COST CONCEPT

by
Dr. Sajjad Mubin

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 What is Cost?

 Cost is a resource utilized to achieve a specific objective or

services in exchange.
 Costs are usually measured in monetary units like rupees,
dollars etc.
 Project cost management includes the processes required to
ensure that the project is completed within an approved
budget.

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 Types of Cost
Direct v/s Indirect Cost
Direct Costs
• Direct costs represent any cost related to the production of
goods or services and can be reasonably measured and allocated
to a specific out put or work such eg raw materials and labor are
primary direct costs which are associated to a product, service or
construction activity. Manufacturing overhead is the cost of
facilities or equipment companies use to produce goods and
services.

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 Direct v/s Indirect Cost
Indirect Costs
• Indirect costs include expenses outside of a company's
production process and are difficult to attribute or to a
specific activity or output eg manufacturing overhead, office
supplies, sales personnel, accounting and customer service
operations represent a few common indirect costs. The
amount of indirect costs should represent a much smaller
proportion of the company's overall business expenditures.
High indirect costs indicate companies spend more money on
potentially non-essential business functions.

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 Types of Cost
Fixed, Variable and Incremental Cost
Fixed Costs
 Fixed costs are those which are unaffected by any change in activity level
over a feasible range of operation..Typical fixed cost include depreciation,
rent, license fee, interest on borrowed capital, insurance and taxes and
management salaries etc. Businesses must pay fixed costs each month
regardless of how many items a company produces or sells.
 Operating leverage is a term that represents the amount of fixed costs tend
to remain constant over a specific range of operating condition. A high
degree of operating leverage indicates a company with high fixed costs must
offset these costs with higher sales.
 Direct and indirect costs are either fixed or variable.

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 Types of Cost
Fixed, Variable and Incremental Cost
Variable
 Variable costs represent items that change based on a company's
production output. Raw materials, employee wages, utilities, and
shipping charges are a few common variable costs. However, sales will
also fall since companies have lower production outputs and fewer
opportunities to generate consumer sales.
Incremental Cost or incremental revenue
 Is the additional cost or revenue that results from increasing the output
of a system.

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 Types of Cost
Recurring and nonrecurring Costs
Recurring Cost
 Recurring costs are those that are repetitive and occur when an organization
produces similar goods or services on a continuous basis. Variable costs are also
recurring costs, because they repeat with each unit of output. A fixed cost that is
paid on a repetitive basis are also recurring costs for example for an organization
providing architectural and engineering services, office space rental is a
recurring cost.
Nonrecurring cost
 Nonrecurring costs are those that are not repetitive, even though the total
expenditure may be cumulative over a relatively short period of time. Typically
nonrecurring costs involve developing or establishing a capability or capacity to
operate eg purchase of an equipment or real state upon which plant will be build
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is a nonrecurring cost.
 Types of Cost
Cash Cost v/s Book Cost
Cash Cost
• A cost that involves payment of cash is called a cash cost (and results in a cash
flow) eg direct payment to the contractor against his work done.
Book Cost
• Cost which doesn’t involve a cash transaction and is reflected in the
accounting system is a noncash cost often referred as book cost. Book
costs are those which that do not involve cash payment but rather
represent the recovery of past expenditure over a fixed period of time.
The most common example of book cost is depreciation charged for a
use of assets such as plant and equipment. Depreciation is not a cash
flow, but it affects major cash flows such as income tax.

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 Types of Cost
Opportunity and Sunk Costs
Opportunity Cost
• An opportunity cost is incurred because of use of limited resources, such as to
use those resources to monetary advantage in an alternative foregone. Thus it is
the cost of best rejected (ie foregone) and is often hidden or implied.
• For example, suppose a project require certain space to operate. The vacant
warehouse owned by the company can be used as office for the project. The cost
for that space to the project should be the income or saving that alternative uses
of the space may bring to the firm.
Sunk Cost
• 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 outcome. It can be a past
expenditure which cannot be recovered or capital which has already been
invested and cannot be retrieved.
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 Types of Cost
Capital v/s O&M
The costs of a project to the owner include both the initial capital cost and the
subsequent operation and maintenance costs. Each of these major cost categories
consists of a number of cost components.
The capital cost for a construction project includes the expenses related to the
initial establishment of the facility:
 Land acquisition, including assembly, holding and improvement;
 Planning and feasibility studies
 Architectural and structural design
 Materials, equipment and labor;
 Field supervision of construction;
 Construction financing;
 Insurance and taxes during construction;
 Owner's general office overhead;
 Equipment and furnishings not included in construction; and
10  Inspection and testing.
 Types of Cost
Operation and Maintenance Cost
The operation and maintenance cost in subsequent years over the project life
cycle includes the following expenses:
 Operating staff;
 Labor and material for maintenance and repairs;
 Periodic renovations;
 Insurance and taxes;
 Financing costs;
 Utilities; and
 Owner's other expenses. (Site/Head Office Expenses)

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 Types of Cost
Operation and Maintenance Cost
The magnitude of each of these cost components depends on the nature,
size and location of the project. The owner is interested in achieving the
lowest possible overall project cost in par with its investment objectives. It
is important for design professionals and construction managers to realize
that while the construction cost may be the single largest component of
the capital cost, other cost components are not insignificant. For example,
land acquisition costs are a major expenditure for building construction in
high-density urban areas, and construction financing costs can reach the
same order of magnitude as the construction cost in large projects such as
the construction of

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 Life-cycle Cost
 In engineering practice the term life-cycle cost is often encountered. This term
refers to a summation of all the costs, both recurring and nonrecurring, related
to a product, structure, system, or service during its life span. Life cycle begins
with identification of the economic need or want (the requirement) and ends
with retirement and disposal activities. It is a time horizon that must be defined
in the context of the specific situation—whether it is a highway bridge, a jet
engine for commercial aircraft, or an automated flexible manufacturing cell for
a factory. The end of life cycle may be projected on a functional or an economic
basis. For example, the amount of time that a structure or piece of equipment is
able to perform economically may be shorter than that permitted by its physical
capability. Changes in the design efficiency of a boiler illustrate this situation.
The old boiler may be able to produce the steam required---but not
economically enough for the intended use.
 The life cycle may be divided into two general time periods; the acquisition
phase and the operation phase. These phases is further subdivided into
interrelated but different activity periods.
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 Life-cycle Cost
The acquisition phase begins with an analysis of the economic need or
want—the analysis necessary to make explicit the requirement for the
product, structure, system, or service. Then, which the requirement
explicitly defined, the other activities in the acquisition phase can proceed
in a logical sequence. The conceptual design activities translate the defined
technical and operational requirements into a preferred preliminary design.
Included in these activities are development of the feasible alternatives and
engineering economic analyses to assist in section of the preferred
preliminary design. Also, advanced development and prototype-testing
activities to support the preliminary design work occur during this period.

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 Life-cycle Cost
The next group of activities in the acquisition phase involves detailed
design and planning for production or construction. This step is followed
by the activities necessary to prepare, acquire, and make ready for
operation the facilities and other resources needed for the production,
delivery, or construction of the product, structure, system, or service
involved. Again, engineering economy studies are on essential part of the
design process to analyze and compare alternatives and to assist in
determining the final detailed design and planning for production or
construction. This step is followed by the activities necessary to prepare,
acquire and make ready for operation the facilities and other resources
need for the production, delivery, or construction of the product,
structure, system, or service involved. Again, engineering economy studies
are on essential part of the design process to analyze and compare
alternatives and to assist in determining the final detailed design.
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Project Lifecycle

• Strategy • Utilization
• Objectives • Design • Outcomes
• Stakeholders • Site • Lessons Learned
• Feasibility • Execution
• Management
 Life cycle Cost
(Conventional Delivery Method)

Conceptualization

Need based
Assessment
Efforts/
Cost
Cumulative
Cost/Efforts

Termination
Inception Planning & Desig- Doc. T&C Execution Time
Feasibility ning Erection/Installation/Construction
Designing
• Conceptual Design Execution
Planning & • Preliminary Design Documentation • Design
Feasibility •Detail Design • Drawings Implementation Termination
• Technical - Architectural • Specifications • Installation and •Testing as per
Feasibility - Geotechnical •Preparation of Erection specification (NDT)
•Commissioning17
•Economical - Structure •Tender documents •Construction
Feasibility - HVAC •M&E • Final settlement
 THANK YOU
sajjadmubin@yahoo.com

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