Ch 8
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Abdul Aziz Al TouqiCh 8
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Abdul Aziz Al TouqiCost Estimation and
Budgeting
Chapter 8
Definitions
Cost estimation: the
Cost management:
process of creating a
data collection, cost
reasonable budget
accounting and cost
baseline for the
control.
project.
Common Sources of Project Cost
Labor Materials Subcontractors
Equipment &
Travel
facilities
Type of Costs
• Direct (labor and material) Vs. Indirect (overhead, and sale
and administration)
• Recurring Vs. Nonrecurring
• Fixed Vs. Variable
• Normal Vs. Expedited
Cost Classifications
Cost Estimation
Common cost estimation methods:
▪ Ballpark (order of magnitude) ±30%
▪ Comparative ±15%
▪ Feasibility ±10%
▪ Definitive ±5%
Learning Curves
• Each doubling of output results in a reduction in time to perform
the last iteration.
𝑌𝑥 = a𝑋 𝑏
Where:
𝑌𝑥 = time required for the x unit of output
a= time required for the initial unit of output
X= the number of units to be produced
b= learning curve slope= log (learning %)/log(2)
Problems with Cost Estimation
▪ Low initial estimations
▪ Unexpected technical difficulties
▪ Lack of definition
▪ Specification changes
▪ External factors
Creating a Project Budget
The budget is a plan that identifies the
resources, goals, and schedule that
allows a firm to achieve those goals.
• Top-down budgeting
• Bottom-up budgeting
• Activity-based costing (ABC)
Top-Down Budgeting
• Based on collecting the judgments and experiences of top and
middle managers and available past data concerning similar
activities.
• These managers estimate overall project cost as well as the
costs of the major subprojects.
• These costs estimates are then given to lower-level, who
expected to continue to the breakdown into budget estimates
for specific tasks.
• This process continues to the lowest level.
Bottom-Up budgeting
• Elemental tasks, their schedules, and their individual budgets
are constructed following WBS.
• The people doing the work are consulted regarding time and
budget.
• Estimates are made in terms of resources.
• The resulting task budgets are aggregated to give the total direct
costs.
• The PM adds indirect costs as general and administration costs
• It is more accurate than top-down
Activity-Based Costing
Project use activities & activities use resources
1. Assign costs to activities that use resources
2. Identify costs drivers associated with this activity
3. Compute a cost rate per cost driver unit or transaction
4. Multiply the cost driver rate times the volume of cost driver
units used by the project
Example of Time-based budget
Budget Contingencies
The allocation of extra funds to cover uncertainties and improve
the chance of finishing on time.
Contingencies are needed because:
• Project scope may change
• Murphy’s Law is present
• Cost estimation must anticipate interaction costs
• Normal conditions are rarely encountered
In-class exercise… cost classification
1. Classify cost per activity
Activity Costs Direct Indirect Recurring Nonrecurring Fixed Variable Normal Expedited
1.
2.
3.
In-class exercise… cost estimation per
activity
Activity Costs Rate Units Rate*units Overhead Total
(cost/unit) charge
1.
2.
3.
In-class exercise…budgeting… Activity-based
cost and time-based budget
Month
Activity January February March April May Jun e July August September October November December Total by
activity
Cumul
ative
