HandOut1B Types of Project Costs
HandOut1B Types of Project Costs
HandOut1B Types of Project Costs
Lesson 1: Cost Estimating: Overview, Classifications and its Relationship to Other Aspects of
Project Management
Objective:
Upon completion of the lesson, the learners will be able to:
1. Explain the meaning and relevance of cost estimates specifically construction
estimates.
2. Discuss how project costs are classified.
1
freelancer. The second freelancer convinces you that .NET is not the way to go and that your
website project would be better off based on the Java platform. The cost associated with the
.NET freelancer would be treated as Sunk Costs. However, if the second freelancer could build
on the .NET work of the first freelancer, then your costs would not have sunk.
Ideally, platform selection in software development projects should be taken very early in the
project, such as right after you Collect Requirements. As the decision impacts many other
factors, such as skill and infrastructure resources, it should be taken as early as possible in the
project life-cycle. Sunk costs are often a consequence of not collecting requirements
properly.
2
Direct costs are broadly classified as those directly associated with a single area (such
as a department or a project). In project management, direct costs are expenses billed
exclusively to a specific project. They can include project team wages, the costs of
resources to produce physical products, fuel for equipment, and money spent to address
any project-specific risks.
Indirect costs, on the other hand, cannot be associated with a specific cost center and
are instead incurred by a number of projects simultaneously, sometimes in varying
amounts. In project management, quality control, security costs, and utilities are usually
classified as indirect costs since they are shared across a number of projects and are not
directly billable to any one project.
A cost estimate is more than a simple list of costs, however: it also outlines the assumptions
underlying each cost. These assumptions (along with estimates of cost accuracy) are compiled
into a report called the basis of estimate, which also details cost exclusions and inclusions. The
basis of estimate report allows project stakeholders to interpret project costs and to understand
how and where actual costs might differ from approximated costs.
Beyond the broad classifications of direct and indirect costs, project expenses fall into more
specific categories. Common types of expenses include:
Project cost estimates are classified into categories based on how well the scope is
defined at the time of estimation, on the types of estimation techniques used, and on the general
accuracy of estimates. These categories are not standardized, but they are all based on the
recognition that a cost estimate can only be as accurate as the project scope is detailed. In
its estimating manual, the American Society of Professional Estimators (ASPE) classifies cost
estimates in order of increasing accuracy on a five-level scale. Level 1 is an order of magnitude
estimate and Level 5 is a final bid.
AACE International (formerly the Association for the Advancement of Cost Engineering)
offers a helpful chart summarizing key points. Here’s an overview of the cost estimate
categories:
Order of magnitude estimates: An order of magnitude estimate, or ASPE Class 5, is an
extremely rough cost estimate created before a project has been defined. It is based only on
expert judgment and the costs of similar past projects. An order of magnitude estimate is
typically presented as a range of costs spanning -25% to +75% of the actual project cost. It is
only used in high-level decision making to screen projects and determine which ones are
financially feasible.
Intermediate estimates: An intermediate estimate can be created using stochastic or
parametric techniques when a project is defined to some limited extent. Like an order of
3
magnitude estimate, its main purpose is determining project feasibility based on the general
project concept.
Preliminary estimates: Created when a project’s deliverables are about halfway defined, a
preliminary estimate uses somewhat detailed scope information to incorporate unit costs.
Preliminary estimates are accurate enough to be used as a basis for project financing. Some
project budgets are authorized based on the preliminary estimate.
Substantive estimates: A substantive estimate uses a reasonably finalized project design to
create a fairly accurate cost estimate based mainly on unit costs. At this point, the project’s
objectives and deliverables are established, so a substantive estimate is accurate enough to
create a bid or tender to complete a project. Substantive estimates may also be used to control
project expenditure.
Definitive estimates: Drafted when a project’s scope and constituent tasks are almost fully
defined, a definitive estimate makes full use of deterministic estimating techniques, such as
bottom-up estimating. Definitive estimates are the most accurate and reliable and are used to
create bids, tenders, and cost baselines.
Of course, even definitive estimates do not remain static through project execution.
Since all estimates are based on numerous assumptions and are contingent upon risks of all
magnitudes, cost estimates are often updated if these base assumptions change significantly or
additional risks are realized. When this happens, the project cost baseline is revised accordingly
so that you can continue to assess project performance accurately.
Estimates of all types are created using a combination of estimation techniques (with
varying levels of accuracy). As we have seen, the most accurate estimates rely more on
deterministic methods than on conceptual methods.
4
Risk detailing: All projects can be affected by negative risks, so it is important to build
allowances into cost estimates. Thorough risk identification and allocation of contingency
reserves is the most common approach. Estimates should be overestimated rather than
underestimated, and estimators should establish tolerance levels for cost deviation.
Uniformity: For performing organizations that conduct many projects of the same type, expect
unit costs to be reasonably consistent across projects and only adjusted for inflation. This type
of unit cost uniformity is possible for organizations that have undertaken several similar
projects, which enables them to create reference lists for recommended unit costs.
Validity: Confirming the validity of a cost estimate involves checking the underlying data for
accuracy. Improve validity by relying on established cost literature, and on cost indices when
up-to-date literature is unavailable.
Verification: Cost verification is the act of checking that mathematical operations used in an
estimate were performed correctly. Cost verification is much easier if estimates are properly
documented.
In the book Project Management for Business, Engineering, and Technology, project
management experts John M. Nicholas of Loyola University and Herman Steyn of University
of Pretoria, South Africa, say the best estimates are made by teams that include designers,
builders, suppliers (this is opposed to estimates from more homogenous teams). They describe
these diverse estimating teams as concurrent engineering teams.
Alternatively, factors that undermine cost estimations include poor raw data or
assuming that resources are 100 percent utilized. Some of the most common pitfalls for cost
estimators are:
Lack of experience with similar projects: Accuracy in cost estimating tends to increase as
estimators, project teams, and organizations gain experience working with similar projects.
Inexperienced estimators and project teams may not be familiar with the scope of a project,
which may lead to inaccuracies with - even with deterministic estimating techniques. At an
organizational level, the use of analogous estimating techniques is typically not reliable if the
organization has not conducted similar projects before.
Length of the planning horizon and of the project: Professional estimators stress the
importance of not making premature estimates. As we have discussed, accurate estimating
depends on the degree to which a project is defined. For large, complex projects, approaches
such as rolling wave planning mean that future work is less well defined. It is important that
cost estimating practices reflect this and that cost estimates are revised as more up-to-date
information becomes available. For mega projects that take several years to complete, it’s
important to take currency value fluctuation and political climates into account.
Human resources: Creating accurate estimates becomes more difficult as the number of
human resources involved in a project increases. While it is standard practice to assume that
any resource will only be productive 80% of the time and to create estimates accordingly, it
becomes harder to account for costs in managing and organizing people. This is especially
noticeable in project activities that involve building consensus or coordinating tasks across
many people.
Difficulty also arises when estimating costs of human resources via resource costing or
parametric estimating. Both estimating techniques revolve around the concept of unit-based
costing, but the complexities of managing people make it difficult both to obtain accurate unit
costs and to forecast the task completion time accurately. Further, it’s unlikely that workers’
skill levels will be identical (even if they are classified as such), so some time deviation is
5
inevitable. This shows the value of systematically overestimating instead of underestimating,
especially when dealing with human workers.
Not fully understanding the work involved in completing work packages: This is
sometimes a problem for inexperienced project teams who have not worked on similar projects
before.
Expecting that resources will work at maximum productivity: A more appropriate rule of
thumb is to assume 80% productivity.
Dividing tasks between multiple resources: Having more than one resource working on a
task typically necessitates additional planning and management time, but this extra time is
sometimes not taken into account.
Failing to identify risks and to prepare adequate contingency plans and
reserves: Negative risks can both raise costs and extend durations.
Not updating cost estimates after project scope changes: Updated cost estimates are an
integral part of scope change management procedures, as project scope changes render prior
estimates useless.
Creating hasty, inaccurate estimates because of stakeholder pressure: Since project
managers are held accountable for estimates, order of magnitude estimates are a much better
choice than numbers pulled out of thin air.
Stating estimates as fixed sums, rather than ranges: Point estimates are misleading. All
estimates have inherent degrees of uncertainty, and it is important to adequately communicate
these via estimate ranges.
Making a project fit a fixed budget amount: The scope of a project should determine its
budget, not the other way around. As Trevor L. Young explains in his book How to be a Better
Project Manager, estimating is a “decision about how much time and resource are required to
carry out a piece of work to acceptable standards of performance.” The reverse approach —
planning projects to fit budgets — is likely to result in projects that fail to meet requirements
and to deliver results.
The job of estimating project costs and ongoing budget control is not done in a vacuum.
Several other project management specialties influence it, and the cost estimation, in turn, has
impact on those other project aspects. Some of these are:
6
clarity on quality requirements can prove costly during the quality control process, when
defects or noncompliance must be addressed (often at substantial cost).
Risk management: All projects face risks. Adequate risk identification and preparation of
contingency plans and reserves are vital to prevent risks from causing cost overruns.
Time management: Project costs are directly related to the time taken to complete a project,
and so a failure to construct an accurate and viable project schedule will likely cause cost
overruns.
References:
https://www.brighthubpm.com/project planning
Construction Cost Estimating: Basics and Beyond |Smartsheet
https://www.smartsheet.com/ultimate-guide-project-cost-estimating
Feedback Activity
1. Make a concept map on cost estimating. Definitions, classification and uses must be
emphasized. General terms must be defined.
2. In your perspective, what is the relevance of cost estimating in the field of
construction? How can you be a good estimator? Express your answer in maximum
100 words.
3. You can consult other references (references when used must be cited). Submit your
output on our group e-mail account not later than 6:00 pm today September 29, 2021.