Cost Management of Engineering Projects
Prof. Jaydeep Pipaliya, Assistant Professor
Department of Civil Engineering
CHAPTER: 2
Cost Concepts
Cost Concepts in decision making:
● Fixed, Variable, and Mixed Costs:
● A fixed cost, such as rent, does not change in lock step with the level of activity.
Conversely, a variable cost, such as direct materials, will change as the level of
activity changes.
● Those few costs that change somewhat with activity are considered mixed
costs.
● Decision Making: Cost Concept # 1. Marginal Cost:
● Marginal cost is the total of variable costs, i.e., prime cost plus variable
overheads. It is based on the distinction between fixed and variable costs.
Fixed costs are ignored and only variable costs are taken into consideration for
determining the cost of products and value of work-in-progress and finished
goods.
●
● Decision Making: Cost Concept # 2. Out of Pocket Costs:
● This is that portion of the costs which involves payment to outsiders, i.e., gives
rise to cash expenditure as opposed to such costs as depreciation, which do
not involve any cash expenditure. Such costs are relevant for price fixation
during recession or when make or buy decision is to be made
●
● Decision Making: Cost Concept # 3. Differential Costs:The change in costs
due to change in the level of activity or pattern or technology or process or
method of production is known as differential costs. If any change is proposed
in the existing level or in the existing methods of production, the increase or
decrease in total cost as a result of this decision is known as differential cost.
● If the change increases the cost, it will be called incremental cost. If there is
decrease in cost resulting from decrease in output, the difference is known as
decremental cost.
●
● Decision Making: Cost Concept # 4. Sunk Costs:
● A sunk cost is an irrecoverable cost and is caused by complete
abandonment of a plant. It is the written down value of the abandoned
plant less its salvage value. Such costs are historical which are incurred in
the past and are not relevant for decision-making and are not affected by
increase or decrease in volume. Thus, expenditure which has taken place
and is irrecoverable in a situation is treated as sunk cost.
● Decision Making: Cost Concept # 5. Opportunity Cost:
● It is the maximum possible alternative earning that might have been earned
if the productive capacity or services had been put to some alternative use.
In simple words, it is the advantage, in measurable terms, which has been
foregone due to not using the facility in the manner originally planned.
Relevant Cost:
● What Is Relevant Cost? Relevant cost is a managerial accounting term that
describes avoidable costs that are incurred only when making specific
business decisions.
● The concept of relevant cost is used to eliminate unnecessary data that
could complicate the decision-making process
Differential Cost:
● What is Differential Cost? Differential cost is the difference between the
cost of two alternative decisions, or of a change in output levels.
● The concept is used when there are multiple possible options to pursue,
and a choice must be made to select one option and drop the others.
Incremental Cost:
● Incremental cost is the total cost incurred due to an additional unit of
product being produced.
● Incremental cost is calculated by analyzing the additional expenses involved
in the production process, such as raw materials, for one additional unit of
production.
Opportunity Cost:
● What is opportunity cost simple words?
● Opportunity cost is an economics term that refers to the value of what you
have to give up in order to choose something else. In a nutshell, it's a
value of the road not taken.
Objectives of Costing Sysytem:
1. Ascertainment of Cost:The aim is to determine the cost of each product,
process, or operation, and to ensure that all expenses are absorbed into the
cost of the products, the techniques, and the process of costing used.
2. Cost Control:Ascertaining costs alone is not sufficient. Naturally, it is not
enough because it is the cost that determines the selling price and, in turn, the
profitability. As such, the norm that everyone attempts to follow is “the lower
the cost, the greater to profit.”
3. Guidelines for Management:Costing is a faithful servant for managers
within an organization. It aids managerial decision-making from all practical
points of view.
Inventory valuation:
● What is Inventory Valuation? | Importance, Methods and Examples
● Inventory valuation is an accounting practice that is followed by companies
to find out the value of unsold inventory stock at the time they are
preparing their financial statements.
● Inventory stock is an asset for an organization, and to record it in the
balance sheet, it needs to have a financial value.
● This value can help you determine your inventory turnover ratio, which in
turn will help you to plan your purchasing decisions.
Why is inventory valuation important?
● Identifying the unsold items is just one step in inventory valuation. You also
need a rate that you can multiply by the quantity to arrive at a final value.
● You may have paid different prices for these items throughout the year, so
you need to choose a technique to calculate a common rate.
● Continuing our previous example, let’s look at your purchases for a
particular type of sneakers during the year:
● There are three methods for inventory valuation: FIFO (First In, First Out), LIFO
(Last In, First Out), and WAC (Weighted Average Cost).
● In FIFO, you assume that the first items purchased are the first to leave the
warehouse. In other words, whenever you make a sale, under FIFO, the items will
be subtracted from the first list of products which entered your store or
warehouse.
● In LIFO, you make the opposite assumption: that the last items that enter your
store are the first ones to leave.
● The WAC method uses the item’s average cost throughout the year. The average
cost per unit is calculated by dividing the total cost by the total number of units
purchased during the year.
● In the above example, the FIFO value is more than the LIFO value because you
paid more per unit at the end of the year. However, this is not always the case. If
your purchase price drops throughout the year, the FIFO value will be less than
the LIFO value and the WAC value will change accordingly.
● If the quantity of items unsold at the end of the year is greater than the first or
last order, then the calculation will be slightly different. For example, if you have
150 unsold items at the end of the year, then the calculations will look like this:
● FIFO: Items bought first will be sold first
● Use the newest purchase rate for the number of items included in the newest
order, then use the previous rate for the remaining items.
● 90 * 35 = 3150 (All the items purchased in the month of December)
● 60 * 31 = 1860 (Remaining items to be valued using the rate from October)
● Total 5010
● LIFO: Items bought last will be sold first
● Use the oldest purchase rate for the number of items included in the oldest
order, then use the next rate for the remaining items.
● 100 * 30 = 3000 (All the items purchased in the month of January)
● 50 * 31 = 1550 (Remaining items to be valued using the rate from March)
● Total 4550
● WAC: Average cost
per unit
● 150 * 31.5 = 4725
(The average price per
unit will remain the
same as there is NO
change in rate and
quantity purchased)
Creation of database for operational control:
● Operation Control:
– Operational control or task control is the process of assuring that
specific tasks are carried out effectively and efficiently. The focus of
operational control is on individual tasks or operations.
– For instance, it is concerned with scheduling and controlling individual
jobs through a shop rather than with measuring the performance of the
shop as a whole.
– It involves control over individual items for inventory rather than the
management of inventor as a whole.
Creation of database for operational control:
● Operational control is concerned with activities that can be programmed.
For instance, if the demand for an item, the cost of storing it, its production
cost and production-time, and the loss involved in not filling an order are
known, then the optimum inventory level and the optimum procurement
schedule can be prepared.
Creation of database for operational control:
● Automated plants, production scheduling, inventory control, order processing,
payroll accounting, cheque handling, etc are examples of activities that are
susceptible to operational control.
● As new- techniques are developed, more and more activities may become
susceptible to operational control.
● For example, the production schedule that was formerly set according to the
foreman’s intuition is now derived through linear programming.
Provision of data for decision making:
● In project management we make decisions on a daily basis.
● Most are relatively unimportant; some are critical and will cause the project
to be successful or to fail.
– Types of Decision-making in Project Management:
– #1: Programmed and Non-Programmed Decisions
– #2: Routine and Strategic Decisions
– #3: Tactical (Policy) And Operational Decisions
– #4: Organizational and Personal Decisions
Creation of database for operational control:
● Step 1: Always identify the decision you have to make during an ongoing project.
Don’t let external factors affect it.
● Step 2: Keep relevant information and data handy to make calculative decisions.
● Step 3: Never think of getting stuck. There is always one or multiple alternatives
that will help you keep the project going even during uncalculated risks.
● Step 4: Keep track of changes in the data and decide how your decisions might
impact the progress of the project.
● Step 5: Know your options and see what will work the best among existing
alternatives.
● Step 6: It’s action time. Once you know what data represents, it is time to set
your words in stone.
Your Approach to Decision-making in Project Management:
● Identify the Issue First: Once you come to terms with the fact that a problem
exists, then the next steps should basically define your goals, collect the
necessary data and information that will help in a rational decision-making
process.
● Consider All Solution Scenarios: Get your team together to brainstorm on all
solution scenarios. It is best not to filter any possibilities that may be remotely
reasonable at this stage.
● The Criteria Generate Should Be Objective: Ensure that the possible solutions
are feasible and reasonable according to the measurement criteria of success or
failure of the decision.
Your Approach to Decision-making in Project Management:
● Choose and Implement the Best Solution: Making use of every filtration
process, you should be able to decide on the best solution for the impending
problem. Quickly put that into action.
● Keep Monitoring the Results: You will only find out if the decision you made
failed or succeeded if you keep monitoring and tracking the outcome of the
solution. This can either be short-term or long-term, depending on the
severity of the problem.
Project Decision Making Models:
● #1: SWOT Analysis
● Intend to do a feasibility study of the project? Consider undertaking a
SWOT Analysis, which is a commonly used decision-making model in these
cases.
● Taking into account four key parameters – Strength, Weakness,
Opportunity, and Threat – you can gauge the viability of the project and
bring unsorted issues to the point of conclusion.
Project Decision Making Models:
● #2: Maslow’s Pyramid
● Maslow’s Pyramid theory was deduced by Abraham Maslow in 1943. This
model of project management decision making focuses primarily on basic
human needs and maps the impact on human behavior.
● The theory establishes that hierarchical need is a vital element of project
management. According to Maslow, there are five levels of human needs
that include physiological needs, security requirements, social
relationships, recognition, and self- actualization.
● The pyramid highlights the resource, in this case, the project manager can
journey through these individual levels to reach the ultimate point of
self-actualization.
Project Decision Making Models:
● #3: Pareto Principle
● Popularly known as the 80-20 rule, the Pareto Principle helps in the
prioritization of problems, which is then followed by looking for relevant
solutions. To get a better understanding of the theory, you can describe the
80-20 rule with this example
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