Question

Great University is planning to build a new parking deck for increasing the number of parking spaces for its faculty members, staff, and students. Marcus Araujo is the Vice Chancellor (Business Affairs) at Great University. Mr. Araujo had hired Mala Iyer (a bachelor’s degree holder in Mathematics) as a Project Scheduler in December 2019. The proposal for the new project had to be given to the Board of Trustees by April 15th, 2020. As part of the project proposal, Mr. Araujo was planning to include a section on Costs and Budgets for the project.   

In his weekly meeting with Mala Iyer (on March 25th, 2020), Mr. Araujo asked her to give him the preliminary outline for the costs and budgets for the new parking deck project. Marcus Araujo then added “Mala, I know that you have not prepared costs and budgets in the past. However, I would like you to make an attempt to include the details of different types of project costs, direct and indirect costs, recurring and non-recurring costs, fixed and variable costs, normal and expedited costs, cost estimations, and project budget”.   
Mala, with not much of a background in accounting and business, was at a loss on where to begin. Help Mala Iyer by explaining the following concepts (including the limitations and advantages of using the different methods) as they relate to the new parking deck project:

a) Different Types of Project Costs.
b) Direct and Indirect Costs, Recurring and Non-Recurring Costs, Fixed and Variable Costs, and Normal and Expedited Costs.
c) Cost Estimations (Ballpark Estimates, Comparative Estimates, Feasibility Estimates, and Definitive Estimates).
d) Project Budgets (Top Down Budgeting, Bottom-up Budgeting, and Activity Based Costing).
e) Developing Budget Contingencies.
  

Answer 1

a). Different type of product cost

• Direct cost

Direct costs are those directly linked to doing the work of the project. For example, this could include hiring specialised contractors, buying software licences or commissioning your new building.

• Indirect cost

These costs are not specifically linked to your project but are the cost of doing business overall. Examples are heating, lighting, office space rental (unless your project gets its own offices hired specially), stocking the communal coffee machine and so on.

• Fixed cost

Fixed costs are everything that is a one-off charge. These fees are not linked to how long your project goes on for. So if you need to pay for one-time advertising to secure a specialist software engineer, or you are paying for a day of Agile consultancy to help you start the project up the best way, those are fixed costs.

• Variable cost

These are the opposite of fixed costs - charges that change with the length of your project. It's more expensive to pay staff salaries over a 12 month project than a 6 month one. Machine hire over 8 weeks is more than for 3 weeks. You get the picture.

• Sunk cost

These are costs that have already been incurred. They could be made up of any of the types of cost above but the point is that they have happened. The money has gone. These costs are often forgotten in business cases, but they are essential to know about. Sunk cost is a loss which should not play any part in determining the future of the project.

b)

• Direct and Indirect cost

The major difference between direct costs and indirect costs is that only direct costs can be traced to specific cost objects. A cost object is something for which a cost is compiled, such as a product, service, customer, project, or activity. These costs are usually only classified as direct or indirect costs if they are for production activities, not for administrative activities which are considered period costs. Examples of direct costs are direct labor, direct materials, commissions, piece rate wages, and manufacturing supplies. Examples of indirect costs are production supervision salaries, quality control costs, insurance, and depreciation.

• Recurring and non recurring cost

Recurring costs refer to any expense that is known, anticipated, and occurs at regular intervals. Nonrecurring costs are one of a kind expenses that occur at irregular intervals and thus are sometimes difficult to plan for or anticipate from a budgeting perspective. Recurring cost includes unusual charge, expense, or loss that is unlikely to occur again in the normal course of a business, such as tax, insurance etc. Non recurring costs include write offs such as design, development, and investment cost, and fire or theft losses, lawsuit payments, losses on sale of assets, and moving expenses.

• Fixed and Variable Costs

Variable costs vary based on the amount of output, while fixed costs are the same regardless of production output. Fixed cost doesnt vary from time to time. Examples of variable costs include labor and the cost of raw materials, while fixed costs may include lease and rental payments, insurance, salary and interest payments.

• Normal cost and Expedited cost

Normal cost refers to the cost incurred during normal operation, during normal working hours.These are costs that are routine associated with completion of the scheduled work agreed. They can include overtime costs as long as the hours were already scheduled. Where Expedited cost is the cost that is required for extra fast or even dedicated shipments or otherwise hiring extra people to get a task done quicker manner. They are unplanned costs that are associated with steps taken to speed up the completion of a task or tasks to get back on schedule.

c) Cost estimating methods are Ballpark estimates, Feasibility estimates, Definitive estimates, Comparative estimates

1. Ballpark estimates also known as ‘‘order of magnitude’’ estimates, often used when there is not sufficient information or time available. They are typically used for making competitive bids for project contracts, or for initial rough cut estimates of resources needed for a project
2. Feasibility estimates are developed after preliminary project design work is completed. They are often used in construction projects, where published information on material costs is widely available.As more relevant information becomes available further down the project life cycle.
3. Definitive estimates are can be developed only after the completion of most design work They are clear understanding of the scope and capabilities of the project, changes to project specifications are virtually nonexistent. It is developed further down the project life cycle with more accurate information and fewer project uncertainties, provide a much more accurate expected cost of the project at completion.
4. Comparative estimates are widely uses historical data from previous project activities as the frame of reference for current estimates one of the method is parametric estimation most projects are similar to previous projects by way of similar features or parameters and, therefore, are likely to incur similar costs.

d) Project budgets

• Top down budgeting

Top-down budgeting requires direct input from the organization’stop management. This approach seeks to first ascertain the opinionsand experiences of top management regarding estimated project costs.

• Bottom up budgeting

The bottom-up budgeting approach begins inductively from the workbreakdown structure to apply direct and indirect costs to projectactivities.The sums of the total costs associated with each activity are then aggregated, first to the work package level, then at the deliverablelevel, at which point all task budgets are combined.

• Activity based budgeting

Most project budgets use some form of activity based costing. Activity-based costing (ABC) is a budgeting method thatassigns costs first to activities and then to the projectsbased on each project’s use of resources. It is that project activities are any discrete task thatthe project team undertakes to make or deliver the project. Activity-based costing  is based on the notionthat projects consume activities and activities consumeresources.

e) Developing Budget Contingencies.

A contingency budget is money set aside to cover unexpected costs during the construction process. This money is on reserve and not allocated to one area of the work, and simply “insurance” against other costs. Set an amount for your contingency budget. If your total costs are below your contingency rate, set aside an additional amount associated with unexpected costs and risks that cannot be foreseen. For example, we have a contingency budget of $15,000 but only set aside $7,000 for specific risks that may arise.