COST ACCOUNTING

Another approach to classifying costs that is similar to

ABC accounting is:
using a work breakdown structure (WBS) to group
cost elements.
It has become a common practice for a WBS to be a required
project management tool on most contracts.
Not only does a WBS provide a framework for planning and
controlling the resources needed to perform the technical
objectives, but it facilitates a summary of project data regarding
the cost and schedule performance.
Table 1.5 shows an example WBS for a study project wherein the
deliverable item is an intellectual product documented in technical
Publications.

When used to classify and record costs, the WBS becomes the
cost element structure (CES), as well .
The general format, however, is applicable for the CES of a
manufactured product or construction project .

While there is no universal WBS/CES

standard, some have been developed for government
acquisition.
One comprehensive example is the U.S. Army Cost Element Structure

This CES provides a definition of each cost element within the

structure.
It also provides structure for cost elements in all procurement
phases: development, production, and operation and support.
Sometimes the code of accounts to be used is
determined by law.
For example, the Federal Energy Regulatory Commission (FERC) has
established a Uniform System of Accounts for the electrical power
generation industry.
The account numbering plan used consists of a system of three-digit whole
numbers as shown in Table 1.6.

Regardless of how cost elements are classified and grouped, it is

important that :
this is done in a manner that is consistent with the way
future work is estimated and budgeted.
Historical cost records represent the way a company
conducts its business and can be analyzed to determine whether
improvements

have been made and how costs may trend in the

future. Therefore, the integrity of the cost accounting system is
essential to developing a project cost baseline.
Example 3John recognizes that the deck he is building is an
improvement to his home that would be considered a capital
investment. He decides that he needs to structure his cost
accounts to provide data for future maintenance estimates.
Here is the code of accounts he develops:

Notice that John hired some of the labor and has cost records
(invoices) for the work.
For the labor he performed, John might use a fair market value to
account for the cost of these activities. Also, values of indirect cost
elements are not
shown in this list.
For, example, John could have included the rental value of the tools
used in the construction.
This valuation approach would have allowed him to get a better
understanding of the total value of the deck.
Johns code of accounts allows him to group material and labor
costs to find the total cost of the footings, deck structure, and
painting.
Table 1.8 shows how he rearranges the cost elements to get this
visibility:
Cost element allocation would be ratioed to the cost of the
material and labor in each component of the asset.
This arrangement of cost elements is similar to the ABC or WBS
approach.

COST MANAGEMENT
There are many ways that cost elements and cost structure can
be displayed to provide information for cost management.
We will consider four of the most common methods of
how cost information is applied to cost management.
These are:
cost estimating
cost trending
cost forecasting
lifecycle costing.
Although these methods will be discussed in more detail in later
chapters, it is important to see how they relate to cost elements
and structure.

Cost Estimating
Cost Estimating predicts the quantity and
cost of resources needed to accomplish an activity or
create an asset.
The building blocks of a cost estimate are :
a well-defined scope (what we are trying to estimate),
a cost element structure (how we organize the
information),and
historical cost data (data from cost accounting records
and/or experience of knowledgeable people).
Key questions to ask regarding a cost estimate always
include
What cost data was used? and How can we reduce the
cost of x?
Therefore, cost element data and its structure are
paramount ingredients of a sound cost
estimate.

Cost Trending
Cost trends are established from historical cost
accounting information.

Cost management questions may focus on :

how expenditures are trending relative to physical
accomplishments.
How much are we spending for pipe fitters and how much
piping has been installed during the last six months?
or What has been our monthly cost for steel this last year
and how many bowls have we produced?
Again, having access to cost history in the structure needed is
key to providing the required information.

Cost Forecasting
Forecasts are much like estimates.
Whereas an estimate is always for future activities and
assets, forecasts are predictions of the cost at
completion for cost elements in progress.
Therefore, a sound cost forecast will be based on cost element
data from inception of the work to the date of the
forecast, the cost trend of that data compared to
accomplishments, and a cost estimate of the work remaining to
be completed.
Cost element history in the proper activity structure is essential
for
realistic cost forecasts.

Life-Cycle Costing
Life-cycle costs (LCC) are associated with an asset and
extend the cost management information beyond
the acquisition (creation) of the asset to the use and
disposal of the asset.
Asset acquisition consists of:
- the design/development phase and
- the Production /construction phase.
Generally, cost elements are segregated into these phases
because design/development costs are often recovered over
more than one asset.

For example,
Design and development cost of a new airplane is amortized
over the production.
The design of a housing project is recovered through sales of the
houses built.
Once the asset is created,it enters the operation and support
(O&S) phase, sometimes called operations and maintenance
(O&M).
A new set of cost elements and CES is applicable to this phase
and cost data must be collected to support cost management
efforts.
The final phase is disposal of the asset with another unique set
of cost elements.

APPENDIX AGLOSSARY

Life-Cycle Cost (LCC) Method

A technique of economic evaluation that sums over a given
study period the costs of initial investment (less resale value),
replacements, operations (including energy use), and
maintenance and repair of an investment decision (expressed in
present or annual value terms).

"What is Life Cycle Costing?

The Life Cycle Cost (LCC) of an asset is defined as:
The total cost throughout its life including:
Planning, design, acquisition and support costs and any other costs directly
attributable to owning or using the asset".
Life Cycle Costing adds all the costs of alternatives over their life period and enables
an evaluation on a common basis for the period of interest (usually using discounted
costs).
This enables decisions on acquisition, maintenance, refurbishment or disposal to be
made in the light of full cost implications.

Why use Life Cycle Costing?

The determination of costs is an integral part of the asset management process and is
a common element of many of the asset managers tools, particularly Economic
Appraisal, Financial Appraisal,Value Management, Risk Management and Demand
Management.

In the past, comparisons of asset alternatives, whether at the concept or detailed

design level, have been based mainly on initial capital costs.
Growing pressure to achieve better outcomes from assets means that ongoing
operating and maintenance costs must be considered as they consume more
resources over the assets service life.
For example,
the operating costs of a hospital consume an equivalent of the capital cost every two
to three years and can continue to do so for forty years or more.
The operating costs of a school can consume the equivalent of its capital cost every
four to five years and remain in service for a century.
Both the capital and the ongoing operating and maintenance costs must be
considered wherever asset management decisions involving costs are made.
This is the Life Cycle Cost approach.
Life Cycle Costing is a process to determine the sum of all the costs associated
with an asset or part thereof, including acquisition, installation, operation,
maintenance, and refurbishment and disposal costs.
It is pivotal to the asset management process as an input to the evaluation of
alternatives via Economic Appraisal, Financial Appraisal, Value Management, Risk
Management and Demand Management.

Life Cycle Costing

Life Cycle Costing is an analysis of not just the initial cost of a

product, but an analysis of all of the costs it will incur over its lifetime, i.e. the
cost to own vs. the cost to buy.
A relevant example would be :
Compact fluorescent light bulbs (CFLs):
Let's take a current estimate and say that incandescent bulbs cost $1 a bulb and
CFLs are $5 apiece.
Additionally, we will consider that the average CFL might last 8 years, while the
incandescent may last 1. The last factor is the energy cost per year.
Current CFL's meant to replace 100W incandescent are 23W.
Each year the bulbs will be on for 500 hours a year.
With this information we can figure out that replacing the incandescent 8 times
and paying for more energy use costs us $68, and using the longer-life CFL will
only cost us $18 over the same 8 year span.
Life cycle costing can be applied to products such as light bulbs and flooring, but
also is a valid technique to discuss entire schools as a whole

Refer to Table 1.9 to see how John might group cost elements
of the deck project to reflect its LCC.

Example 4John rearranges the project cost elements to

understand what it cost to design and construct the deck and to
get a perspective on what it might cost to maintain and eventually
remove the deck.
If John wants to, he can develop a cost estimates for the
maintenance and disposal phases.
As a first cut at the estimate, he can refer to the construction cost
element history for most of the information and add estimates for
termite inspection and replanting the grass.