CCP_SEC1_Cost

CCOSTOST
Hisham Haridy, PMP, PMI-RMP, PMI-SPCCP_SEC 1

1. Cost Elements
2. Pricing and Costing
3. Materials
CContentontent
C O S T
4. Labor
5. Engineering Role and Project Success
6. Machinery, Equipment, and Tools
7. Economic Cost
8. Activity-Based Cost Management

COST ELEMENTSCOST ELEMENTS
1. Cost
The value of an activity or asset.
2. Cost Elements
The value of the resources that are expended to complete the activity or produce
the asset.
Resources used are categorized as equipment, labor, material, and “other.”
C O S T
Material
Labor
Equipment

Variable Fixed
Must be provided and are dependent on the
volume of work activity or asset production
Must be provided independent of the
volume of work, either direct or indirect.
3. Cost Structuring
Further structure the cost elements to:
Understand how they influence activity cost .
Get a better understanding of how they can be controlled.
CostStructuring
volume of work activity or asset production
that they support.
Examples the cost of Material, Labors , etc.
volume of work, either direct or indirect.
Examples set-up, Permit fees and Head
office costs, etc.
Direct Indirect
The resources that are expended solely to
complete the activity or asset.
Examples concrete, labors, non reusable
forms, and permit fees.
The resources that need to be expended
to support the activity or asset.
Examples expenses for utilities, taxes,
legal services, etc.
CostStructuring
C O S T

4. Cost Center
Groups of activities within a project that provide a convenient point for collecting
and measuring costs.
Profit Centers
Investment
C O S T
Responsibility
Centers
Cost Centers
Investment
Centers

5. Cost Accounting
The historical reporting of disbursements and costs and expenditures on a
project.
Steps:
Classification can be done using the code of accounts or WBS or Activity-
Recording Classifying Summarizing
Classification can be done using the code of accounts or WBS or Activity-
Based Costing (ABC)
6. Code of Accounts
All recorded cost elements are classified.
Sometimes referred to as a chart of accounts or as cost code of accounts.
A company’s code of accounts is configured to support the recording of cost data in
the general ledger.
C O S T

C O S T
Typical Code of Accounts

Financial Statements according to
GAAP
Income Statement
(Statement of Operations)
The Balance Sheet
(Financial Position) Statement of Cash Flows
7. Financial Reporting
(Statement of Operations) (Financial Position)
Revenue
Expenses
Profits
Operation
Investment
Financing
Assets
Liabilities
Equity
Current
Non-Current
Current
Non-Current
Paid in Capital
Retained Earnings
C O S T

8. Assets
Asset is an economic resource.
Anything tangible or intangible that can be owned
or controlled to produce value and that is held to
have positive economic value is considered an
asset.
Simply stated, assets represent value
Simply stated, assets represent value
of ownership that can be converted into cash
(although cash itself is also considered an asset).
C O S T
Tangible Assets Intangible Assets
Value is based on physical properties
Examples; buildings, land, machinery
Claim to future income
Examples; various types of financial
assets.

9. Cost Management
A. Estimating
Predicts the quantity and cost of resources needed to accomplish an activity
or create an asset.
A well-defined scope.
A cost element structure.
Historical cost data.
Historical cost data.
B. Cost Trending
Established from historical cost accounting information.
How expenditures are trending relative to physical accomplishments.
C. Cost Forecasting
Much like estimates.
An estimate is always for future activities and assets, and establishes the
Budget at Completion (BAC) for performance baselines.
C O S T

D. Life-Cycle Costing (LCC)
The total cost to the organization for the ownership and acquisition of the product
over its full life cycle.
This is the concept of life cycle costing-looking at the cost of the whole life of
the product, NOT just the cost of the project.
Life-cycle cost include construction costs, operational and maintenance costs,
taxes, financing, replacement and renovation.taxes, financing, replacement and renovation.
C O S T
Life-Cycle Cost
Elements

Costing Pricing
Cost Estimating is the determination of
approximately how much will it cost the
performing organization to provide the
product or service involved
The determination of the amount to be
charged to the client for the product
or service.
PRICING AND COSTINGPRICING AND COSTING
1. Costing Vs. Pricing
Price = Cost + Profit
Direct cost + Indirect cost + Overhead
C O S T

Inputs
Transforming
Mechanism
Tools and Techniques
Outputs
1. WBS/Scope
2. Historical Records
(Historical data base
management – Continuous
1. Costing and Pricing
Strategies
i. Cost estimating
1. Project Estimate
2. Project Acquisition
3. Business Decision
2. The costing-Pricing Process
management – Continuous
improvement and Risk
Mitigation)
3. Vendor Quotations
i. Cost estimating
ii. Budgeting
iii. Cost forecasting
2. Financial Management
i. Return on Investment
ii. Return on Assets
iii. Net Profit Margin
3. Business Decision
C O S T

3. Financial Management
a. Return on investment (ROI) =
[(Profit =(Project Outputs)- Project Costs (Inputs)]
Project Costs (Inputs)
Measures the profitability in dollars invested
b. Net Profit Margin (NPM) =
Net Income
Total Revenue
Measure of the effectiveness of a company at cost control
c. Return on Assets (ROA) =
Net Income
Total Assets
Depicts the efficiency with which management has used resources to
generate income
c. Assets Turnover =
Total Revenue
Total Assets
Return on Assets (ROA) =
Net Profit Margin X Assets Turnover
C O S T

Return on investment (ROI)???
C O S T

Net Profit Margin (NPM)????
Return on Assets (ROA) ?????
C O S T

1. Material Procurement
Materials are one of the bulk sums in any project .
If materials are not procured accurately ,it may have a significant bad effect to the
project cost and performance.
The five rights for material procurement
MATERIALSMATERIALS
C O S T
Time
Cost
Quality
Quantity
Vendor

2. Materials Competition
Competition factors including cost, availability, durability, weight, wear
resistance, and ease-of-fabrication are among relevant considerations
regarding choice of materials.
Other items for consideration include: quality assurance/quality control,
materials handling, and materials hazards.
MATERIALSMATERIALS
materials handling, and materials hazards.
3. Materials Handling
A requirement of the production process.
An inefficient materials handling system
can slow production operations, creating other
excessive costs as a result of production delays.
C O S T

These basic principles for material handling:
MATERIALSMATERIALS
1. Material movement should be over the shortest distance
possible.
2. Terminal time should be in the shortest time possible,
since the objective is to move materials.
3. Eliminate manual material handling when mechanized
methods are feasible.
C O S T
methods are feasible.
4. Avoid partial transport loads, since full loads are more
economical.
5. Materials should be identifiable

MATERIALSMATERIALS
4. Materials Handling Decisions
There are four basic decision factors that affect materials handling.
i. Type of material to be handled: Clay in loaders, structural steel by crane,
liquids in pipelines.
ii. Production system type: Job shop or batch process and continuous
process.
iii. Facility type: Low ceiling height, rectangular area, open area.iii. Facility type: Low ceiling height, rectangular area, open area.
iv. Materials handling system costs: Initial Cost, lifecycle costs, disposal
costs.
C O S T

MATERIALSMATERIALS
Raw Materials Bulk Materials Fabricated Materials
Engineered/
Designed
Materials
Materials utilized in
a production or
fabrication process
Materials readily
available with minimal
lead times for order
Bulk materials transformed
into custom-fit items for a
particular product or project.
Materials require
substantial work in
order to attain their
5. Types of Materials and Related Information
The most basic.
Ex: Raw materials
such as coal,
limestone, etc.
and delivery.
EX: Steel Sheet, steel
bars, steel pips..etc
Ex: Steel pipe transformed by
fabrication into custom
dimensions for particular use.
final form.
EX: Pumps, motors,
boilers, chillers, fans,
compressors, etc.
C O S T

MATERIALSMATERIALS
5. Production Materials Purchase and Management
i. Materials Quality
Poor quality materials can result in product defects leading to increased costs.
Higher-quality materials in excess of requirements will lead to excessive costs.
ii. Materials Traceability & Vendor Surveillance
Vendor surveillance may require periodic inspection at the vendors’ location.Vendor surveillance may require periodic inspection at the vendors’ location.
Materials traceability is accomplished by means of Mill Certifications.
iii. Materials Quantity
Materials storage is a further burden that can exceed the value of the
materials.
Insufficient inventories may create dangers of “stock-outs” interrupting process.
To balance these demands, determine Economic Order Quantity (EOQ) number.
C O S T

MATERIALSMATERIALS
iv. Economic Order Quantity (EOQ)
EOQ = (2 x D x P) / S
Where:
EOQ: The optimal order quantity (not function of item cost)
D: Annual demandD: Annual demand
S : Storage costs
P : Purchase order costs which is setup cost (ordering, shipping,
handling) not the cost of goods
A garden tractor manufacturer has a requirement for 15,000 engines per year.
The engines each cost $75. The order cost for a purchase order is $250. The
storage costs for the engine are $12 per year, which includes space costs and
financing costs.
Economic Order Quantity (EOQ)???
C O S T

MATERIALSMATERIALS
v. Reorder Point
Where:
PR: Reorder point
O: Order time
R : Production rate
I : Minimum inventory level or safety stock
(RP) = (O x R) + I
Assume that the production process uses 60 engines per day for the 60 garden
tractors produced per day. If the lead time for an order is 5 days, and the safety
stock level is 180 engines (minimum level), then the reorder formula in this
example yields:
Reorder Point (RP)???
C O S T

MATERIALSMATERIALS
vi. Just-In-Time Inventory Techniques
The just-in-time concept implies that the exact material quantities needed
are delivered at the exact time needed.
The goal is to reduce inventories and the related costs, such as storage
space.
Traditional practices that focus on safety stocks can mask unprofitable
variations in the production process.variations in the production process.
By removing these safety stocks, the goal of just-in-time systems is a lean
production process and an enhanced competitive position.
The production facility therefore receives more frequent deliveries of smaller
shipments on a periodic basis.
C O S T

MATERIALSMATERIALS
C O S T
Just-In-Time Inventory Techniques

MATERIALSMATERIALS
C O S T
Lean Production Process

MATERIALSMATERIALS
viii. Expediting
Non-standard and costly items A continual basis items
A system of plans/specifications
requirements and competitive
bidding.
A systems contract may be the best
solution.
vii. Individual Purchasing Orders and Systems Contracts
Expediting involves the monitoring of
all steps in the procurement cycle to
ensure on-time delivery of the
necessary materials.
This monitoring includes checking
design status, material status,
production status, and shipping
status.
C O S T

MATERIALSMATERIALS
ix. Materials Inspection
Inspections can range from simple visual
methods to machine-assisted inspections
incorporating techniques such as X-ray and
ultrasonic technology to detect flaws.
The goal is to ensure that the correct grade
and quality of materials are being receivedand quality of materials are being received
from suppliers.
x. Global Materials Decisions
Materials fabrication decisions, as to locations
and methods, are being made on a global basis.
Ex, Nike and Dell.
C O S T

MATERIALSMATERIALS
6. Plant Material Management
Materials that are not incorporated into product or project.
Instead assist in production operations.
i. Specialized Plant Materials
Such as replacement parts may be available only from the Original
Equipment Manufacturer (OEM) and require significant lead time.
ii. Plant Materials Benchmarkingii. Plant Materials Benchmarking
Plant materials usage and longevity should be tracked through such measures
as benchmarking.
Benchmarking involves the examination of other organizations as to their
practices
7. Safety Data Sheet and Hazard Communication
Must be readily available and accessible to those dealing with hazardous
materials as required by (OSHA).
C O S T

MATERIALSMATERIALS
8. Material Life Cycle
All materials have a life cycle from initial development through to manufacture,
incorporation in the product, and eventual disposal.
i. Waste Materials
Original materials cost.
Handling costs.
Disposal costs.
ii. Surplus materials
Excessive order.
Change in material requirements.
Incorrect quantity information.
C O S T

I. Labor Classification
Labors are human resources and personnel performing in the activity or the
project.
LABORSLABORS
Direct Labor Indirect Labor Overhead Labor
Directly produce the
product
Not part of product but
that are required to
Allocated as a business expense
independent of the volume ofproduct that are required to
complete the project.
independent of the volume of
production.
C O S T

LABORSLABORS
Base Wages
Fringe Benefits
Paid Time-Off (PTO)
Medical and Life
Insurance Benefits
Government Mandated
Benefits
The amount that
goes directly to the
Labors are paid for
local and national
Some firms and labor
contracts include
Government retirement
funds, unemployment
II. Developing Labor Rates
1. Employees
goes directly to the
employee
local and national
holidays ,vacations
and sick time
contracts include
contributions to a
medical and life
insurance program
funds, unemployment
insurance, retirement
healthcare insurance
C O S T

LABORSLABORS
Workshop
An engineer gets 5 days of sick time, 10 days of vacation, and 10 holidays /year.
1. Calculate the adders cost
If the nominal working time is 52 w/y , 40 h/w , 8 h/d
2. What is the real productive time?
3. What is the actual hour cost?
If the firm contributes $500 per month for medical insuranceIf the firm contributes $500 per month for medical insurance
4. What is the added cost /h?
If the firm contributes Retirement(6.2%), Retirement Medical (1.45%), State
Unemployment (1.0%).
5. What is the added cost /h?
6. What is the total hourly cost?
7. What is the percentage of adders?
C O S T

LABORSLABORS
2. Engineering/Contractors Overhead and Profit
When hiring contract employees, labor rates are usually broken down differently.
i. Base wages, including fringes
ii. Worker’s compensation (if applicable)
iii. Overhead
iv. Profit, (if applicable for time and material situations).
3. Fully Loaded or Billing Rate
C O S T
The base wage, plus adders.
An owner pays for the worker’s time when he
or she is on the job.
4. Overtime
(PTO, insurance, and some governmental programs) are
not added to overtime.
Some other governmental retirements are usually added
to overtime.

LABORSLABORS
5. Weighted Average Rates/Crew Composite Rates
The labor composite unit rate is used with unit rate cost estimating.
We use composite labor rate and material, equipment and temporary
construction materials to calculate an activity composite unit rate
C O S T

LABORSLABORS
Workshop
A contractor needs to make up time in the schedule. If the contractor works the
concrete crew, 10 hours per day, Monday through Saturday for two weeks, how
much extra will it cost the contractor?
Overtime is paid for all hours over eight Monday through Friday, and the first
eight hours on Saturday.
Double-time is paid for hours greater than eight on Saturday and all Sunday
work.
Based on the following data, What is the average hourly cost of the crew?
C O S T

LABORSLABORS
6. Indirect and Overhead Labor
There are two methods of determining Indirect and Overhead Labor costs
i. To do a direct estimate of the indirect staff required and cost them out the
same way as the direct work crews.
ii. To use historical job percentages to determine an appropriate allowance
for indirect labor.
C O S T

LABORSLABORS
III. Productivity
1. Factors Affecting Productivity
i. Union or non-union craft labor
ii. Local Labors
iii. Remote area and transportation
iv. Weather conditions
C O S T
iv. Weather conditions
v. Local holidays
vi. Temporary living quarters
vii. Overtime
viii. Standard work hours and work days?

2. Learning Curve
The concept of learning curve theory is ; If people do a job repeatedly, each
time they double the number of times they repeat the job, the time to do the
work is reduced by a constant percentage.
LABORSLABORS
C O S T

LABORSLABORS
3. Productivity Improvement
The opportunity to put in place procedures or make changes to improve
productivity and minimize the cost of some of these factors.
Shorten waiting time for a crew, material may be pre-staged at the work
location.
A manufacturing plant has the added benefit of more permanent personnel
C O S T
and the same physical location.
Minimize the impact of adverse weather.
Lean Management
Training and team building.

4. Performance Monitoring
i. Work Package/ WBS
The required work hours for each work package or work breakdown structure.
ii. Graphical Presentation of EV Data
Graphical presentation of Earned Value analysis such as CPI, SPI, CV and SV.
LABORSLABORS
iii. Work Sampling
C O S T
iii. Work Sampling
A method that can be used to determine
production or unit rates for specific work
activities.

ENGINEERING ROLE AND PROJECT SUCCESSENGINEERING ROLE AND PROJECT SUCCESS
Engineering is a key element toward the success of products and projects.
Computerized techniques, such as CAD, BIM, simulation, and others, require
significant upfront investments in software/training, but correctly applied
have proven their worth in reducing overall costs toward the delivery of
products and processes.
Techniques including constructability, manufacturability, and value analysis
have found use in this area.
Process development:
C O S T
Research
Design
Construction

I. Product, Project, and Process Development
1. Pure and Applied Research
In the development of products, organizations conduct research.
The research can be divided into two types
Pure or Basic Research Applied Research
Involves work without a specific end The attempt to develop usable products or
2. Product, Project, and Process Life Cycles
The life cycle of a particular product/project will have a significant influence on
all design decisions, including producing plant and equipment.
Civil infrastructure projects often have lives of many decades and should be
designed for low-cost maintenance and upgrades.
C O S T
Involves work without a specific end
product or use in mind.
The attempt to develop usable products or
add new feature-sets to existing products

3. Computer-Aided Design (CAD)/Engineering
(CAE)
Utilization of computerized work stations and
software to develop and analyze a product,
project, or process design.
C O S T
4. Computer-Aided Manufacturing (CAM)
CAD/CAE ported directly into CAM software.
Design is directly sent to machines like CNC
Computer-numerically controlled

5. Prototypes
Developed prior to large-scale production
i. Test designs
ii. Test customer reaction.
Prototype development is expensive, but is less expensive than discovered afterPrototype development is expensive, but is less expensive than discovered after
numerous units are in customer hands.
C O S T

6. Patents and Trade Secrets
Investments in new products and research are typically both expensive and
time-consuming endeavors.
This investment must receive protection. (20 years, 8 June 1995, WTO).
Organizations can protect this investment through either patents or trade
secrets.
Organizations wishing to emulate patent’s provisions will develop different
approach different or pay to the patent holder.
Trade secrets can be somewhat broader than patent protection in that they
protect both commercial and technical information from disclosure
7. Product Liability
Those injured by a product can seek compensation for their damage.
The tort law in this area has evolved over decades from a concept of “buyer
beware” to a concept of “seller beware”.
C O S T

II. Product, Project, and Process Design
1. Standardization
The attempt to base product designs. The advantages are lower costs, shorter
time, and maintenance personnel are more familiar.
The disadvantage that If there is a flaw, it will be spread over a wide variety of
products.
2. Process Selection
Relates to production methods, continuous and discrete
i. Continuous production methods such as petrochemical plants, power
plants and manufacturers with assembly-line methods. It’s less expensive
in the long run.
ii. Discrete production such as pre-cast concrete plant, or structural steel
fabrication shop. It has a higher labor factor. Favored where labor costs are
less expensive.
C O S T

3. Manufacturability
Slight modifications in a design that promote ease
of product assembly without affecting the product
that designs should be:
i. Forgiving of minor inaccuracies
ii. Easy to fabricate
iii. Based on efficient utilization of labor, materials,
and equipment
4. Constructability (BIM)
The Counterpart of manufacturability applied to
constructed projects to pinpoint problems before
designs are developed to the point where changes
create significant delays and associated costs.
C O S T

5. Make-or-Buy Decision
Which items should be subcontracted out and which should be made in-house.
Do organization’s quality and cost on an item can compete with outside
suppliers.
If trade secrets are involved, the decision will typically be to make the item,
the goal is to enhance overall quality at a lower cost.
It is better to "make" if:
i. You have an idle plant or workforce.
ii. You want to retain control.
iii. The work involves proprietary information or procedures.
C O S T

(Operation)
Total Cost “of
equipment”
$
Cost of rent
equipment
1.5 M
Example of resource equipment
(Asset)
1.5 M
Quantity100,000
C O S T

III.Engineering Production/Construction
1. Production Health and Safety
An accident results in the loss of a trained worker
and an interruption in the process.
Systems must be selected that reduce/eliminate the
potential of accidents
2. Facility Layout
Decisions as to arrangement, including equipment
location, labor location, and services location.
Layout decisions should always consider the potential
impact of additional demand therefore considering
future expansion.
C O S T

3. Assembly And Flow Process Charts
Assist in planning the facility layout.
They help to analyze production operations in
terms of operations sequences performed,
distances between operations, and operation
time requirements.
4. Quantitative Analysis In Facility Layout.
i. Linear programming is a mathematical
technique that is widely used in finding
optimal solutions to problems.
ii. Monte Carlo techniques can be used to
simulate wait time for a crane in a plant and
its cost impact while data can be generated
via computer programs with random number
generators. C O S T

5. Reengineering
Redesign of process to achieve improvements such as cost, quality, service,
and speed.
Reengineering focuses on the optimization of the total organization, rather than
sub-optimization of individual departments.
Reengineering focuses on the “whys” of an action or process as opposed to the
“hows”.
C O S T

MACHINERY, EQUIPMENT, & TOOLSMACHINERY, EQUIPMENT, & TOOLS
Equipment Value
Categories
Replacement cost (the cost
new of an item having the same or
similar utility)
Reproduction Cost
Market value (used equipment,
secondary market value)
Fair Market Value-in-
Place
C O S T
Fair Value
Fair Market Value-in-
Exchange
Orderly Liquidation
Value
Forced Liquidation
Value
Salvage Value/Part-Out
Value
Scrap Value

I. Equipment Value Categories
Equipment values can be divided into two major categories:
1. Replacement cost (the cost new of an item having the same or similar utility)
2. Market value (used equipment, secondary market value)
1. Replacement cost (the cost new of an item having the same or similar
C O S T
1. Replacement cost (the cost new of an item having the same or similar
utility)
i. Reproduction Cost
The cost new of an identical item.
ii. Fair Value
Cost new of an item considering similar items cost, and taking into account
utility and all standard adjustments and discounts to list price. $350,000

2. Market value (used equipment, secondary market value)
i. Fair market value in place
The amount expressed in terms of money that may reasonably be expected to
exchange between a willing buyer and a willing seller $250,000, 125%
ii. Fair market value in exchange
C O S T
be exchanged in a third party transaction between a willing buyer and a
willing seller (retail value) $200,000, 100%
iii. Orderly Liquidated Value
The estimated gross monetary amount that could typically be realized from a
liquidation sale, given a reasonable period of time to find a purchaser.
(wholesale value) $160,000 , 80%

iv. Forced Liquidated Value
The amount expressed in terms of money that may reasonably be expected
from a properly advertised and conducted auction where time is of the
essence (blow-out value). $120,000, 60%
v. Salvage value / part out value
The amount expressed in terms of money that the buyer will pay to a seller,
C O S T
recognizing the component value of parts of the equipment that can be used or
resold to end-users, usually for repair or replacement purpose $8,000, 4%
vi. Scrap Value
the estimated monetary amount that could be realized for the property if it
were sold for its material content, not for productive use, as of a specific date
value ie. $/ton of steel $2,000, 1%

Very Good (VG) Good (G) Fair (F) Poor (P) Scrap (X)
Used with
equipments with
excellent
appearance and
Used with
equipments
that were
modified or
Used with
equipments used at
some point below
its fully specified
Used with
equipments used at
some point below
its fully specified
The
equipment is
no longer
serviceable
3. Equipment Condition Terms and Definition Example
C O S T
appearance and
being used to its
full design
specification
without being
modified or
requiring any
repairs
modified or
repaired
and is being
used at or
near it fully
specified
utilization
its fully specified
utilization due to
the effect of age or
application.
It may require some
general repairs and
replacement of
some minor parts.
its fully specified
utilization that
will require
extensive repairs
and/or
replacement of
major elements
in the near future.
serviceable
and cannot
be utilized to
any
practical
degree.

I. Equipment Valuation
1. Residual Value
Residual value is the salvage value of an asset.
It represents the amount of value that the owner of an asset can expect to
eventually obtain when the asset is disposition
2. Residual Value Determination Methods
C O S T
i. Income approach (present value of future cash flows)
ii. Market approach (Trade data)

Normal Curve Disrupted-Market Regulatory Change Curve
long-lived equipment,
usually L-Shape.
Usually U-Shape, results from
equipment shortage or regulatory
pressures causing suddenly
deviation.
Illustrates sudden impact on
market value that regulation can
cause.
C O S T
High Obsolescence Curve New Tax Law / High Inflation Curve
Illustrates impact of technological obsolescence
such as computers and high-tech equipment.
Tax laws and inflation can cause a normal
residual curve to rise in a short time.

3. Variables That Affect Residual Value
i. Initial Cost
For residual purposes, the estimator should consider hard costs only.
Hard cost includes
a. The cost new equipment
b. Items necessary to make it operate such as motors, electrical, and
controls.
C O S T
controls.
Soft costs should not be included such as foundations, freight, debugging,
taxes, and installation.
ii. Maintenance
It can affect the useful life of equipment. In calculating a residual value,
estimators must consider how the equipment will be maintained and/or the
maintenance provisions in the lease

iii. Use, Wear, and Tear:
Equipment in harsh service versus mild service can be substantial. Ex: hopper
used in grain service lives 40 to 50 years. However, if used in salt service,
their useful lives can be as short as 15 years.
iv. Population
This gives statistical significance to the residual value, because the value will
be based on a large sample.
C O S T
be based on a large sample.
v. Age
Equipment presented as new in January 2012, could have a 2011 or 2010
build date.
Both are new with the same condition but the price is different.

vi. Economy
A used truck in a robust economy may be sold for lower price and longer time
in a recession.
Cost of money should also be calculated in the overall cost.
vii. Changes in Technology
An analysis of technological changes occurring over the past 20 years shows
that future advances in technology were generally known at the time of lease
C O S T
that future advances in technology were generally known at the time of lease
origination.
Time necessary to “fix” an image from minutes to seconds.
viii. Foreign Exchange
Changes in foreign exchange value could affect selling / residual value,
causing them to suddenly drop or increase.
Strong foreign currency may rise the price of foreign equipment, which in
turn, may pull residuals up, and vice versa

ix. Tax Law
Sometimes tax laws can affect new equipments price, hence affecting used
equipment price.
x. Legislation/Regulation
Regulations may impact values in positive ways, however, the impact is often
negative.
xi. Equipment Location
C O S T
xi. Equipment Location
Does the equipment required to be delivered to a prime market location or will
it have to be sold in a remote area?
xii. Method of Sale
Price of cash sales will not be like installment sales.

ECONOMIC COSTSECONOMIC COSTS
Opportunity Costs Sunk Costs Book Costs Incremental Costs
The foregone
benefit by choosing
one alternative
over another.
Funds already spent in by
virtue of past decisions. Since
these expenditures are in the
past, by definition, they should
The value of an
item as reflected
in the firm’s books.
Book costs do not
When comparing
between many
alternatives, cost
differences
I. Types of Costs
C O S T
over another.
You have two
projects to choose
from: Project A
with an NPV of
$45,000 or Project
B with an NPV of
$85,000. What is
the opportunity
cost of selecting
project B?
past, by definition, they should
not influence current
decisions.
Project A had initial budget of
$ 1,000 out of which $ 800
has already been spent. To
complete project A, we will
need additional $ 500. Another
Project B will require $ 1200
for completion. Which project
do you want to select?
Book costs do not
represent cash
flows and thus are
not taken into
account for
economic analysis
decisions.
differences
between them are
called incremental
costs.
If two units have
annual costs of
$1,500, $1,800,
then incremental
cost difference is
….?.

Inflation Deflation Escalation Currency Variation
A rise in the price level of
a good or service, or
market basket of goods
and/or services
A fall in the general
price level for goods
and services or a
representative market
A technique to
accommodate price
increases or
decreases during
A significant cost
impact both on those
inside the country as
well as those outside
II. Changes in Costs
C O S T
and/or services
i. Money supply
ii. Exchange rates
iii. Demand-pull
inflation
iv. Cost-push inflation
representative market
basket of goods and
services
decreases during
the life of the
contract
well as those outside
the country.

Regulations Taxes
Depreciation
and Depletion
Mandating
certain actions
by
organizations
Governments are most often maintained by the taxes that
they impose. These taxes take many forms, such as
income taxes, property taxes, inventory taxes,
employment taxes, gross receipts taxes, and sales taxes
Depreciation
is a non-cash
expense that
reduces taxable
III. Governmental Cost Impact
C O S T
organizations
may or may
not have an
impact on
costs.
employment taxes, gross receipts taxes, and sales taxes
Effective tax rates termed average tax rates are
calculated for income taxation purposes by the percentage
of total taxable income paid in taxes.
The marginal tax rate is the tax rate on the next
dollar of taxable income.
Investment Tax Credits that governments may give
firms tax credits to encourage economic activity.
reduces taxable
income.
Depletion
analogous to
depreciation but
for natural
resources.

IV. Depreciation
Large assets (e.g., equipment) purchased by a company lose value over time.
There are two forms of depreciation:
1. Straight Line Depreciation
2. Accelerated Depreciation
Accelerated depreciation depreciates faster than straight line.
Straight Line Depreciation Accelerated Depreciation
Straight Line Depreciation Accelerated Depreciation
The same amount of depreciation is taken
each year.
D = (C - S) / N
There are two forms:
1. Double Declining Balance D = ( 2 / N ) (BVt-1)
2. Sum of the Years Digits
Dr = (C - S) x [ (N-r+1) / ((N(N + 1) /2 )]
Example: A $1,000 item with a 10-year
useful life and no salvage value (how much
the item is worth at the end of its life)
Would be depreciated at $100 per year.
Example: A $1,000 item with a 10-year useful life
and no salvage value (how much the item is worth at
the end of its life)
Would be depreciated at $180 the first year, $150 the
second, $130 the next, etc.
C O S T

Year
Depreciation
Formula
Depreciation
Amount
Book Value
0 0 0 5000
Your company bought a new equipment with Life time =5years ,Initial cost =5,000,
Salvage value =1,000.
Find the equipment value throughout the life period.
C O S T
1 (5000-1000)/5 800 4200
2 (5000-1000)/5 800 3400
3 (5000-1000)/5 800 2600
4 (5000-1000)/5 800 1800
5 (5000-1000)/5 800 1000
4000
Straight Line Depreciation

3000
3500
4000
4500
5000
Depreciation Curve
C O S T
0
500
1000
1500
2000
2500
0 1 2 3 4 5
Depreciation Curve
Straight Line Depreciation

Double Declining Balance Sum of the Years Digits
A uniform rate of depreciation is applied
annually to the undepreciated value as
of the end of the previous year.
The rate used is double the
depreciation rate used in the
The depreciation charge is calculated as follows:
1. Calculate the sum of years' digits as SYD=
n(n+1/2).
2. For each year, calculate the sum of years' digits
fraction as the ratio of the number of remaining
straight line method.
In the first year, this depreciation rate is
applied to the initial cost of the asset
without subtracting the salvage value.
5 years, 100,000 (40%), 100,000
*40%, 60*40%, ..etc
fraction as the ratio of the number of remaining
years over the sum of years' digits.
3. Multiply the sum of years' digits fraction by
depreciable cost.
4. 5years, (5+4+3+2+1), 5/15, 4/15, 3/15, 2/15,
1/15
C O S T

Your company bought a new equipment with Life time =5years ,Initial cost
=5,000, Salvage value =1,000.
Year
Depreciation
Formula
Depreciation
Amount
Equipment
Value
Book Value
C O S T
0 0 0 5000 5000
1 (2/5) (5,000-0) 2000 3000 3000
2 (2/5) (5,000-2,000) 1200 1800 1800
3 (2/5) (5,000-3,200) 720 1080 1080
4 (2/5) (5,000-3,920) 432 648 1000
5 (2/5) (5,000-4,352) 259.2 388.8 1000
Double Declining Balance

3000
3500
4000
4500
5000
Depreciation Curve
C O S T
0
500
1000
1500
2000
2500
0 1 2 3 4 5
Depreciation Curve
Double Declining Balance

Your company bought a new equipment with Life time =5years ,Initial cost
=5,000, Salvage value =1,000.
Year
Depreciation
Formula
Depreciation
Amount
Book Value
0 0 0 5000
C O S T
0 0 0 5000
1 (5/15) (5,000-1,000) 1333 3667
2 (4/15) (5,000-1,000) 1067 2600
3 (3/15) (5,000-1,000) 800 1800
4 (2/15) (5,000-1,000) 533 1267
5 (1/15) (5,000-1,000) 267 1000
Sum of the Years Digits

2500
3000
3500
4000
4500
5000
Depreciation Curve
Depreciation Curve
C O S T
Sum of the Years Digits
0
500
1000
1500
2000
2500
0 1 2 3 4 5
Depreciation Curve

Another form of depreciation is called Units of Activity (or Production)
In this method, the depreciation charge is calculated as follows:
a. Divide the depreciable cost over the expected useful life of the asset (in hours, miles, or
similar units) to obtain the depreciation rate per unit.
b. At the end of each year, multiply the depreciation rate per unit by the actual usage during
that year.
In the units of activity (or production) method, the depreciation charge is not
In the units of activity (or production) method, the depreciation charge is not
known in advance for each year. It is calculated after the conclusion of each
year's activities.
An organization, or an individual, may choose the depreciation method that best
fits their business needs.
In depreciating real estate, only the straight line method is allowed.
An organization, or an individual, may switch the depreciation method, during the
life of the asset, only once and only to the straight line method.
C O S T

V. Economic Analysis Techniques
1. Time Value of Money
In order to compare different alternatives on the same basis, these cash amounts of
income and expenditures must be set to equivalent terms.
There will be an interest rate set which provides the common basis for calculations.
When evaluating expected income/cost flows in the future, this interest rate can also be
referred to as a “discount rate,” since money in the future is “worth” less than money in
the present.
Common Language terms are;
C O S T

Economic Analysis Techniques
Standard Formulas for Economic Analysis
C O S T

i. Present Value (PV):
The value today of future cash flows.
This is the method of determining today’s value of future money.
PV =
FV
(1+i)n
Where:
PV: Present Value
FV: Future Value
Example
What is the present value of $300,000 received three years from now if we
expect the interest rate to be 10 percent?
FV: Future Value
i : Interest rate
n : number of time periods
PV =
300000
= $225,394
(1+0.1)3
C O S T

ii. Net Present Value (NPV)
The sum of the present value of all income and expenditures of a project. (> 0
is ok).
It is the present value of the total benefits (income or revenue) minus the costs
over many time periods.
NPV= PV (all cash inflows) – PV (all cash outflows)
FV
Example
You have two projects to choose from. Project A will take three years to
complete and has an NPV of $45,000. Project B will take six years to complete
and has an NPV of $85,000. Which one would you prefer?
Decision: Maximum NPV Project “B”
NPV = ∑
FV
- Initial Investment
(1+i)n
NPV = ∑ PVCF - II
C O S T

Time Income / Present Value of Income Present Value of Cost
Example
Cash flow as follow with interest 10%.
NPV?
200
50 100 300
100
I or WACC= 10%
0
1 2 3
NPV= 353 - 291 = $ 62
Time
Period
Income /
Revenue
Present Value of Income
at 10% Interest Rate
Costs
Present Value of Cost
at 10% Interest Rate
0 0 0 200 200
1 50 45 100 91
2 100 83 0 0
3 300 225 0 0
Total 353 291
Decision: Accepted
C O S T

iii. Capitalized Cost (CC)
Capitalized cost (CC) represents the present sum of money that needs to be set
aside now, at some interest rate, to yield the funds required to provide the
service.
A= P X I
Where:
P: Present Value
i : Interest rate
Example
A bridge is built for $5,000,000 and will have maintenance costs of $100,000
per year at 6%, what is the capitalized cost of service?
i : Interest rate
A : End of year payment of uniform amount series
CC = 5,000,000 +
100,000
= $6,666,667
0.06
C O S T

iv. Equivalent Uniform Annual Cost (EUAC) or Benefit
It may be preferable to resolve the comparison to annual cash flow analysis.
The comparison may be made on the basis of Equivalent Uniform Annual Cost
(EUAC), Equivalent Uniform Annual Benefit (EUAB) or on the EUAB-EUAC
difference.
EUAC = (P – S) (A/P, i, n) +SI
Where:
P: Present Value
S: Salvage value
Example
A bridge Assume that the two units, Unit A and Unit B are compared on the
basis of EUAC. Unit A has an initial cost of $20,000 and $3,000 salvage value,
while Unit B has an initial cost of $15,000 and $2,000 salvage value. Unit A has
a life of ten-years, whereas Unit B has a five-year life. Cost of capital is ten
percent.
C O S T
S: Salvage value
i : Interest rate
A: Annuity
n : number of time periods

v. Rate of Return (ROR)
Many organizations often set hurdle rates (benchmark rate of return) that a
capital investment decision must achieve to be acceptable.
In the case where investment funds are limited, projects with the highest
ROR values can be selected.
0 = ∑
FV
- Initial investment
(1+i)n
Where:
Project “Proceed”
The NPV of the cost is set equal to the NPV of the benefit. The NPV Cost of
Unit A versus Unit B is $10,000 ($20,000 - $10,000). The NPV of the Unit A
– Unit B Benefit is $15,000.
Example
Unit A cost of $20,000 and Unit B of $10,000 and each 1-year life. Incremental
benefit of $15,000 for A compared to B. Organization hurdle rate is 20%.
Decision: ROR= 50% > 20%, investment
Where:
i : Rate of return
C O S T

vi. Payback Period
The payback period is the length of time required to recover an initial
investment through cash flows generated from the investment.
The shorter the time period, the better the investment opportunity.
Common use because it used be small and medium enterprises (represent 80%
of the market).
Payback period is THE LEAST precise of all capital budgeting methods because:
1. There is NO discounting involved, so the time value of money is completely
1. There is NO discounting involved, so the time value of money is completely
ignored.
2. The payback rule also fails to consider any risk differences (Calculated the
same way for both very risky and very safe projects).
Payback Period=
Initial Investment
(Annual cash inflows)
C O S T

Example
A project costs $100,000 to implement and has annual net cash inflows of
$25,000.
Example
Project A has an investment of $ 500,000 and payback period of 3 years.
Payback Period=
100,000
= 4 years
25,000
Project A has an investment of $ 500,000 and payback period of 3 years.
Project B has an investment of $ 300,000 and payback period of 5 years. Using
the payback period criteria, which project will you select?
Project “A”
Key selection: Lowest Payback period
C O S T

Example
Example
Years 0 1 2 3 4
Cash flow -1000 500 400 300 100
Net Cash
flow
-1000 -500 -100 200 300
Payback period = 2.33 years
Example
Years 0 1 2 3 4
Cash flow -1000 100 300 400 600
Net Cash
flow
-1000 -900 -600 -200 400
Payback period = 3.33 years
C O S T

vii.Benefit Cost Ratio (BCR)
A comparison of revenue to costs. Greater than 1 is good.
BCR of > 1 means that benefits (i.e. expected revenue) is greater than the
cost. Hence it is beneficial to do the project.
BCR=
Benefits (or Payback or Revenue)
Costs
C O S T

ACTIVITY BASED COST MANAGEMENTACTIVITY BASED COST MANAGEMENT
Case
Jon, Ian, Michel and Nancy order separate items for lunch.
Jon’s order amounts to $14
Ian consumed $30
Michel’s order is $16
Nancy’s order is $24
C O S T
Nancy’s order is $24
Total $84
What is the average cost per lunch?
$84 ÷ 4 =
$21
Jon and Michel
are overcosted
Jan and Nancy
are
undercosted

I. Overhead Expenses and Direct Expenses
Overhead expenses have been displacing the recurring costs.
Organizations have visibility of direct costs, but not have any insights into overhead
or its reasons.
Activity Based Cost Management can help provide for insights.
C O S T
Indirect Expenses are
Displacing Direct Expenses

Activity-Based Management Activity-Based Costing
Focuses on activities during
production and performance process
Improves the value received by
customers
Recognizes several levels of costs
Accumulates costs into related cost
pools
Uses multiple cost drivers to assign
C O S T
Enhances profitability costs to products and services
Cost Driver
A factor that can causes a change in the cost of an activity.
An activity can have more than one cost driver attached to it.
For example, a production activity may have the following associated cost-
drivers: a machine, machine operator(s), floor space occupied, power consumed,
and the quantity of waste and/or rejected output.

C O S T
Each Activity Has its Own Driver

II. Activities are Expressed with Action Verbs and Trace Expenses to Output
General Ledger ABC/M
Transaction - centric Work - centric
Uses chart of accounts Uses chart of activities
What was spent What it was spent for
C O S T
Records the expenses
Calculates the costs of activities
and unit cost
Organized around cost centres to
accumulate transactions into their
accounts.
But this format is deficient for
decision support
Describes activities using an
“action verb- adjective-noun”
format, such as inspect defective
products, open new customer
accounts

Cost Elements Activities Cost Object
III. ABC/M is a Cost Re-assignment Network
ABC re-assigns all of the costs into the final products, service lines, and
customers.
ABC cost re-assignment network consists of the three modules connected by
cost assignment paths.
C O S T
Cost of a
resource or
input consumed
by an activity.
Aggregations of
actions performed
in an organization
which are useful
for ABC
computations
A product or
department for
which costs are
accumulated or
measured

C O S T

IV. Using The Attributes of Activity –Based Costing
One role for calculating costs is to identify which activities are:
1. Not required and can be eliminated (Ex: Duplication of effort)
2. Ineffectively accomplished and can be reduced
3. Required to sustain the organization (not be possible to reduce or eliminate).
4. Discretionary and can potentially be eliminated (Ex: Annual employees’ picnic).
Traditional methods do not provide any way to tag/highlight individual costs.
C O S T
Traditional methods do not provide any way to tag/highlight individual costs.
ABC/M allow managers to differentiate activities from one another.

V. Local vs. Enterprise-Wide ABC/M
A common misconception is that ABC/M system must be enterprise-wide. However
In practice, the majority of ABC/M is applied to subsets of the organization for
process improvement rather than revenue enhancement.
The local model is used for tactical purposes, often to improve productivity. In
contrast, the enterprise-wide model is often used for strategic purposes because
C O S T
contrast, the enterprise-wide model is often used for strategic purposes because
it helps focus on where to look for problems and opportunities.
Also, enterprise-wide models are popular for calculating profit margin at all
levels.
Commercial ABC/M software now enables consolidating some, and usually all, of
the local, children ABC/M models into the enterprise-wide, parent ABC/M model.

VI. An Example of Unitized Costs
C O S T

VII.Applications Of Local ABC/M
The objective of local ABC/M models is not to calculate the profit margins; it is to
compute the diverse costs of outputs to better understand how they create the
organization’s cost structure.
An interesting application is when marketing department is trying multiple tools,
such as newspapers, radio, television, tradeshows, Websites, ...etc.
C O S T
ABC/M calculation determine the costs versus benefits of all the channel
combinations to rank in order which are the least to best return on spending.

1. Cost Estimating
2. Process Product Manufacturing
3. Discrete Part Manufacturing
COST ESTIMATINGCOST ESTIMATING
C O S T

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