QUS 208

3.0 Nature Cost & Cost-in-use in

Construction

CONCEPT OF COST-IN-USE / LIFE CYCLE COST

There is always need apply economic analysis to engineering projects in order to

assess the real cost of using resources when establishing priorities between

competing proposals. This hypothesis applies equally well to building projects,

where the term real costs should encompass the initial acquisition costs and the

running costs of maintaining and operating a building throughout its effective life,

including refurbishment.

In some cases the appraisal should extend even further to include the relative

benefits accruing to owners/occupiers from alternative designs, and possibly the

demolition or disposal at the end of the building's life. The term cost in use is

sometimes refers to as life cycle costing, a technique of cost prediction by which

the initial construction and associated costs and the annual running and

maintenance costs of a building, or part of a building, can be reduced to a

common measure. This is a single sum which is the annual

Life cycle cost can be defined as the total cost of that asset over its operating life,

including the initial acquisition costs and subsequent running cost. It is also

defined as the life cycle cost of an asset as the present value of the total cost of

the asset over its operating life, including initial capital cost, occupational cost,

operating cost, and the cost/benefit of the eventual disposal of the asset at the

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end of its life/use. Hence the life cycle cost approach is concerned with the

time-stream of costs and benefits that flow throughout the life of a project, with

future costs and benefits converted to present values.

The life cycle costing approach enables the way which a building functions to be

expressed in terms of the cost of repairing and renewing the finishings and fittings,

heating, lighting and servicing, and of the cost of labour needed in operating the

building. These costs can be added to the amortized initial acquisition cost of the

building to give the total annual cost of providing, maintaining and operating the

building. In what is probably a better and more commonly adopted approach, all

the costs can be converted to the present value (PV) by discounting techniques

e.g., discounted cashflow. The cost implications of building designs are often

wider than the effect on the initial costs. For some types of buildings, the

equivalent of initial cost is less than the running costs, and small changes in design

have a much larger impact on running costs than on first costs.

COST-IN-USE TERMINOLOGY

Initial Cost: Initial cost means the moneys required for the capital construction or

renovation of a major facility. Initial cost means the required cost necessary to

construct or renovate a facility.

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Running Cost: Running costs are cost incurred in the day-to-day operation of

an organization. Running costs might include: Wages. Utilities,

Maintenance and repairs, Utilities, Insurance, Security, Rent, Sales, General and

administrative expenses.

It is important to distinguish between running costs and capital costs as there are

significant accounting and taxation issues which comes directly from how a

particular item of expenditure is treated. It can affect whether a particular

transaction is subject to capital gains tax as opposed to income tax, as well as the

possible entitlement to capital allowances. Whilst

operational costs are cost incurred in the day-to-day operation of

an organization, capital costs are costs associated with one-off expenditure on

the acquisition, construction or enhancement of significant fixed

assets including land, buildings and equipment that will be of use or benefit for

more than one financial year.

Maintenance Costs: means all costs and expenses of operating, repairing,

maintaining and replacing the building. Maintenance cost is the total cost or

budget set aside to keep, restore or improve a building. Maintenance cost differs

in various places due to some peculiarities such as building location, availability of

resources, lack of funds, non-availability of building materials, inadequate

transportation and many others.

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Replacement Cost: Replacement cost is a term referring to the amount of money

a business must currently spend to replace an essential asset like a real estate

property, an investment security etc., with one of the same or higher value.

Sometimes referred to as a "replacement value,". A replacement cost may

fluctuate, depending on factors such as the market value of components used to

reconstruct or repurchase the asset and the expenses involved in preparing

assets for use. Replacing an asset can be an expensive decision, and companies

analyze the net present value (NPV) of the future cash inflows and outflows to

make purchasing decisions. Once an asset is purchased, the company determines

a useful life for the asset and depreciates the asset's cost over the useful life.

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