Principles of Cost Estimates in Project Management

Generally in project management, it is very important to accurately estimate the cost of a project. It is even more necessary for management decision and control. Before a project comes on stream, the cost implications must be known well in advance and properly estimated. This serves as a guide to proper project management and control. Proper cost estimates will allow for proper planning of costs, allocation of resources to various units of a project, cost control and most importantly budgetary control.

Cost Definitions and Principles

The word “cost” when used in accounting conveys lots of meaning and so must be properly qualified. There are many types of costs and part of our discussion in this article is to properly discuss various costs and see how they properly fit into the study of project management. It is so because when we mention “cost”, we should clarify the type of cost we are talking about.

Let us discuss the key types of costs that are important for our study.

Direct Costs

Direct costs are those costs which are attributed directly to a job or project. For example, if an engineer spends five hours to design an engineering column, then that time spent by the engineer can be described as a direct labour and the cost can be recorded as a direct cost to be charged directly to the design of the engineering column.

Factory Costs

The concept of factory cost is mainly applicable to manufacturing concerns. Factory cost is the total cost of a job or project before the addition of a mark-up for the purpose of profit. Factory costs will include the following:

a. direct materials costs

b. direct labour costs

c. indirect labour costs

d. design costs.

Fixed Costs

Fixed costs are those costs which remain virtually unchanged and must continue to be incurred even though the workload might fluctuate between zero and the maximum or installed capacity. Fixed costs will generally include the following:

a. management salaries

b. administrative salaries

c. heating and electricity expenses

d. insurance

e. maintenance of building, etc.

f. business permits.

Indirect Costs

In an ideal setting like a manufacturing facility, the provision of office accommodation, management, welfare services, accounting, heating and lighting all constitute costs that must be incurred in running the manufacturing facility. Others will include salaries and wages.

Generally, all these costs are termed indirect costs or overhead costs.

Table 1: Cost Structure for a Simple Manufacturing Project

Standard Labour Costs

Labour constitutes a very critical component of project cost. It includes the labour of both junior and senior personnel, engineers, accountants and the rest who are involved in a project. When trying to estimate the labour cost for any project, it would be very difficult to use the different rates of pay to be earned by every individual. There might be two engineers engaged in a project but they may not be earning the same salaries. Generally, in project management, it is advisable to use standard costing to estimate the cost of labour.

For labour costs, it is convenient to classify people according to some convenient rules based on the type of jobs that they do.

For example, engineers in a project may be averaged out to cost K1,000,000 per annum. Therefore, we can estimate that the standard cost for an engineer for a project is K1,000,000 per annum. That is the cost that will be imputed in the cost estimate for engineers.

Also, for accountants involved in a project, there may also be the need to work out the standard cost for an accountant. For example, we might estimate the standard cost for an accountant to be K1, 500,000 per annum.

For all types of labour, we should have estimates of the standard costs. It enables the project to be properly cost.

Table 2: Example of Labour Grade for Standard Costing in a Project Engineering Company

Overhead Recovery

In table 1, we saw the cost structure for a simple manufacturing project. We easily computed the cost of direct materials and also direct labour. We also recorded overheads. In practical terms, direct labour costs are not difficult to estimate.

Direct labour cost is equal to time recorded on a job multiplied by the standard hourly rate. So, how can we recover overheads?

An amount can be added that is proportional to labour cost (usually a percentage) to recover a part of a company’s indirect overhead costs. In table 1, we saw total direct labour as N900,000. Overheads standing at N1,350,000 is about 150% of total direct labour costs. Generally, the method of recovering overheads as a levy on direct labour costs is called absorption costing.

However, setting the percentage overhead rate is a technical matter requiring professional accounting skills.

Work Breakdown

Consider a project to build a new university Chibombo which is about 20 kilometres from Lusaka, the Imo State capital. Even where we have defined the project as a new university, it will be very necessary to consider the total picture of the new university project.

The university project will include the following:

a. access roads b. administrative buildings c. lecture halls d. clinics e. laboratories f. churches and mosques g. students hostels h. university teaching hospital complex.

Breaking the total project into smaller units constitutes what is referred to as a work breakdown. Work breakdown enables the project managers or administrators to break down a large or complex project into smaller and more manageable units.

The ideal thing to do is to break a project into smaller units called subprojects. The sub-project itself could be further divided into much smaller units for effective analysis and design.

When a project is broken down into smaller sub-projects, it becomes very easy to cost each sub-project properly. After costing each subproject properly, then we could then add up the costs of the sub-projects to generate the cost of the total project.

CONCLUSION

In this article, we discussed cost estimates: definition and principles. We discussed direct costs, factory costs and fixed costs. We discussed standard labour costs and overhead recovery. We also discussed the concept of work breakdown. All these have enabled us to understand the basic principles of cost estimates.