3.

COST CONCEPTS

Facilitator: Eng. Cyliacus S.N.

ARUSHA TECHNICAL COLLEGE

1 Tuesday, April 23, 2024

 3.1 Fixed and Variable Costs:
 Fixed Cost: Fixed costs are expenses that do not

change with the level of production or output.

 Example in Engineering Project: The annual

lease cost of a piece of construction equipment,

such as a crane, is a fixed cost.
 It remains constant whether the crane is used

extensively or remains idle.

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 3.1 Fixed and Variable Costs:
 Variable Costs: Variable costs are expenses that
vary directly with the level of production or
output.
 Example in Engineering Project: The cost of raw
materials, like concrete or steel, is a variable
cost.
 As the construction project progresses, the
quantity of materials used and the associated
costs will vary.

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 3.2 Opportunity Costs:
 Opportunity cost is the value of the next best
alternative forgone when a decision is made.
 Example in Engineering Project: Suppose a civil
engineering firm has a piece of land that could be
used for either a commercial or residential
project.
 If the firm decides to use it for a commercial
project, the opportunity cost is the potential profit
that could have been earned from a residential
project on the same land.
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 3.3 Economic Analysis of Project Costs:
 Direct Costs:
 Are expenses directly tied to the production of a
specific good or service.
 Example in Engineering Project: The cost of
hiring labor for the construction of a building is a
direct cost.
 It directly contributes to the construction project.

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 3.3 Economic Analysis of Project Costs:
 Indirect Costs (Overhead Costs):
 Indirect costs are expenses not directly tied to a
specific project but necessary for overall
business operations.
 Example in Engineering Project: The salary of
project managers, administrative staff, and
utilities for the construction site office are
indirect costs. They contribute to the overall
functioning of the construction firm.

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 3.3 Economic Analysis of Project Costs:
 Sunk Costs:
 Sunk costs are costs that have already been
incurred and cannot be recovered.
 Example in Engineering Project: If a feasibility
study for a project has already been conducted,
and the decision is made not to proceed with the
project, the cost of the feasibility study becomes
a sunk cost.

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 3.3 Economic Analysis of Project Costs:
 Life Cycle Costing:
 Life cycle costing involves considering the total
cost of ownership of a project, including initial
costs, operating costs, maintenance costs, and
disposal costs over its entire life.
 Example in Engineering Project: For a water
treatment plant, life cycle costing would include
the initial construction costs, ongoing operational
costs, maintenance costs, and eventual
decommissioning costs.
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3.4 FIXED, VARIABLE, AND INCREMENTAL COSTS
 Fixed costs: unaffected by changes in activity level over a feasible
range of operations for the capacity or capability available.
 Typical fixed costs include:
 insurance and taxes on facilities
 general management and administrative salaries
 license fees
 interest costs on borrowed capital.
 Fixed costs will be affected When:
 large changes in usage of resources occur
 plant expansion or shutdown is involved

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3.4 FIXED, VARIABLE, AND INCREMENTAL COSTS
 Variable costs: associated with an operation that vary
in total with the quantity of output or other measures of
activity level.
 Example of variable costs include :
costs of material and labor used in a product or
service, because they vary in total with the number of
output units -- even though costs per unit remain the
same.
 Example 2.1

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3.4 FIXED, VARIABLE, AND INCREMENTAL COSTS
 Incremental cost: additional cost that results from
increasing output of a system by one (or more) units.
 Incremental cost is often associated with “go / no go”
decisions that involve a limited change in output or
activity level.
EXAMPLE: the incremental cost of driving an
automobile might be $0.27 / mile. This cost depends on:
1. mileage driven;
2. mileage expected to drive;
3. age of car;
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3.4 SUNK COST AND OPPORTUNITY COST

 A sunk cost is one that has occurred in the past

and has no relevance to estimates of future costs
and revenues related to an alternative course of
action;
 An opportunity cost is the cost of the best
rejected ( i.e., foregone ) opportunity and is
hidden or implied;

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 3.5 CASH COST VERSUS BOOK COST
 Cash cost is a cost that involves payment in cash and results
in cash flow;
 Book cost or noncash cost is a payment that does not involve
cash transaction
 book costs represent the recovery of past expenditures over a
fixed period of time;
 Depreciation is the most common example of book cost;
 depreciation is what is charged for the use of assets, such as
plant and equipment; depreciation is not a cash flow;

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 3.6 LIFE-CYCLE COST
 Life-cycle cost: sum of all costs, both recurring and nonrecurring,
related to a product, structure, system, or service during its life
span.
 Life cycle begins with the identification of the economic need or
want and ends with the retirement and disposal activities.

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 3.7 PHASES OF THE LIFE CYCLE
PHASE STEP COST

Acquisition Needs Assessment Rising at increasing rate

Conceptual design Rising at increasing rate
Detailed Design Rising at decreasing rate

Operation Production/Construction Rising at decreasing rate

Operation/Customer Use Constant
Retirement/Disposal Constant

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 3.8 CAPITAL AND INVESTMENT
 Investment Cost or capital investment: capital (money)
required for most activities of the acquisition phase;
 Working Capital: funds required for current assets needed for
start-up and subsequent support of operation activities;
 Operation and Maintenance Cost includes many of the
recurring annual expense items associated with the operation phase
of the life cycle;
 Disposal Cost includes non-recurring costs of shutting down the
operation;

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 3.9 RECURRING AND NONRECURRING COSTS
 Recurring costs: repetitive and occur when a firm
produces similar goods and services on a continuing
basis.
 Variable costs are recurring because they repeat
with each unit of output.
 A fixed cost that is paid on a repeatable basis is also a
recurring cost:
Office space rental
$

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3.9 RECURRING AND NONRECURRING COSTS
 Nonrecurring costs: not repetitive, even though the
total expenditure may be cumulative over a relatively
short period of time;
 Typically involve developing or establishing a capability
or capacity to operate;
 Examples are purchase cost for real estate upon which
a plant will be built, and the construction costs of the
plant itself;

18 Dr. Mohammad Abuhaiba, PE 4/23/2024 2:05 PM

 3.10 DIRECT, INDIRECT AND OVERHEAD COSTS
 Direct costs can be reasonably measured and
allocated to a specific output or work activity
labor and material directly allocated with a
product, service or construction activity;
 Indirect costs are difficult to allocate to a
specific output or activity
costs of common tools, general supplies, and
equipment maintenance ;

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 3.10. DIRECT, INDIRECT AND OVERHEAD COSTS

 Overhead consists of plant operating costs that are not

direct labor or material costs
 indirect costs, overhead and burden are the same;
 Prime Cost is a common method of allocating
overhead costs among products, services and activities in
proportion the sum of direct labor and materials cost ;

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 3.11 STANDARD COSTS
 Representative costs per unit of output that are
established in advance of actual production and service
delivery;
Standard Cost Element Sources of Data
Direct Labor Process routing sheets,
standard times,
standard labor rates;

Direct Material Material quantities per unit,

standard unit materials cost;
Factory Overhead Costs Total factory overhead costs allocated
based on prime costs;
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3.12 CONSUMER GOODS AND PRODUCER GOODS AND SERVICES

 Consumer goods and services: directly used by people

to satisfy their wants;
 Producer goods and services: used in the production
of consumer goods and services:
machine tools,
factory buildings,
buses and farm machinery

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23 Tuesday, April 23, 2024