job, the right
equipment and tools for the right work and the right quality of materials, in the right quantity,
from the right source, at the right price and delivered at the right time. Managers are expected
to be well equipped to execute the project, with due consideration to the quality of work, yet
within the estimated cost and limits. Here is a list of common cost control problems found
on construction projects:

Improper estimates, standards and budgeting techniques.

Unrealistic budgets.

Activities started or completed out of sequence.

Inadequate WBS (Work Breakdown Structure) or insufficient WBS detail.

Lack of management policy on control practices.

Poor corporate and project management governance structure and policies.

Reducing budgets or bids to be competitive.

Inadequate planning. This is very common, particularly on privately funded projects.

Unnoticed and uncontrolled increases are scope. The all too common “Scope Creep”.

Lack of comparison between “actual” and “planned” costs.

Unforeseen technical problems. Inadequate contingencies and management reserves.

Project schedule delays and lack of systems to flag and deal with delays.

Additional overtime and acceleration costs.

Escalation of material costs.

Contractual discrepancies and inconsistencies. These could result in gaps and ambiguities
in contracts which often result in cost increases and erosion of bargaining strength.

Unrealistic appraisal of in-house resources.

Improper assessment of risks by the bidding team and by executive management.

Excessive pressure on the bid team to WIN the project. ”Must win” projects are often
destined for eventual failure.

1
Table3.1 for techniques used I controlling the cost

3.1.1 Use of cost control:

Amount of detail and the time interval between cost control reports must be
considered, which is different according to the level of management for which they prepared.
For a site manager, it is necessary to receive the cost report on weekly basis. After preparing
the reports based on the cost data collected, it is important to project the costs into future and
to estimate of re-estimate the cost of the work yet to be completed. Any new information
must take into account since the commencement of the contract. The estimator would become
more reluctant in the future to use cost data that have been fed back from the site if an
adequate reporting system is used. In addition, the estimator can save time to determine
sufficient detail about the data and conditions they acquired.

There are two areas within to check whether the cost control reporting system is efficient or
not. First, is to check on the profitability of the work. The value of the work that will be
returned is compare with the cost of the work carried out. This is a straightforward
comparison between the valuation figure and the total expenditure to check on profit or loss if
no detailed cost control is used. The second would be check on the efficiency, carried out
against the standard of the output rates that were used by the estimator in compiling the
estimate. Efficiency is concerned with the site management and supervisory staff, whereas
the profitability is concerned with the contract management level and above.

2
 Upper levels of management will usually paid attention to the contracts that show minimum
or negative profitability. It is because they will have to investigate the costs in more detail to
locate the particular operations through inefficiency or under-pricing are the cause of the
problem.

3.1.2 Control of materials:

Controls of materials are not highly considered in creating cost control

systems. This is because that labour and plant are the areas that more variations exist and
most probably profit acquires or losses over the original estimated costs. Controls for
materials should be in terms of unit measurement and not in terms of cost.

In cases of deficit, one cannot be sure, if that the cost is basis, whether the material bought at
prices lower than estimate have a high wastage, or whether materials are economically, with
little wastage but bought in prices over the estimate. The cost comparison alone made for
materials would only indicate no true quantity of the rate of usage for the materials.

One easy way in controlling materials is to draw a graph of the quantities of various materials
that should have been used, which is calculated from present measurement of the quantities
of work carried out. A graph like this would be drawn for major items only. Against this
graph for each individual material can draw a second graph, indicates the quantities of,
materials that have been delivered to this site.

The information can get from the invoice received and a running total can easily be
maintained. The intercept on vertical ordinate between two graph should be equal in quantity
of the materials on site. It is necessary to check the stock on the site to make the comparison
effective, usually once a month. In large difference, it is necessary to check more often.

3.1.3 Standard cost and variance:

To provide useful analyse of cost data that has collected, there must be a
’standard’ available. Estimating possible outcome from historic performance and experience
usually sets standards in construction or in special cases from the use work measurements
techniques.

From estimated costs the initial budget can be ascertain and the variances between actual
and estimated is calculated. The variance is negative or unfavourable if the actual cost is
greater that the standard and in reverse situation the variance is favourable. Variances can
occur in two reasons:

a) The actual price paid for resources is greater or less than estimated in the standard.
b) The actual quantity of resource used is greater or less than estimated in the standard.

The two factors deserve consideration if the work is to be carried out at its budgeted cost.
Inefficiencies are important in terms of cost and attention can be paid on limited areas
where these inefficiencies exist when using the variance that occur because of price
differences and quantity differences.

3
 Actual cost (AC) = actual quantity (AQ) X actual price (AP).

Standard cost (SC) = standard quantity (SQ) X standard price (SP)

Total cost variance = standard cost (SC) – actual cost (AC)

= (SQ X SP) – (AQ X AP)

Variance analysis will first of all be applied to the purchase and use of materials.
There will usually be either a ‘material price variance’ or ‘material usage variance’. The
material price variance will amount to the difference between the standard and actual
prices for the quantity of materials used whereas the materials usage variance will be the
difference between the standard and actual quantities of materials used.

Material price variance = AQ (SP- AP)

Material usage variance = SP (SQ –AQ)

Material cost variance = SC -AC = (SQ X SP) – (AQ X AP)

3.1.4 Labour variance:

There are two variances in labour costs. There are ‘labour rate’ and ‘labour
efficiency’ variances. The labour rate variance occurs from the difference between the
standard wage rate and the actual wage rate paid.

Labour rate variance = actual time worked (standard – actual rate)

= AH (SH –AR)

The labour efficiency variance occurs from the difference between the actual time and the
standard time to do a job, which is measured at the standard rate.

Efficiency variance = standard rate (standard time – actual time)

= SR (SH –AH)

Therefore,

Labour cost variance = standard cost – actual cost

= SC – AC

= labour rate variance + labour efficiency variance

= AH(SH – AR) + SR(SH –AH)

= (standard hours X standard rate) – (actual hours X

actual rate)

4
 Effective cost and schedule control requires a good contractual agreement; an
acceptable scheduling system; an engineering resource plan relating personnel, time, and
cost; effective progress measurement, cost trending and forecasting systems, and a change
management system. Using a disciplined approach to contract management will provide
better project control and minimize the surprises having a negative impact on your project.

3.1.5 Construction participants:

The agencies supporting the construction industry include but are not limited to the
following:

a) Construction business promoters like government bodies, public and private

enterprises for real estates and industrial development and other similar agencies.
b) Construction management consultant firms.
c) Architect-engineer associates.
d) Construction manpower recruitment and training agencies.
e) Construction materials developing, manufacturing, stocking, transportation and
trading firms.
f) Construction plant and machinery manufacturing, distributing and repair and
maintenance organisations.
g) Banking and finance institutions.
h) Risk insurance and legal services companies.
i) Construction quality assurance and research and development establishment.
j) Constructors and contracting firms.

There are six main agencies actively associated with the execution of major works.There
are client construction management consultants, architects-engineering associates, financial
institutions, input suppliers and contractors.

3.1.6 construction management consultants:

The emerging trend these days among the clients is to hire the construction
management consultants for rendering certain services on current basis for the entire life of
the project. The nature of tasks assigned to this group by the clients varies, but it generally
includes the following:

a) Project feasibility, including cost estimates.

b) Sit survey and soil investigations.
c) Scrutiny and coordination of design and drawing work.
d) Estimating, initial planning and budgeting costs.
e) Processing pre-qualification of conduction agencies, tendering and awarding contracts
to the successful bidder’s
f) Designing project organisations for executing works and developing standard
operating procedures and systems.
g) Developing detailed construction plans, project schedules and performance measuring
standards.

5
 h) Supervising works, including administration of contracts and controlling of project
time, cost and quality objectives.

Fig 3.1 construction management

3.1.7 Contract:

An agreement enforceable by law is called contract. The contract invariably follows a

proposal from one party and its acceptance by the other. As per P.W.D., contract is an
undertaking by a person or firm to do some work under certain terms and conditions. The
work may be for the construction of maintenance and repairs, for the supply of materials, for
the supply of labours, for transport of materials etc.

Essential of contract:

Following are the main essentials requirements of a valid contract so that it may be
legally binding on both the parties.

a) Legally competent parties.

b) Free consent of the parties.
c) A lawful subject matter.
d) Proper and valid consideration.
e) Meaningful contract in writing signed by both parties.

6
Legally competent parties:

As per Indian Contract Act, the parties entering into contract should be legally
competent.

In general, anyone can make the contract provided he is of the age of majority and is of
sound mind. Signing officers should be in power to sign the contract i.e., no contracts shall be
made by a subordinate authority who has not been directed or authorised to do so.

Free consent of the parties:

In other words, it is called a genuine agreement or mutual assent between the two parties.
“It means concurring of two minds in respect of the same opinion, purpose or understanding
as regards the course to be pursued.” It is fundamental that there is no contract useless the
parties’ do the same thing in the same sense viz offer and acceptance. The consent of
contracting parties must be real and genuine. Contract is said to be free when;

i. It is not caused under influence. The relation between two parties is not such that one
of the parties is in a position to dominate the will of the others and uses the position to
obtain an unfair advantage over the other.
ii. It is not caused by MISTAKE. Where the parties have not meant the thing or though
meaning the same thing, have formed untrue conclusions as to the subject matter, it is
called MISTAKE. A mistake may be of expression, intention or omission.
iii. It is not caused by FRAUD. FRAUD is false representation of material facts
intentionally.
iv. It is not caused under DURESS. To constitute duress there must be some actual or
threatened exercise of power possessed by the party exacting or receiving the
payments, over the person or property of the one assenting, form which the latter had
no means of immediate relief other than giving the assent sought.

A lawful subject matter:

Contracts become invalid in the following cases:

i. When the proposed contract violates some law of the state or Indian union.
ii. When it is contrary to the rules of common law and when it is forbidden by the
responsibility by simply saying that he entered into the contract unknowingly, because
it is his duty to study the subject matter of the contract carefully before signing any
contract.

Proper and valid considerations:

The valid consideration in the legal sense can be defined as the act or a promise to do
something by a party in return of money or promise or grant of some interests by the other
party. In all engineering contracts, the contractors get money from the parties for whom the
work is done. Impossible promises or acts not entertained by the courts because there is no
valid consideration.

7
The consideration may not be adequate or a full return of the promise but it must be
competent, real and should not be illegal, ambiguous, impossible or uncertain.

Meaningful contract in writing signed by both parties:

Meaning of the agreement should be certain or capable of being made certain and
according to law the contract documents must be signed by the authorised persons of both the
parties. In case of public bodies, and official duly authorised for this purpose signs the
contract fixing the seal of the public body on the agreement.

3.1.7.1 Types of contracts:

The following are the various types of contracts for execution of Civil
Engineering works,

1. Item Rate Contract.

2. Percentage Rate Contract.
3. Lump-sum Contract.
4. Labour contract.
5. Material supply contract.
6. Cost plus percentage rate contract.
7. Cost plus sliding or fluctuating fee-scale contract.
8. Target contract.
9. Negotiated contract.

3.1.8 Contract documents:

When the tender of a contractor is accepted, an agreement between the

contractor and the owner takes place. The following documents defining the rights and
obligation of the owner and the contractor are attached to the agreement bond and this is
called contract document. Each page of it bears the signature of the contractor and the
accepting authority and all corrections are also similarly initialled. The contract documents
contains.

1. Title page.
2. Index page.
3. Tender inviting notice (NIT).
4. Tender form
5. Schedule of issue of materials.
6. Drawings
7. Specifications
8. Conditions of contract.
9. Special conditions.

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 3.1.9 TENDER:

Tender is an offer in writing to excuse some specified work at certain rates, which within a
fixed time under certain conditions of contract and agreement between contractor and owner.

3.1.9.1 Tender form:

Tender form is a printed standard form giving the bill of quantities,

contractor’s rates and cost of work, Estimated money, Security deposit, Time allowed for the
work, Columns for signature of contractor, signature of witness to contractor’s signature and
signature of the officer. This is a part of tender document.

3.1.9.2 Tender-documents:

The following items constitute a tender document which is signed by a

contractor page by page, necessary entries are made and a forwarding letter n letter head of a
contractor with bank draft for the earnest money. These time limits for the submission of a
tender. The name of work and name of the contractor are subscribed on the cover:

i. The Notice Inviting Tender (N.I.T).

ii. Tender form
iii. Schedule of quantities of work to be done, tools and plants to be supplied by the
department, if any.
iv. General and special conditions of contract.
v. Complete specifications.
vi. One set of drawings where necessary.

3.1.9.3 Tender notice:

Tender notice is issued in the prescribed form for calling tenders ofr execution
of some works. The following information’s are furnished in the tender notice.

i. Name of the authority or department inviting tenders.

ii. Name of work and its location.
iii. Estimated cost.
iv. Time of completion.
v. Cost of tender form and conditions of contract.
vi. Date, time and place of opening the tenders.
vii. Earnest money and security money.
viii. Validity of tender, etc.

Tender notice is advertised in all the leading newspapers and also pasted on the notice
boards of the department inviting tenders.

3.1.9.4 A Typical tender notice:

A typical notice inviting tenders is given below. The blank spaces are to be
filled up by a party who invites tenders.

9
N.I.T

Tender No………….

1. Sealed Tenders are invited for the following work,

Name of work……Estimated cost….. Price of tender form….Earnest
money………..Time completion…………..
2. Tender form and other documents can be obtained form the office of the Executive
Engineer………….Division everyday (except Sundays and holidays0 from…..AM
to…PM at a charge of Rs……per set.
3. Each tender must be accomplished by a deposit of Rs………..as earnest money in the
form of cash or treasury challan or post office or saving bank deposit of N.S.C.
pledged to the Executive Engineer.
4. Tenders will be received in the tender box by Executive Engineer up to……PM and
will be opened at……….on the same date.
5. The authority reserves the right to reject any tender/all tenders without assigning any
reasons.
6. The rate should be quoted in the bill quantities, legibly both in figures and words.

Signature

Executive Engineer

Date……. or

Authority in charge

Division………..

Place……….

Tender notice includes many number of information’s and conditions in addition to a

few mentioned in the typical tender notice viz., refund of earnest money, period of validity of
rates quoted, site inspection, near relative of a contractor, rates to include all taxes, (about 2%
of gross amount) source and specifications of materials, change of address etc. when tender
form is obtained from the office, the tender notice will include all such particulars. These
items are not given in contract document. Hence the tender notice paper is very important
document on which the subsequent agreements with the contractors are based. Therefore it is
necessary that the tender notice must be included in the contract document.

Global tender:

For very large and highly specialise jobs, the authority concerned invites tenders globally to
get competitive offers form various specialised or reputed agencies throughout the world. The
contents and particulars of global tender are same as that of any ordinary tender notice. Only
the global tender notice is written under the heading of N.I.T. it is circulated to reputed
newspapers which cover the outside countries as well as embassy officers located in
important countries throughout the globe.

10
Informal tender:

A tender is said to be informal:

i. When it is not submitted in the form sold for the purpose.

ii. When it is not supported by earnest money.
iii. When it is not properly filled up.

Unbalanced tender:

Particularly for item rate contract, if a contractor, on the basis of shrewd anticipation
or from outside information, may quote high rate for items of work which are likely to be
increased and low rate for those item of works which are likely to decreased, it is called
unbalanced tender.

3.1.10 Engineering Economy

The economy study is an aid for making realistic and practical decision on the
part of engineers.

The concept of economy study may be summarized with the following points:

a) All alternatives physically capable of achieving the design objective should be clearly
defined.
b) The physical Consequences of each alternative should be identified and evaluated in
terms of money units.
c) The difference between alternatives should be the basis for comparison.
d) The alternatives be compared on a uniform basis as interest rate, period of analysis
and unit cost etc.

Interest and interest formulae

Interest

The term is used to designate a rental for the use of money. Fundamentally, the rental
paid for the use of equipment, building, etc. is essentially the same as interest paid for the use
of capital.

Interest rate

An interest rate is the ratio of the gain received from an investment over a period of
time, usually 1 year and the investment is usually taken as Rs 100. It is expressed in the
percentage form and designated as “i”.

Time value of money

Time value of money means that two equal amount at different points of time do not
equal value if the interest rate is greater than zero. It iis the relationship between interest and
time that leads to the concept of ‘The time value of money’. For example rupee in hand now

11
can accumulate interest for investing period while a rupee received at the end of the the
investing period will not yield any return.

Simple interest

When the total interest earned or charged is directly proportional to the

principal involved, the interest rate and the no. of interest periods for which the principal is
committed, the interest is called simple interest.

I = (P) (n) (i)

where I = Total interest

P = principal amount lend or borrowed

n = No. of years(interest period)

I = interest rate per year

Compound interest

Wherever the interest rate change for any interest period is based on the remaining
principle amount plus any amount plus any accumulated interest changes upto the beginning
of the period, the interest is said to be compound. Compound interest is much more common
in practice than a simple interest and is used in book.

Notations and cash flow diagram

The following notations we throughout this book for compound interest calculations.

I = annual interest rate

N = the no. of annual interest periods

P = present sum of money i.e., Present worth at zero time

F = Future sum of money i e. Future worth equal to the Compound amount at the end
of n years

A = a single payment, in a series of n equal payments, made at the end of each annual
interest period

G = uniform period- by-period increase or decrease in amount (the arithmetic

gradient)

cash flow diagram

The use of cash flow diagram is strongly recommended for situations in which the analyst
needs to visualize what is involved when flows of money occur at various times. Indeed, the
usefulness of cash flow diagram for economic analysis problems is analogous to that of the
free body diagrams of engineering mechanics problems.

12
So the graphic presentation of each value plotted at appropriate time is called a cash flow
diagram. The normal conventions for cash flow diagrams are as follows;

a) The horizontal line is a time scale with progression of time moving from left to right.
The value indicated on time scale (viz., 0, 1, 2, indicates the end of the respective period.

b) The arrows signify cash flow, normally downward arrows represent disbursement or
costs and upward arrows represent receipts or benefits.

3.1.11 Comparision of alternativies

In engineering economy, the prospective receipts and disbursements of two or

more alternative proposals must be placed on an equivalent basis for comparison. This may
be accomplished by proper use of interest formulae developed. The most common basis for
comparison are

A) The present worth amount

B) The annual equivalent amount
C) The capitalized amount
D) The rate of return method

A) The Present Worth amount

The method is described as follows,

1) Indicate all expenses and benefits at appropriate point or time in the form of cash flow
separately for each alternative; Represent downward arrows for expenses (costs) and
upward arrows for benefits or savings. In the algebraic expression + sign for expenses
and “-ve” sign for benefits.
2) Shift the amount at zero time by using proper interest formulae and find total present
worth amount of each alternative and compare. There may be two cases.

Case I.When service life of each alternative is same.

Item no. (ii) Will clearly indicate which alternative has lower present worth. The alternative
having lower present worth is economically accepted.

Case II.When service life of alternatives is different.

The cycle of item no. (ii) is repeated till the common Service life is obtained. The common
life is taken as the LCM value of a given lives. The overall present worth of alternatives are
obtained and then compared lot the selection of economical alternative.

B)Annual Equivalent Amount

The annual equivalent amount is another basis for comparison that has characteristics
similar to the present worth amount, The cash flows is converted into a series of equal annual
amount by first calculating worth amount for the original series and then multiplying, it with

13
capital recovery factor (A\P , I, n) . The comparison is made by seeing annual equivalent
amount of each alternative.

C) The Capitalized Amount

The annual equivalent amount obtained is assumed to extend for infinite period and the
capitalized amount is obtained by using(A\i). The equivalent annual amount is calculated for
replacement and maintenance cost and added to the initial cost of the alternative.

D) Rate of Return Method

It is defined as the interest rate that reduces the present worth amount of a series of
receipts and disbursements to zero for each alternative. In economic terms, the fundamental
concept of rate of return is that it is the rate of interest earned on the unrecovered balance
of an investment so that the un recovered balance is zero at end of investment life.

The computation of rate of return generally requires a trial and error solution until the
‘ i*’ can be interpolated. The common convention used is ‘+’ sign for each inflows and ‘-’
signs for cash outflows.

3.1.12 BREAK EVEN ANALYSIS

Break even analysis is used for both engineering and business enterprises.

BEA for both business and engineering decision making process for selection of
various alternatives. BEA implies that some point in the business operations, total revenue
equals total cost. Basically, even analysis is concerned with finding the point at which
revenue and cost agree exactly, hence the term Breakeven (point). The BEP is therefore the
volume of output at which neither profit nor a loss is incurred. If the production rate is greater
than of BEP, A profit will result. When the rate is less than that of (BEP), a loss will be
sustained.

Fig 3.2 Break even analysis

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Functions of Break Even Chart

The various functions of Break Even Chart ace as follows,

i) It is an important tool of business management and it gives crystal clear view of the
position of a business.

ii) BEP of the chart marks clearly no profit no loss situation

iii) It is useful in understanding the effects of variations of fixed cost, variable cost
and revenue on the profitability of a business. So it is used to portray the effects of proposed
changes in operational policy,

iv) Angle of incidence and margin of safety indicates the business position whether
favourable or unfavourable.

v) It indicates likely profit or losses at various outputs levels.

vi) It is a decision making tool in the hands of management.

Limitations of breakeven chart:-

i) When the market conditions may not remain constant over the range of projected
capacity it becomes difficult to classify the costs as fixed or variable, the BEP
may not portray the true picture.

ii) The break even chart is a tool for a short run analysis.

iii) The total cost line (sum of variable cost and fixed cost) need not be straight line.
In actual practice, costs do not vary in direct proportion.

iv) The revenue line may also not be a straight line.

v) It represents a static picture whereas business operations are very much dynamic

vi) Analysis of break-even chart presents additional difficulty when a company

produces a variety of products.

3.1.12 Depreciation

Depreciation is defined as the loss in value of an asset with the passage of

time. This loss must be realized during the life of the asset with a reasonable amount of profit
on it. A reserve fund should be created to realize the cost of asset at the end of its life and it
must not be confused with the profit. The main purpose of the depreciation is to provide for
the recovery of capital that has been involved in the possession of physical property.

15
Types of depreciation

A common classification of depreciation is as fallows;

a) Physical depreciation
b) Functional depreciation
c) Contingent depreciation
j) Physical depreciation

Depreciation resulting in physical impairment of an asset is known as physical

depreciation. This results in lowering the ability of the asset to render its intended service.
The primary cause of physical depreciation is wear and tear because of its constant use such
as abrasion, shocks, vibrations, impact etc. and the deterioration due to action of elements
such as corrosion of pipe, chemical decomposition.

ii) Functional Depreciation

Functional depreciatioon often called OBSOLESCENE is defined as the loss in the

vaIue of the property due to change in fashion, design or structure or due to inadequacy to
meet the growing demand, necessity for replacement due to new invention being more
economical and more efficient etc.

iii)Contingent depreciation

I) accidents (due to negligence)

II) Diseases (pollution of water, parasites)

III) Diminution of supply (natural gas, electricity, water etc.)

Difference between Depreciation and Obsolescence

Depreciation Obselesene

i) This is the physical loss in the value of i) This is the functional loss in the value of
property due to wear and tear and decay etc. the property due to change in design,
structure, fashion, utility, demand etc.

ii) It depends upon its original condition, ii) It depends upon the technological
quality of maintenance and mode of use. advancement, art etc.

iii) It varies with age. iii) Not dependent on age.

iv) There are several methods for calculating iv) No method is available for calculation of
the amount of depreciation. obsolescence.

16
 3.1.13 Salvage value (or resale value)
It is the value of the property at the end of its utility period without being
dismantled. Salvage value implies that the property has further utility. It is affected by several
factors. The reason of the present owner for selling may influence the salvage value. If the
owner is selling because there is very little commercial need for the property, this will affect
the resale value. It is also affected by the present cost of reproducing units and the price level
of the unit may either increase or decrease the resale value. It is affected by the location of
the property. The physical condition of property will also have a great influence upon the
resale price that can be obtained. A structure that has been well maintained and carefully
handled will fetch more salvage value.

Scrap value
The value of a property realised when it becomes absolutely useless except for sale as
junk is its scrap value. The utility of the article is assumed to be zero.

Book value
It is defined as the value of the property shown in the account books in that particular
year i.e. the original cost less total depreciation till that year.

3.1.13 Methods for calculating depreciation

There are several methods of calculating depreciation. Some of them are
simple and used regularly whereas some are relatively uncommon. The following notations
have been used;
Ci- Initial cost of an asset at zero time.

(This will include the cost of asset + transporting charge + installation and other charges
spent initially)

Cs - Salvage value (or scrpe value) to be estimated at the end of utility Period.

`n = The life of the asset.

Bm = Book value at the end of period '

Dm =Depreciation charge during the period 'W.

i) Straight line method

In this method, the property is assumed to lose, value by a constant amount every
year. At the end of the life, the salvage value (or scrap value) is left. This method is
recommended for all the equipment’s/assets which have constant demand and do not face any
obsolescence during their useful life. It is widely used in the case of all civil engineering
appliances and applications.

ii) Declining balance method (or constant percentage method)

In this method, the property is assumed to lose value annually at a constant percentage
of its book value.
17
 Let FDB be the fixed percentage

D1 = Depreciation for 1st year = Ci x FDB

B1 = Book value at end of Ist year = - Ci – Ci x FDB = Ci(1 -FDB)

D2 = Depreciation for 2nd year = Book value at beginning of 2nd year X FDB

3.2 THE PROJECT BUDGET

For cost control on a project, the construction plan and the associated cash flow
estimates can provide the baseline reference for subsequent project monitoring and control.
For schedules, progress on individual activities and the achievement of milestone
completions can be compared with the project schedule to monitor the progress of activities.
Contract and job specifications provide the criteria by which to assess and assure the required
quality of construction. The final or detailed cost estimate provides a baseline for the
assessment of financial performance during the project. To the extent that costs are within the
detailed cost estimate, then the project is thought to be under financial control. Overruns in
particular cost categories signal the possibility of problems and give an indication of exactly
what problems are being encountered. Expense oriented construction planning and control
focuses upon the categories included in the final cost estimation. This focus is particular
relevant for projects with few activities and considerable repetition such as grading and
paving roadways.

For control and monitoring purposes, the original detailed cost estimate is typically
converted to a project budget, and the project budget is used subsequently as a guide for
management. Specific items in the detailed cost estimate become job cost elements. Expenses
incurred during the course of a project are recorded in specific job cost accounts to be
compared with the original cost estimates in each category. Thus, individual job cost
accounts generally represent the basic unit for cost control. Alternatively, job cost accounts
may be disaggregated or divided into work elements which are related both to particular
scheduled activities and to particular cost accounts.

In addition to cost amounts, information on material quantities and labour inputs

within each job account is also typically retained in the project budget. With this information,
actual materials usage and labour employed can be compared to the expected requirements.
As a result, cost overruns or savings on particular items can be identified as due to changes in
unit prices, labour productivity or in the amount of material consumed.

The number of cost accounts associated with a particular project can vary
considerably. For constructors, on the order of four hundred separate cost accounts might be
used on a small project. These accounts record all the transactions associated with a project.
Thus, separate accounts might exist for different types of materials, equipment use, payroll,
project office, etc. Both physical and non-physical resources are represented, including
overhead items such as computer use or interest charges. Table 1-1 summarizes a typical set

18
of cost accounts that might be used in building construction. Note that this set of accounts is
organized hierarchically, with seven major divisions (accounts 201 to 207) and numerous
sub-divisions under each division. This hierarchical structure facilitates aggregation of costs
into pre-defined categories; for example, costs associated with the superstructure (account
204) would be the sum of the underlying subdivisions (i.e. 204.1, 204.2, etc.) or finer levels
of detail (204.61, 204.62, etc.). The sub-division accounts in Table 3.2 could be further
divided into personnel, material and other resource costs for the purpose of financial
accounting.

TABLE 3.2 Illustrative Set of Project Cost Accounts

201 Clearing and Preparing Site
202 Substructure
202.1 Excavation and Shoring
202.2 Piling
202.3 Concrete Masonry
202.31 Mixing and Placing
202.32 Formwork
202.33 Reinforcing
203 Outside Utilities (water, gas, sewer, etc.)
204 Superstructure
204.1 Masonry Construction
204.2 Structural Steel
204.3 Wood Framing, Partitions, etc.
204.4 Exterior Finishes (brickwork, terra cotta, cut stone, etc.)
204.5 Roofing, Drains, Gutters, Flashing, etc.
204.6 Interior Finish and Trim
204.61 Finish Flooring, Stairs, Doors, Trim
204.62 Glass, Windows, Glazing
204.63 Marble, Tile, Terrazzo
204.64 Lathing and Plastering
204.65 Soundproofing and Insulation
204.66 Finish Hardware
204.67 Painting and Decorating
204.68 Waterproofing
204.69 Sprinklers and Fire Protection
204.7 Service Work
204.71 Electrical Work
204.72 Heating and Ventilating
204.73 Plumbing and Sewage
204.74 Air Conditioning
204.72 Fire Alarm, Telephone, Security, Miscellaneous
205 Paving, Curbs, Walks
206 Installed Equipment (elevators, revolving doors, mail chutes, etc.)
207 Fencing

In developing or implementing a system of cost accounts, an appropriate numbering

or coding system is essential to facilitate communication of information and proper
aggregation of cost information. Particular cost accounts are used to indicate the expenditures

19
associated with specific projects and to indicate the expenditures on particular items
throughout an organization. These are examples of different perspectives on the same
information, in which the same information may be summarized in different ways for specific
purposes. Thus, more than one aggregation of the cost information and more than one
application program can use a particular cost account. Separate identifiers of the type of cost
account and the specific project must be provided for project cost accounts or for financial
transactions. As a result, a standard set of cost codes such as the MASTERFORMAT codes
may be adopted to identify cost accounts along with project identifiers and extensions to
indicate organization or job specific needs. Similarly the use of databases or, at a minimum,
inter-communicating applications programs facilitate access to cost information.

Converting a final cost estimate into a project budget compatible with an

organization's cost accounts is not always a straightforward task. Cost estimates are generally
disaggregated into appropriate functional or resource based project categories. For example,
labour and material quantities might be included for each of several physical components of a
project. For cost accounting purposes, labour and material quantities are aggregated by type
no matter for which physical component they are employed. For example, particular types of
workers or materials might be used on numerous different physical components of a facility.
Moreover, the categories of cost accounts established within an organization may bear little
resemblance to the quantities included in a final cost estimate. This is particularly true when
final cost estimates are prepared in accordance with an external reporting requirement rather
than in view of the existing cost accounts within an organization.

One particular problem in forming a project budget in terms of cost accounts is the
treatment of contingency amounts. These allowances are included in project cost estimates to
accommodate unforeseen events and the resulting costs. However, in advance of project
completion, the source of contingency expenses is not known. Realistically, a budget
accounting item for contingency allowance should be established whenever a contingency
amount was included in the final cost estimate.

3.3 FORECASTING FOR ACTIVITY COST CONTROL

For the purpose of project management and control, it is not sufficient to consider
only the past record of costs and revenues incurred in a project. Good managers should focus
upon future revenues, future costs and technical problems. For this purpose, traditional
financial accounting schemes are not adequate to reflect the dynamic nature of a project.
Accounts typically focus on recording routine costs and past expenditures associated with
activities. Generally, past expenditures represent sunk costs that cannot be altered in the
future and may or may not be relevant in the future. For example, after the completion of
some activity, it may be discovered that some quality flaw renders the work useless.
Unfortunately, the resources expended on the flawed construction will generally be sunk and
cannot be recovered for re-construction (although it may be possible to change the burden of
who pays for these resources by financial withholding or charges; owners will typically
attempt to have constructors or designers pay for changes due to quality flaws). Since

20
financial accounts are historical in nature, some means of forecasting or projecting the future
course of a project is essential for management control. An example of forecasting used to
assess the project status is shown in Table 3.3. In this example, costs are reported in five
categories, representing the sum of all the various cost accounts associated with each
category:

• Budgeted Cost: The budgeted cost is derived from the detailed cost estimate prepared
at the start of the project. The factors of cost would be referenced by cost account and
by a prose description.
• Estimated total cost: The estimated or forecast total cost in each category is the
current best estimate of costs based on progress and any changes since the budget was
formed. Estimated total costs are the sum of cost to date, commitments and exposure.
Methods for estimating total costs are described below.
• Cost Committed and Cost Exposure: Estimated cost to completion in each category
in divided into firm commitments and estimated additional cost
or exposure. Commitments may represent material orders or subcontracts for which
firm dollar amounts have been committed.
• Cost to Date: The actual cost incurred to date is recorded in column 6 and can be
derived from the financial record keeping accounts.
• Over or (Under): A final column in Table 3.3 indicates the amount over or under the
budget for each category. This column is an indicator of the extent of variance from
the project budget; items with unusually large overruns would represent a particular
managerial concern. Note that variance is used in the terminology of project control
to indicate a difference between budgeted and actual expenditures. The term is
defined and used quite differently in statistics or mathematical analysis. In Table 3.3,
labour costs are running higher than expected, whereas subcontracts are less than
expected.

The current status of the project is a forecast budget overrun of Rs.5, 950. With 23 % of
the budgeted project costs incurred to date.

TABLE 3.3 Illustration of a Job Status Report

Budgeted Estimated Cost Cost Cost To Over or
Factor Cost Total Cost Committed Exposure Date (Under)
Labour Rs.99,406 Rs.102,342 Rs.49,596 --- Rs.52,746 Rs.2,936
Material 88,499 88,499 42,506 45,993 --- 0
Subcontracts 198,458 196,323 83,352 97,832 15,139 (2,135)
Equipment 37,543 37,543 23,623 --- 13,920 0
Other 72,693 81,432 49,356 --- 32,076 8,739
Total 496,509 506,139 248,433 143,825 113,881 5,950

For project control, managers would focus particular attention on items indicating
substantial deviation from budgeted amounts. In particular, the cost overruns in the

21
labourandin the "other expense category would be worthy of attention by a project manager
in Table 3.3. A next step would be to look in greater detail at the various components of these
categories. Overruns in cost might be due to lower than expected productivity, higher than
expected wage rates, higher than expected material costs, or other factors. Even further, low
productivity might be caused by inadequate training, lack of required resources such as
equipment or tools, or inordinate amounts of re-work to correct quality problems. Review of
a job status report is only the first step in project control.

The job status report illustrated in Table 3.3 employs explicit estimates of ultimate
cost in each category of expense. These estimates are used to identify the actual progress and
status of expense category. Estimates might be made from simple linear extrapolations of the
productivity or cost of the work to date on each project item. Algebraically, a linear
estimation formula is generally one of two forms. Using a linear extrapolation of costs, the
forecast total cost, Cf , is:

where Ct is the cost incurred to time t and pt is the proportion of the activity completed at
time t. For example, an activity which is 50 percent complete with a cost of Rs.40,000 would
be estimated to have a total cost of Rs.40,000/0.5 = Rs.80,000. More elaborate methods of
forecasting costs would disaggregate costs into different categories, with the total cost the
sum of the forecast costs in each category.

Alternatively, the use of measured unit cost amounts can be used for forecasting total cost.
The basic formula for forecasting cost from unit costs is:

whereCf is the forecast total cost, W is the total units of work, and ct is the average cost per
unit of work experienced up to time t. If the average unit cost is Rs.50 per unit of work on a
particular activity and 1,600 units of work exist, then the expected cost is (1,600)(50) =
Rs.80,000 for completion.

The unit cost in Equation (12.2) may be replaced with the hourly productivity and the unit
cost per hour (or other appropriate time period), resulting in the equation:

Where the cost per work unit (ct) is replaced by the time per unit, ht, divided by the cost per
unit of time, ut.

22
More elaborate forecasting systems might recognize peculiar problems associated with work
on particular items and modify these simple proportional cost estimates. For example, if
productivity is improving as workers and managers become more familiar with the project
activities, the estimate of total costs for an item might be revised downward. In this case, the
estimating equation would become:

where forecast total cost, Cf, is the sum of cost incurred to date, Ct, and the cost resulting
from the remaining work (W - Wt) multiplied by the expected cost per unit time period for
the remainder of the activity, ct.

As a numerical example, suppose that the average unit cost has been Rs.50 per unit of work,
but the most recent figure during a project is Rs.45 per unit of work. If the project manager
was assured that the improved productivity could be maintained for the remainder of the
project (consisting of 800 units of work out of a total of 1600 units of work), the cost estimate
would be (50) (800) + (45)(800) = Rs.76,000 for completion of the activity. Note that this
forecast uses the actual average productivity achieved on the first 800 units and uses a
forecast of productivity for the remaining work. Historical changes in productivity might also
be used to represent this type of non-linear changes in work productivity on particular
activities over time.

In addition to changes in productivities, other components of the estimating formula can be

adjusted or more detailed estimates substituted. For example, the change in unit prices due to
new labour contracts or material supplier's prices might be reflected in estimating future
expenditures. In essence, the same problems encountered in preparing the detailed cost
estimate are faced in the process of preparing exposure estimates, although the number and
extent of uncertainties in the project environment decline as work progresses. The only
exception to this rule is the danger of quality problems in completed work which would
require re-construction.

Each of the estimating methods described above require current information on the state of
work accomplishment for particular activities. There are several possible methods to develop
such estimates, including.

• Units of Work Completed: For easily measured quantities the actual proportion of
completed work amounts can be measured. For example, the linear feet of piping
installed can be compared to the required amount of piping to estimate the percentage
of piping work completed.
• Incremental Milestones: Particular activities can be sub-divided or "decomposed"
into a series of milestones, and the milestones can be used to indicate the percentage
of work complete based on historical averages. For example, the work effort involved
with installation of standard piping might be divided into four milestones:

23
 o Spool in place: 20% of work and 20% of cumulative work.
o Ends welded: 40% of work and 60% of cumulative work.
o Hangars and Trim Complete: 30% of work and 90% of cumulative work.
o Hydro-tested and complete: 10% of work and 100% of cumulative work.

Thus, a pipe section for which the ends have been welded would be reported as
60% complete.

• Opinion: Subjective judgments of the percentage complete can be prepared by

inspectors, supervisors or project managers themselves. Clearly, this estimated
technique can be biased by optimism, pessimism or inaccurate observations.
Knowledgeable estimators and adequate field observations are required to obtain
sufficient accuracy with this method.
• Cost Ratio: The cost incurred to date can also be used to estimate the work progress.
For example, if an activity was budgeted to cost Rs.20,000 and the cost incurred at a
particular date was Rs.10,000, then the estimated percentage complete under the cost
ratio method would be 10,000/20,000 = 0.5 or fifty percent. This method provides no
independent information on the actual percentage complete or any possible errors in
the activity budget: the cost forecast will always be the budgeted amount.
Consequently, managers must use the estimated costs to complete an activity derived
from the cost ratio method with extreme caution.

Systematic application of these different estimating methods to the various project

activities enables calculation of the percentage complete or the productivity estimates used in
preparing job status reports.

In some cases, automated data acquisition for work accomplishments might be instituted.
For example, transponders might be moved to the new work limits after each day's activity
and the new locations automatically computed and compared with project plans. These
measurements of actual progress should be stored in a central database and then processed for
updating the project schedule. The use of database management systems in this fashion.

Example3.1: Estimated Total Cost to Complete an Activity

Suppose that we wish to estimate the total cost to complete piping construction activities on a
project. The piping construction involves 1,000 linear feet of piping which has been divided
into 50 sections for management convenience. At this time, 400 linear feet of piping has been
installed at a cost of Rs.40,000 and 500 man-hours of labour. The original budget estimate
was Rs.90,000 with a productivity of one foot per man-hour, a unit cost of Rs.60 per man
hour and a total material cost of Rs. 30,000. Firm commitments of material delivery for the
Rs.30,000 estimated cost have been received.

The first task is to estimate the proportion of work completed. Two estimates are readily
available. First, 400 linear feet of pipe is in place out of a total of 1000 linear feet, so the

24
proportion of work completed is 400/1000 = 0.4 or 40%. This is the "units of work
completed" estimation method. Second, the cost ratio method would estimate the work
complete as the cost-to-date divided by the cost estimate or Rs.40,000/Rs. 90,000 = 0.44 or
44%. Third, the "incremental milestones" method would be applied by examining each pipe
section and estimating a percentage complete and then aggregating to determine the total
percentage complete. For example, suppose the following quantities of piping fell into four
categories of completeness:

complete(100%) 380 ft.

hangars and trim complete (90%) 20 ft.
ends welded (60%) 5 ft.
spool in place (20%) 0 ft.

Then using the incremental milestones shown above, the estimate of completed work would
be 380 + (20)(0.9) + (5)(0.6) + 0 = 401 ft and the proportion complete would be 401 ft/1,000
ft = 0.401 or 40% after rounding.

Once an estimate of work completed is available, then the estimated cost to complete the
activity can be calculated. First, a simple linear extrapolation of cost results in an estimate of
Rs.40,000/0.4 = Rs.100,000. for the piping construction using the 40% estimate of work
completed. This estimate projects a cost overrun of 100,000 - 90,000 = Rs.10,000.

Second, a linear extrapolation of productivity results in an estimate of (1000 ft.)(500 hrs./400

ft.)(Rs.60/hr.) + 30,000 = Rs.105,000. for completion of the piping construction. This
estimate suggests a variance of 105,000 - 90,000 = Rs.15,000 above the activity estimate. In
making this estimate, labour and material costs entered separately, whereas the two were
implicitly combined in the simple linear cost forecast above. The source of the variance can
also be identified in this calculation: compared to the original estimate, the labour
productivity is 1.25 hours per foot or 25% higher than the original estimate.

Example 3.2: Estimated Total Cost for Completion

The forecasting procedures described above assumed linear extrapolations of future

costs, based either on the complete experience on the activity or the recent experience. For
activities with good historical records, it can be the case that a typically non-linear profile of
cost expenditures and completion proportions can be estimated. Figure 3.3 illustrates one
possible non-linear relationships derived from experience in some particular activity. The
progress on a new job can be compared to this historical record. For example, point A in
Figure 3.3 suggests a higher expenditure than is normal for the completion proportion. This
point represents 40% of work completed with an expenditure of 60% of the budget. Since the
historical record suggests only 50% of the budget should be expended at time of 40%
completion, a 60 - 50 = 10% overrun in cost is expected even if work efficiency can be
increased to historical averages. If comparable cost overruns continue to accumulate, then the
cost-to-complete will be even higher.

25
Fig. 3.2 Illustration of Proportion Completion versus Expenditure for an Activity

3.4 FINANCIAL ACCOUNTING SYSTEMS AND COST ACCOUNTS

The cost accounts described in the previous sections provide only one of the various
components in a financial accounting system. Before further discussing the use of cost
accounts in project control, the relationship of project and financial accounting deserves
mention. Accounting information is generally used for three distinct purposes:

• Internal reporting to project managers for day-to-day planning, monitoring and

control.
• Internal reporting to managers for aiding strategic planning.
• External reporting to owners, government, regulators and other outside parties.

External reports are constrained to particular forms and procedures by contractual reporting
requirements or by generally accepted accounting practices. Preparation of such external
reports is referred to as financial accounting. In contrast, cost or managerial accounting is
intended to aid internal managers in their responsibilities of planning, monitoring and control.

Project costs are always included in the system of financial accounts associated with an
organization. At the heart of this system, all expense transactions are recorded in a general
ledger. The general ledger of accounts forms the basis for management reports on particular
projects as well as the financial accounts for an entire organization. Other components of a
financial accounting system include:

• The accounts payable journal is intended to provide records of bills received from
vendors, material suppliers, subcontractors and other outside parties. Invoices of
charges are recorded in this system as are checks issued in payment. Charges to
individual cost accounts are relayed or posted to the General Ledger.

26
 • Accounts receivable journals provide the opposite function to that of accounts
payable. In this journal, billings to clients are recorded as well as receipts. Revenues
received are relayed to the general ledger.
• Job cost ledgers summarize the charges associated with particular projects, arranged
in the various cost accounts used for the project budget.
• Inventory records are maintained to identify the amount of materials available at any
time.

In traditional bookkeeping systems, day to day transactions are first recorded in journals.
With double-entry bookkeeping, each transaction is recorded as both a debit and a credit to
particular accounts in the ledger. For example, payment of a supplier's bill represents a debit
or increase to a project cost account and a credit or reduction to the company's cash account.
Periodically, the transaction information is summarized and transferred to ledger accounts.
This process is called posting, and may be done instantaneously or daily in computerized
systems.

In reviewing accounting information, the concepts of flows and stocks should be kept in
mind. Daily transactions typically reflect flows of dollar amounts entering or leaving the
organization. Similarly, use or receipt of particular materials represents flows from or to
inventory. An account balance represents the stock or cumulative amount of funds resulting
from these daily flows. Information on both flows and stocks are needed to give an accurate
view of an organization's state. In addition, forecasts of future changes are needed for
effective management.

Information from the general ledger is assembled for the organization's financial reports,
including balance sheets and income statements for each period. These reports are the basic
products of the financial accounting process and are often used to assess the performance of
an organization. Table3.4 shows a typical income statement for a small construction firm,
indicating a net profit of Rs. 330,000 after taxes. This statement summarizes the flows of
transactions within a year. Table 3.5 shows the comparable balance sheet, indicated a net
increase in retained earnings equal to the net profit. The balance sheet reflects the effects of
income flows during the year on the overall worth of the organization.

TABLE 3.4 Illustration of an Accounting Statement of Income

Income Statement
for the year ended December 31, 19xx
Gross project revenues Rs.72, 00,000

Direct project costs on contracts 55, 00,000

Depreciation of equipment 2, 00,000
Estimating 1, 50,000
Administrative and other expenses 6, 50,000
Subtotal of cost and expenses 65, 00,000

Operating Income 7, 00,000

Interest Expense, net 1, 50,000

27
 Income before taxes 5, 50,000
Income tax 2, 20,000
Net income after tax 3, 30,000
Cash dividends 1, 00,000
Retained earnings, current year 2, 30,000
Retention at beginning of year 6, 50,000
Retained earnings at end of year Rs.8, 80,000.

TABLE 3.5 Illustration of an Accounting Balance Sheet

Balance Sheet
December 31, 19xx
Assets Amount
Cash Rs.1, 50,000
Payments Receivable 7, 50,000
Work in progress, not claimed 7, 00,000
Work in progress, retention 2, 00,000
Equipment at cost less accumulated 14, 00,000
depreciation Rs.32,
Total assets 00,000
Liabilities and Equity

Liabilities
Rs.9, 50,000
Accounts payable
50,000
Other items payable (taxes, wages, etc.)
5, 00,000
Long term debts
15, 00,000
Subtotal
Shareholders' funds
40,000 shares of common stock
8, 20,000
(Including paid-in capital)
8, 80,000
Retained Earnings
17, 00,000
Subtotal
Rs.32,
Total Liabilities and Equity
00,000

In the context of private construction firms, particular problems arise in the treatment
of uncompleted contracts in financial reports. Under the "completed-contract" method,
income is only reported for completed projects. Work on projects underway is only reported
on the balance sheet, representing an asset if contract billings exceed costs or a liability if
costs exceed billings. When a project is completed, the total net profit (or loss) is reported in
the final period as income. Under the "percentage-of-completion" method, actual costs are

28
reported on the income statement plus a proportion of all project revenues (or billings) equal
to the proportion of work completed during the period. The proportion of work completed is
computed as the ratio of costs incurred to date and the total estimated cost of the project.
Thus, if twenty percent of a project was completed in a particular period at a direct cost of
Rs.180,000 and on a project with expected revenues of Rs.1,000,000, then the contract
revenues earned would be calculated as Rs.1,000,000(0.2) = Rs.200,000. This figure
represents a profit and contribution to overhead of Rs.200,000 - Rs.180,000 = Rs.20,000 for
the period. Note that billings and actual receipts might be in excess or less than the calculated
revenues of Rs.200,000. On the balance sheet of an organization using the percentage-of-
completion method, an asset is usually reported to reflect billings and the estimated or
calculated earnings in excess of actual billings.

As another example of the difference in the "percentage-of-completion" and the

"completed-contract" methods, consider a three year project to construct a plant with the
following cash flow for a contractor:

Year Contract Expenses Payments Received

1 Rs.700,000 Rs.900,000
2 180,000 250,000
3 320,000 150,000
Total Rs.1,200,000 Rs.1,300,000

The supervising architect determines that 60% of the facility is complete in year 1 and
75% in year 2. Under the "percentage-of-completion" method, the net income in year 1 is
Rs.780,000 (60% of Rs.1,300,000) less the Rs.700,000 in expenses or Rs.80,000. Under the
"completed-contract" method, the entire profit of Rs.100,000 would be reported in year 3.

The "percentage-of-completion" method of reporting period earnings has the

advantage of representing the actual estimated earnings in each period. As a result, the
income stream and resulting profits are less susceptible to precipitate swings on the
completion of a project as can occur with the "completed contract method" of calculating
income. However, the "percentage-of-completion" has the disadvantage of relying upon
estimates which can be manipulated to obscure the actual position of a company or which are
difficult to reproduce by outside observers. There are also subtleties such as the deferral of all
calculated income from a project until a minimum threshold of the project is completed. As a
result, interpretation of the income statement and balance sheet of a private organization is
not always straightforward. Finally, there are tax disadvantages from using the "percentage-
of-completion" method since corporate taxes on expected profits may become due during the
project rather than being deferred until the project completion. As an example of tax
implications of the two reporting methods, a study of forty-seven construction firms
conducted by the General Accounting Office found that Rs.280 million in taxes were deferred
from 1980 to 1984 through use of the "completed-contract" method.

29
 It should be apparent that the "percentage-of-completion" accounting provides only a
rough estimate of the actual profit or status of a project. Also, the "completed contract"
method of accounting is entirely retrospective and provides no guidance for management.
This is only one example of the types of allocations that are introduced to correspond to
generally accepted accounting practices, yet may not further the cause of good project
management. Another common example is the use of equipment depreciation schedules to
allocate equipment purchase costs. Allocations of costs or revenues to particular periods
within a project may cause severe changes in particular indicators, but have no real meaning
for good management or profit over the entire course of a project. As Johnson and Kaplan
argue:

Today's management accounting information, driven by the procedures and cycle of

the organization's financial reporting system, is too late, too aggregated and too distorted to
be relevant for managers' planning and control decisions....

Management accounting reports are of little help to operating managers as they

attempt to reduce costs and improve productivity. Frequently, the reports decrease
productivity because they require operating managers to spend time attempting to understand
and explain reported variances that have little to do with the economic and technological
reality of their operations...

The management accounting system also fails to provide accurate product costs. Cost
are distributed to products by simplistic and arbitrary measures, usually direct labour based,
that do not represent the demands made by each product on the firm's resources.

As a result, complementary procedures to those used in traditional financial

accounting are required to accomplish effective project control, as described in the preceding
and following sections. While financial statements provide consistent and essential
information on the condition of an entire organization, they need considerable interpretation
and supplementation to be useful for project management.

Example3.3: Calculating net profit

As an example of the calculation of net profit, suppose that a company began six jobs
in a year, completing three jobs and having three jobs still underway at the end of the year.
Details of the six jobs are shown in Table 1-7. What would be the company's net profit under,
first, the "percentage-of-completion" and, second, the "completed contract method"
accounting conventions.

30
 TABLE 3.6 Example of Financial Records of Projects
Net Profit on Completed Contracts (Amounts in thousands of dollars)
Job 1 Rs.1,436
Job 2 356
Job 3 - 738
Total Net Profit on Completed Jobs Rs.1,054

Status of Jobs Underway Job 4 Job 5 Job 6

Original Contract Price Rs.4,200 Rs.3,800 Rs.5,630

Contract Changes (Change Orders, etc.) 400 600 - 300
Total Cost to Date 3,600 1,710 620
Payments Received or Due to Date 3,520 1,830 340
Estimated Cost to Complete 500 2,300 5,000

As shown in Table 3.6, a net profit of Rs.10, 54,000 was earned on the three completed jobs.
Under the "completed contract" method, this total would be total profit. Under the
percentage-of completion method, the year's expected profit on the projects underway would
be added to this amount. For job 4, the expected profits are calculated as follows:

Current contract price = Original contract price + Contract Changes

Credit or debit to date
Contract value of uncompleted = Current contract price - Payments received or due
work
Credit or debit to come
Estimated final gross profit
Estimated total project costs
Estimated Profit to date
= 4,200 + 400 + 4,600
= Total costs to date - Payments received or due to date
= 3,600 - 3,520 = - 80
= 4,600 - 3,520 = 1,080
= Contract value of uncompleted work - Estimated Cost to
Complete
= 1,080 - 500 = 580
= Credit or debit to date + Credit or debit to come
= - 80. + 580. = 500
= Contract price - Gross profit
= 4,600 - 500 = 4,100
= Estimated final gross profit x Proportion of work
complete
= 500. (3600/4100)) = 439

Similar calculations for the other jobs underway indicate estimated profits to date of Rs.1,
66,000 for Job 5 and -Rs.32, 000 for Job 6. As a result, the net profit using the "percentage-
of-completion" method would be Rs.16, 27,000 for the year. Note that this figure would be

31
altered in the event of multi-year projects in which net profits on projects completed or
underway in this year were claimed in earlier periods.

3.5 CONTROL OF PROJECT CASH FLOWS

Project managers also are involved with assessment of the overall status of the
project, including the status of activities, financing, payments and receipts. These various
items comprise the project and financing cash flows. These components include costs
incurred (as described above), billings and receipts for billings to owners (for contractors),
payable amounts to suppliers and contractors, financing plan cash flows (for bonds or other
financial instruments), etc.

As an example of cash flow control, consider the report shown in Table 3.7. In this case,
costs are not divided into functional categories as in Table 3.3, such as labour, material, or
equipment. Table 3.7 represents a summary of the project status as viewed from different
components of the accounting system. Thus, the aggregation of different kinds of cost
exposure or cost commitment shown in Table 3.7 has not been performed. The elements in
Table 3.7 include:

• Costs: This is a summary of charges as reflected by the job cost accounts, including
expenditures and estimated costs. This row provides an aggregate summary of the
detailed activity cost information described in the previous section. For this example,
the total costs as of July 2 (7/02) were Rs. 87, 54,516, and the original cost estimate
was Rs.6, 58, 63,092, so the approximate percentage complete was
8,754,516/65,863,092 or 13.292%. However, the project manager now projects a cost
of Rs.6, 65, 45,263 for the project, representing an increase of Rs.6, 82,171 over the
original estimate. This new estimate would reflect the actual percentage of work
completed as well as other effects such as changes in unit prices for labour or
materials. Needless to say, this increase in expected costs is not a welcome change to
the project manager.
• Billings: This row summarizes the state of cash flows with respect to the owner of the
facility; this row would not be included for reports to owners. The contract amount
was Rs.6, 75, 11,602, and a total of Rs.92, 76,621 or 13.741% of the contract has been
billed. The amount of allowable billing is specified under the terms of the contract
between an owner and an engineering, architect, or constructor. In this case, total
billings have exceeded the estimated project completion proportion. The final column
includes the currently projected net earnings of Rs.9, 66,339. This figure is calculated
as the contract amount less projected costs: 6, 75, 11,602 – 6, 65, 45,263 = Rs.9,
66,339. Note that this profit figure does not reflect the time value of money or
discounting.
• Payables: The Payables row summarizes the amount owed by the contractor to
material suppliers, labour or sub-contractors. At the time of this report, Rs.67, 19,103
had been paid to subcontractors, material suppliers, and others. Invoices of Rs.13,
00,089 have accumulated but have not yet been paid. Retention of Rs.3, 91,671 has

32
 been imposed on subcontract
subcontractors, and Rs.3, 43,653 in direct labour expenses have been
occurred. The total of payables is equal to the total project expenses shown in the first
row of costs.
• Receivables: This row summarizes the cash flow of receipts from the owner. Note
that the actual receipts from the owner may differ from the amounts billed due to
delayed payments or retain-age
retain on the part of the owner. The net-billed
billed equals the
gross billed less retention
ion by the owner. In this case, gross billed is Rs.9
92, 76,621 (as
shown in the billings row), the net billed is Rs.87, 61,673 and the retention is
Rs.514,948.
514,948. Unfortunately, only Rs.72, 09,344 has been received from the owner, so
the open receivable amount is a (substantial!) Rs.20, 67,277 due from the owner.
• Cash Position: This row summarizes the cash position of the project as if all
expenses and receipts for the project were combined in a single account. The actual
expenditures have been Rs. Rs.70, 62,756 (calculated as the total costs of Rs.87,
Rs. 54,516
less subcontractor retentions of Rs.3, 91,671 and unpaid bills of Rs.133, 00,089) and
Rs. 72, 09,344 has been received from the owner. As a result, a net cash balance of
Rs.1, 46,588 exists which can be used in an interest earning bank account or to
finance deficits on other projects.

Table 3.7An
An Example of a Cash Flow Status Report

The overall status of the project requires synthesizing the different pieces of
information
rmation summarized in Table 3.7 3.7. Each
h of the different accounting systems contributing
to this table provides a different view of the status of the project. In this example, the budget
information indicates that costs are higher than expected, which could be troubling. However,
a profit is still
till expected for the project. A substantial amount of money is due from the
owner, and this could turn out to be a problem if the owner continues to lag in payment.
Finally, the positive cash position for the project is highly desirable since financing charges
ch
can be avoided.

The job status reports illustrated in this and the previous sections provide a primary
tool for project cost control. Different reports with varying amounts of detail and item reports
would be prepared for different individuals involved in a project. Reports Repor to upper

33
management would be summaries, reports to particular staff individuals would emphasize
their responsibilities (eg. purchasing, payroll, etc.), and detailed reports would be provided to
the individual project managers. Coupled with scheduling reports described in Chapter 10,
these reports provide a snapshot view of how a project is doing. Of course, these schedule
and cost reports would have to be tempered by the actual accomplishments and problems
occurring in the field. For example, if work already completed is of sub-standard quality,
these reports would not reveal such a problem. Even though the reports indicated a project on
time and on budget, the possibility of re-work or inadequate facility performance due to
quality problems would quickly reverse that rosy situation.

3.6 SCHEDULE CONTROL

In addition to cost control, project managers must also give considerable attention to
monitoring schedules. Construction typically involves a deadline for work completion, so
contractual agreements will force attention to schedules. More generally, delays in
construction represent additional costs due to late facility occupancy or other factors. Just as
costs incurred are compared to budgeted costs, actual activity durations may be compared to
expected durations. In this process, forecasting the time to complete particular activities may
be required.

The methods used for forecasting completion times of activities are directly analogous to
those used for cost forecasting. For example, a typical estimating formula might be:

whereDf is the forecast duration, W is the amount of work, and ht is the observed
productivity to time t. As with cost control, it is important to devise efficient and cost
effective methods for gathering information on actual project accomplishments. Generally,
observations of work completed are made by inspectors and project managers and then work
completed is estimated as described in Section 3.3. Once an estimate of work complete and
time expended on particular activities is available, deviations from the original duration
estimate can be estimated. The calculations for making duration estimates are quite similar to
those used in making cost estimates.

For example, Figure 3.4 shows the originally scheduled project progress versus the
actual progress on a project. This figure is constructed by summing up the percentage of each
activity which is complete at different points in time; this summation can be weighted by the
magnitude of effort associated with each activity. In Figure 1-2, the project was ahead of the
original schedule for a period including point A, but is now late at point B by an amount
equal to the horizontal distance between the planned progress and the actual progress

34
observed to date.

Fig. 3.4 Illustration of Planned versus Actual Progress over Time on a Project

Schedule adherence and the current status of a project can also be represented on geometric
models of a facility. For example, an animation of the construction sequence can be shown on
a computer screen, with different colours or other coding scheme indicating the type of
activity underway on each component of the facility. Deviations from the planned schedule
can also be portrayed by colour coding. The result is a mechanism to both indicate work in
progress and schedule adherence specific to individual components in the facility.

In evaluating schedule progress, it is important to bear in mind that some activities

possess float or scheduling leeway, whereas delays in activities on the critical path will cause
project delays. In particular, the delay in planned progress at time t may be soaked up in
activities' float (thereby causing no overall delay in the project completion) or may cause a
project delay. As a result of this ambiguity, it is preferable to update the project schedule to
devise an accurate portrayal of the schedule adherence. After applying a scheduling
algorithm, a new project schedule can be obtained. For cash flow planning purposes, a graph
or report similar to that shown in Fig. 3.5.can be constructed to compare actual expenditures
to planned expenditures at any time. This process of re-scheduling to indicate the schedule
adherence is only one of many instances in which schedule and budget updating may be
appropriate.

35
 Fig. 3.5 Illustration of Planned versus Actual Expenditures on a Project

3.7 SCHEDULE AND BUDGET UPDATES

Scheduling and project planning is an activity that continues throughout the lifetime
of a project. As changes or discrepancies between the plan and the realization occur, the
project schedule and cost estimates should be modified and new schedules devised. Too
often, the schedule is devised once by a planner in the central office, and then revisions or
modifications are done incompletely or only sporadically. The result is the lack of effective
project monitoring and the possibility of eventual chaos on the project site.

On "fast track" projects, initial construction activities are begun even before the facility
design is finalized. In this case, special attention must be placed on the coordinated
scheduling of design and construction activities. Even in projects for which the design is
finalized before construction begins, change orders representing changes in the "final" design
are often issued to incorporate changes desired by the owner.

Periodic updating of future activity durations and budgets is especially important to avoid
excessive optimism in projects experiencing problems. If one type of activity experiences
delays on a project, then related activities are also likely to be delayed unless managerial
changes are made. Construction projects normally involve numerous activities which are
closely related due to the use of similar materials, equipment, workers or site characteristics.
Expected cost changes should also be propagated thoughout a project plan. In essence,
duration and cost estimates for future activities should be revised in light of the actual
experience on the job. Without this updating, project schedules slip more and more as time

36
progresses. To perform this type of updating, project managers need access to original
estimates and estimating assumptions.

Unfortunately, most project cost control and scheduling systems do not provide many aids for
such updating. What is required is a means of identifying discrepancies, diagnosing the cause,
forecasting the effect, and propagating this effect to all related activities. While these steps
can be undertaken manually, computers aids to support interactive updating or even
automatic updating would be helpful.

Beyond the direct updating of activity durations and cost estimates, project managers should
have mechanisms available for evaluating any type of schedule change. Updating activity
duration estimations, changing scheduled start times, modifying the estimates of resources
required for each activity, and even changing the project network logic (by inserting new
activities or other changes) should all be easily accomplished. In effect, scheduling aids
should be directly available to project managers. Fortunately, local computers are commonly
available on site for this purpose.

Example3.4: Schedule Updates in a Small Project

As an example of the type of changes that might be required, consider the nine activity
project described in Section 10.3 and appearing in Figure 3.6. Also, suppose that the project
is four days underway, with the current activity schedule and progress as shown in Figure 3.7.
A few problems or changes that might be encountered include the following:

1. An underground waterline that was previously unknown was ruptured during the fifth
day of the project. An extra day was required to replace the ruptured section, and
another day will be required for clean-up. What is the impact on the project duration?

To analyze this change with the critical path scheduling procedure, the manager has the
options of (1) changing the expected duration of activity C, General Excavation, to the new
expected duration of 10 days or (2) splitting activity C into two tasks (corresponding to the
work done prior to the waterline break and that to be done after) and adding a new activity
representing repair and clean-up from the waterline break. The second approach has the
advantage that any delays to other activities (such as activities D and E) could also be
indicated by precedence constraints.

Assuming that no other activities are affected, the manager decides to increase the
expected duration of activity C to 10 days. Since activity C is on the critical path, the project
duration also increases by 2 days. Applying the critical path scheduling procedure would
confirm this change and also give a new set of earliest and latest starting times for the various
activities.

2. After 8 days on the project, the owner asks that a new drain be installed in addition to
the sewer line scheduled for activity G. The project manager determines that a new

37
 activity could be added to install the drain in parallel with Activity G and requiring 2
days. What is the effect on the schedule?

Inserting a new activity in the project network between nodes 3 and 4 violates the
activity-on-branch convention that only one activity can be defined between any two nodes.
Hence, a new node and a dummy activity must be inserted in addition to the drain installation
activity. As a result, the nodes must be re-numbered and the critical path schedule developed
again. Performing these operations reveals that no change in the project duration would occur
and the new activity has a total float of 1 day.

To avoid the labour associated with modifying the network and re-numbering nodes,
suppose that the project manager simply re-defined activity G as installation of sewer and
drain lines requiring 4 days. In this case, activity G would appear on the critical path and the
project duration would increase. Adding an additional crew so that the two installations could
proceed in parallel might reduce the duration of activity G back to 2 days and thereby avoid
the increase in the project duration.

3. At day 12 of the project, the excavated trenches collapse during Activity E. An

additional 5 days will be required for this activity. What is the effect on the project
schedule? What changes should be made to insure meeting the completion deadline?

Activity E has a total float of only 1 day. With the change in this activity's duration, it
will lie on the critical path and the project duration will increase.Analysis of possible time
savings in subsequent activities is now required, using the procedures described in Section

Fig. 3.6 A Nine Activity Example Project

Fig. 3.7 Current Schedule for an Example Project Presented as a Bar Chart

38
 As can be imagined, it is not at all uncommon to encounter changes during the course
of a project that require modification of durations, changes in the network logic of
precedence relationships, or additions and deletions of activities. Consequently, the
scheduling process should be readily available as the project is underway.

3.8 RELATING COST AND SCHEDULE INFORMATION

The previous sections focused upon the identification of the budgetary and schedule
status of projects. Actual projects involve a complex inter-relationship between time and cost.
As projects proceed, delays influence costs and budgetary problems may in turn require
adjustments to activity schedules. In the context of project planning in which additional
resources applied to a project activity might result in a shorter duration but higher costs.
Unanticipated events might result in increases in both time and cost to complete an activity.
For example, excavation problems may easily lead to much lower than anticipated
productivity on activities requiring digging.

While project managers implicitly recognize the inter-play between time and cost on
projects, it is rare to find effective project control systems which include both elements.
Usually, project costs and schedules are recorded and reported by separate application
programs. Project managers must then perform the tedious task of relating the two sets of
information.

The difficulty of integrating schedule and cost information stems primarily from the
level of detail required for effective integration. Usually, a single project activity will involve
numerous cost account categories. For example, an activity for the preparation of a
foundation would involve labourers, cement workers, concrete forms, concrete,
reinforcement, transportation of materials and other resources. Even a more disaggregated
activity definition such as erection of foundation forms would involve numerous resources
such as forms, nails, carpenters, labourers, and material transportation. Again, different cost
accounts would normally be used to record these various resources. Similarly, numerous
activities might involve expenses associated with particular cost accounts. For example, a
particular material such as standard piping might be used in numerous different schedule
activities. To integrate cost and schedule information, the disaggregated charges for specific
activities and specific cost accounts must be the basis of analysis.

A straightforward means of relating time and cost information is to define

individual work elements representing the resources in a particular cost category associated
with a particular project activity. Work elements would represent an element in a two-
dimensional matrix of activities and cost accounts as illustrated in Figure 3.8. A numbering or
identifying system for work elements would include both the relevant cost account and the
associated activity. In some cases, it might also be desirable to identify work elements by the
responsible organization or individual. In this case, a three dimensional representation of
work elements is required, with the third dimension corresponding to responsible
individuals. More generally, modern computerized databases can accommodate a flexible

39
structure of data representation to support aggregation with respect to numerous different
perspectives.With this organization of information, a number of management reports or views
could be generated. In particular, the costs associated with specific activities could be
obtained as the sum of the work elements appearing in any row in Figure 3.8. These costs
could be used to evaluate alternate technologies to accomplish particular activities or to
derive the expected project cash flow over time as the schedule changes. From a management
perspective, problems developing from particular activities could be rapidly identified since
costs would be accumulated at such a disaggregated level. As a result, project control
becomes at once more precise and detailed.

Fig.3.8. Illustration of a Cost Account and Project Activity Matrix

Unfortunately, the development and maintenance of a work element database can

represent a large data collection and organization effort. As noted earlier, four hundred
separate cost accounts and four hundred activities would not be unusual for a construction
project. The result would be up to 400x400 = 160,000 separate work elements. Of course, not
all activities involve each cost account. However, even a density of two percent (so that each
activity would have eight cost accounts and each account would have eight associated
activities on the average) would involve nearly thirteen thousand work elements. Initially
preparing this database represents a considerable burden, but it is also the case that project
bookkeepers must record project events within each of these various work elements.
Implementations of the "work element" project control systems have typically foundered on
the burden of data collection, storage and book-keeping.

Until data collection is better automated, the use of work elements to control activities
in large projects is likely to be difficult to implement. However, certain segments of project
activities can profit tremendously from this type of organization. In particular, material
requirements can be tracked in this fashion. Materials involve only a subset of all cost
accounts and project activities, so the burden of data collection and control is much smaller
than for an entire system. Moreover, the benefits from integration of schedule and cost
information are particularly noticeable in materials control since delivery schedules are
directly affected and bulk order discounts might be identified. Consequently, materials
control systems can reasonably encompass a "work element" accounting system.

40
 In the absence of a work element accounting system, costs associated with particular
activities are usually estimated by summing expenses in all cost accounts directly related to
an activity plus a proportion of expenses in cost accounts used jointly by two or more
activities. The basis of cost allocation would typically be the level of effort or resource
required by the different activities. For example, costs associated with supervision might be
allocated to different concreting activities on the basis of the amount of work (measured in
cubic yards of concrete) in the different activities. With these allocations, cost estimates for
particular work activities can be obtained.

3.9REFERENCES

1. American Society of Civil Engineers, "Construction Cost Control," ASCE Manuals

and Reports of Engineering Practice No. 65, Rev. Ed., 1985.
2. Coombs, W.E. and W.J. Palmer, Construction Accounting and Financial
Management, McGraw-Hill, New York, 1977.
3. Halpin, D. W., Financial and Cost Concepts for Construction Management, John
Wiley & Sons, New York, 1985.
4. Johnson, H. Thomas and Robert S. Kaplan, Relevance Lost, The Rise and Fall of
Management Accounting, Harvard Business School Press, Boston, MA 1987.
5. Mueller, F.W. Integrated Cost and Schedule Control for Construction Projects, Van
Nostrand Reinhold Company, New York, 1986.
6. Tersine, R.J., Principles of Inventory and Materials Management, North Holland,
1982.

41
 QUESTION BANK

16 MARKS QUESTIONS

1. Explain the method of estimating project.

2. Explain project time phased baseline development in construction

3. Explaincontractor’s construction budget breakdown with neat diagram.

4. Explain project manpower expenses scheduled with neat sketch.

5. Explain operating expenses budget in construction projects.

6. Write a short note on forecasting profit and loss in construction project.

7. Write a short note on forecasting cash flow in construction project.

8.Explain cost inflation, excavation and contingencies.

9.Explain about master budget in construction project.

10.Explain how to control the schedules in project.

11.Explain how to update schedule budget in project.

2 MARKS QUESTIONS

1. Write a short note on s curve?

The time-related cumulative forecasts of main input resources and outputs, in

monetary value, when plotted graphically against the project time scale, follow the ‘S' curve
pattern. Usually in 'S' curves, construction time is plotted along abscissa, and the item to be
forecast is represented along the ordinate axis. Further, both the time and resources axes are
divided into 100 units representing percentages. By doing this the trends of projects with
different cost and completion periods can be compared with each other. To quote an example,
the standard 'S' curve forecasts for value of the work done and manpower requirements of a
building construction project.

42
 2.Write short note on importance of project budget?

The project budget is essentially, a planning document. It outlines the financial plan
of the project: The project budget depicts the management's vision for the future, it aims at
specifying the future financial, course of action for steering the project. Budget quantifies in
monetary terms the project cost objectives, it allocates responsibility for attaining these
objectives, it reflects the sources earmarked, it pinpoints the results to be achieved by the
responsibility. It provides a standard for measuring effectiveness and efficiency with which
activities are to be performed. A project budget is a financial commitment for actions, an
instrument for delegation of responsibility, a means for communication, an aid for
coordination, a tool for motivation, an authority for implementation and a device foe
controlling performance. A project without a budget is like a missile without a guidance
system or a ship without navigational instruments. If there is no budget, there will be no
means to measure performance. Working without quantified objectives and without
commitments amounts to working Budget and budgetary control are inseparable. Without a
budget, there can be no budgetary control and without budgetary control, even the best
formulated budget will serve no purpose. Budgetary control makes use of budget and
budgetary reports to compare the actual with budgeted standards to bring out the extent of
variations, it reasons out the causes for significant verifications, brings out actions necessary
to achieve objectives and provides a base for its revision when necessary.

3. Briefly explain equipment hourly standard rate in project?

The method of estimation of the equipment hourly rate this involves the estimation of
equipment owning and operation costs:

Equipment rate per hour = Owning cost per hour + operating cost per hour.

Where, Owning cost=Depreciation

And Operating cost = Fuel cost + Maintenance cost + Major repair cost + Operator's cost +
Tyre replacement cost for rubber tyred equipment.

43
 The above mathematical approach for determining the equipment hourly standard rate
can at best be treated as a guideline as there are many factors, determinate as well as
indeterminate, which affect the equipment owning and operating costs. These factors include
the state of the equipment (old or new), corporate capitalization policy, sources of funding for
the new purchase, site delivered price, purchase implication on corporate taxes, economical
plant life in years, resale value, annual operational hours contemplated, past performance
record in the case of old equipment, job conditions, skill of the operator and the repair and
maintenance facilities available. Equipment utilization rate also depends upon its ownership.
This rate will be different if it is taken from the client's own plant than if it is hired from the
market. There is no substitute to the experience of the estimator. Therefore, while
establishing hourly standards for an item of equipment, the mathematically estimated
equipment utilization rate is suitably modified by the experienced estimator according to the
situation.

4. Mention types of budget and schedule?

The project master budget integrates and summarizes the project functional budgets
times, the master budget is also referred to as the finance budget or profit plan. The project
master budget is prepared in the form of a manual. The text of a typical Project budget
manual may summarize the following. The detailed working patterns are attached as b or
appendices with the text:

(a) Project planned objectives: These are stated in physical and financial terms with
the plan assumptions and the functional organization of work.
(b) Organization of responsibility centres: It highlights the division of the functional
organization into responsibility centres (and their being further split up into work
centres where applicable) with the tasks and resources assigned to each responsibility
centre.
(c) Sales revenue budget: It reflects the monthly or quarterly financial targets for the
overall project and its breakdown for each production centre and other en earning
sources.
(d) Production cost budget: It covers the production cost of goods sold, and it can be
further split up into direct costs and indirect costs. These costs can be suitably
arranged so as to bring out the production cost budget for each responsibility centre.
(e) Project general and administration expense budget: It represents the overall site
office, administration, and head office expense budget, arranged in conformity with
the finance heads of accounts and the functional needs.
(f) Budgeted financial forecasts: These include the profit and loss statement, cash
flow forecast and forecast balance sheet.

44
 5. What is meant by inventory planning?

Planning the quantity of inventory and its timing; coordinating inventory with
production or sales needs.Effective inventory planning is instrumental in reducing costs and
increasing productivity. The construction material inventory plan aims at evolving materials
stock-holding levels to meet the project execution plan, with minimum investment on
inventory.

The term 'inventory' implies the cost of materials in stock at a given time. This stock
of materials is held to act as a cushion between supply and demand. The monetary value of
inventory indicates the extent of investment required to maintain minimum stock of materials
for the smooth running of the project. Higher inventory implies higher investment, and less
inventory carries the risk of supplies falling behind demand. A balanced inventory acts as a
cushion between supply and site requirement till supplies are required. It includes
predetermined safety stock to cater for slippages in delivery schedules.

6. Define relating cost and schedule information?

Refer 3.8

7.Write a short note on cost excavation and contingencies?

Inflation and escalation are two common terms that are often misunderstood. Inflation
results in an increased in the prices of goods and services, and thus gradually decreases the
purchasing power of money. On the other hand, escalation in a project work can be taken as
the difference between the original and the latest estimate of the final cost of the project. The
term escalation also includes unforeseen costs which were not anticipated at the time of
preparation of the original estimate. Generally, escalated costs include the effects of inflation
as well as unforeseen expenditures and these are covered in project contingencies. In some
construction contracts, provision for inflation is made in the contract clauses in terms of
increase or decrease of a certain price index such as the consumer price index, wages price
index or construction cost index. These indices are published regularly by Government and
other autonomous organizations and federations. Some of the companies also develop the
company cost indices for monitoring and forecasting cost changes, and pricing tenders to
cater for inflationary tendencies, potential marketing trends and business environments.
However, there is no hard and fast method to estimate the effect of inflation on the project
costs as the variables involved are too many.

45
 8. Briefly explain construction cost breakdown structure?

The process of cost estimation would be simple if it were possible to direct correlate
various cost elements to the activity that incurs them. These costs can then provide a clear
picture of the construction costs and thus simplify planning, forecasting, accounting and.,
controlling costs. But it is not always possible to precisely define various cost elements
activity-wise. In order to identify the costs associated with an activity, construction costs
generally referred to as production costs are categorized into Direct costs' and `Indirect costs'
or `Overheads'.

Production cost = Direct cost + Indirect cost

Direct Costs Breakdown Indirect Costs Breakdown Total Costs Breakdown

Direct Materials Costs Indirect Materials Materials Costs

+ =
Costs

+ + +

Direct Labour Costs Indirect Labour Costs Production/Labour

+ =
Costs

+ +
+

Direct Expenses Indirect Expenses Other Expenses

+ =

= = =

Direct Costs +
Indirect Costs = Total Costs

46