Elements of Cost.pdf

 AACE International Certified Cost Technician Primer 1st Edition – January 2011 Updated September 2018 SUPPORTING SKILLS AND KNOWLEDGE OF A COST ENGINEER Based Upon AACE International R...

 AACE International Certified Cost Technician Primer 1st Edition – January 2011 Updated September 2018 SUPPORTING SKILLS AND KNOWLEDGE OF A COST ENGINEER Based Upon AACE International Recommended Practice 11R‐88, Required Skills and Knowledge of Cost Engineering Part 1 Acknowledgments: Michael Pritchett, CCE CEP (Author) Pete Griesmyer Donald McDonald Jr., PE CCE PSP Valerie Venters, CCC Larry Dysert, CCC CEP Copyright 2011‐2018, AACE International, Inc. AACE International CCT Primer Cost Engineering and Total Cost Management AACE International is dedicated to the tenets of furthering the concepts of Total Cost Management and Cost Engineering. Total Cost Management is the effective application of professional and technical expertise to plan and control resources, costs, profitability and risk. Simply stated, it is a systematic approach to managing cost throughout the life cycle of any enterprise, program, facility, project, product or service. This is accomplished through the application of cost engineering and cost management principles, proven methodologies and the latest technology in support of the management process. Total Cost Management is that area of engineering practice where engineering judgment and experience are used in the application of scientific principles and techniques to problems of business and program planning; cost estimating; economic and financial analysis; cost engineering; program and change control. Cost engineers often specialize in one function with a focus on one side of the asset and project business. They may have titles such as cost estimator, parametric analyst, strategic planner, scheduler, cost/schedule engineer, project manager, or project control lead. They may work for the business that owns and operates the asset (emphasis on economics and analysis), or they may work for the contractor that executes the projects (emphasis on planning and control). But no matter what their job title or business environment, a general knowledge of, and skills in, all areas of cost engineering are required to perform their job effectively. Purpose of This Document This Primer provides someone who is preparing to sit for AACE International’s Certified Cost Technician (CCT™) certification exam, a detailed outline of the skills and knowledge necessary to successfully achieve this certification. The Primer is based upon AACE International Recommended Practice 11R‐88, Required Skills and Knowledge of Cost Engineering. It is intended to outline what core skills and knowledge of cost engineering a person is required to have in order to be considered a professional practitioner, and in doing so, establish the emphasis of core subjects for AACE International education and certification programs. This Primer addresses part one of 11R‐88, “Supporting Skills and Knowledge.” It is recommended that in addition to this document, reading Skills and Knowledge 6th Edition, AACE International’s TCM Framework, and other specialty texts such as Schaum’s Beginning Statistics 2nd Edition, Schaum’s Statistics Crash Course and economics reference workbooks. The latest reference list can be found at the AACE International website – www.aacei.org. To successfully pass the CCT exam, there will be problems that must be correctly solved. It is beyond the scope of this primer to provide example problems. CCT candidates can find example problems in publications such as AACE International’s S&K 6th Edition, and other reference material, as identified on the certification section of www.aacei.org. A general caution, while this primer is intended to support one seeking to successfully achieve AACE International’s CCT certification, it cannot be substituted for one’s actual knowledge and experience. Carefully review the current minimum requirements necessary for achieving any of the AACE certifications at www.aacei.org. This publication was developed by the AACE International Education Board to assist young professionals in preparing for the AACE International Certified Cost Technician (CCT) exam. The Education Board will continue to update and improve this document as needed to support the CCT exam. Recommendations and or comments are highly welcomed and should be forwarded to the AACE International Education Board at [email protected]. Copyright 2011‐2018, AACE International, Inc. AACE International CCT Primer Table of Contents 1. Elements of Cost a. Cost b. Cost Dimensions c. Cost Classifications d. Cost Types e. Pricing f. Cost Estimating 2. Elements of Analysis a. Statistics and Probability b. Economic and Financial Analysis c. Optimization and Models d. Physical Measurement 3. Enabling Knowledge a. Enterprise in Society b. People and Organizations in Enterprises c. Information Management d. Quality Management e. Value Management f. Environmental, Health and Safety (EHS) [AACE International Recommended Practice 11R‐88, January 17, 2006] Copyright 2011‐2018, AACE International, Inc. AACE International CCT Primer  I. SUPPORTING SKILLS AND KNOWLEDGE 1. Elements of Cost A. Costs: Cost ‐ In project control and accounting, it is the amount measured in money, cash expended or liability incurred, in consideration of goods and/or services received. From a total cost management perspective, cost may include any investment of resources in strategic assets including time, monetary, human, and physical resources [RP 10S‐90]. Cost – Is the value of an activity or asset. Generally, this value is determined by the cost of the resources that are expended to complete the activity or produce the asset. Resources used are categorized as material, labor, and “other”. Although money and time are sometimes thought of as resources, they only implement and/or constrain the use of the physical resources just listed. The “other” cost category consists of resources needed to support the activity and/or asset. An example would be the facilities needed to produce an activity or asset, which would include the tooling, electricity, taxes, and maintenance, etc., necessary to keep the facility available for use. Other costs might be office supplies, communication costs, travel costs, and security costs [S&K 6th Ed., 1.1. 1.2]. 1. Resources Any consumable, except time, required to accomplish an activity. From a total cost and asset management perspective, resources may include any real or potential investment in strategic assets including time, monetary, human, and physical. A resource becomes a cost when it is invested or consumed in an activity or project [RP10S‐90]. [Refer to S&K 6th Edition, Chapter 1, for more detailed discussion on this topic] B. Cost Dimensions: 1. Lifecycle: The stages or phases that occur during the lifetime of an object or endeavor. A life cycle presumes a beginning and an end with each end implying a new beginning. In life cycle cost or investment analysis, the life cycle is the length of time over which an investment is analyzed (i.e., study period) The following are typical life cycles: Asset Life Cycle – the stages or phases of asset existence during the life of an asset. Asset life cycle stages typically include: Ideation –recognize an opportunity or need for a new or improved asset; evaluate research, develop and define optional asset solutions that address the opportunity; and select an optimum asset solution. Creation – create or otherwise implement the asset solution through execution of a project or program. Operation – deploy or put the new or modified asset into service, function, production, operation, or other use. Modification –improve, modify, or otherwise change or recycle the asset through execution of a project or program. Copyright 2011‐2018, AACE International, Inc. AACE International CCT Primer  Termination – decommission, close, retire, demolish, remove, dispose, or otherwise terminate the asset from the enterprise’s portfolio (often through execution of a project or program) [TCM Framework, 2.1.3]. Product Life Cycle – Complete history of a product through its concept, definition, production, operation, and obsolescence or disposal phases. The distinction between product life cycle and project life cycle is that the latter does not include the last two phases. Project Life Cycle – The stages or phases of project progress during the life of a project. Project life cycle stages typically include: Ideation – given overall requirements of the project, the project team assesses alternative concepts for performing the project and selects an optimal performance strategy. Strategic performance requirements for projects are established. Planning – project plans are developed that address the strategic requirements and selected performance strategy. Execution – the plans are implemented through the execution of planned project activities. Closure – the asset or deliverable is reviewed, tested, verified, validated, and turned over to the customer. Learning for future use in ideation is documented. [RP 10S‐90; TCM Framework, 2.1.4] 2. Process (Product vs. Project) Process – Sequence or independent and linked procedures which, at every stage, consume one or more resources (employee time, energy, machines, money) to convert inputs (data, material, parts. Etc.) into outputs. These outputs then serve as inputs for the next stage until a known goal or end result is reached [Business Dictionary.com]. Product 1) General: Good, idea, method, information, object, service, etc, that is the end result of a process and serves as a need or want satisfier. It is usually a bundle of tangible and intangible attributes (benefits, features, functions, uses) that a seller to a buyer for purchase [Business Dictionary.com]. 2) Law: Commercially distributed good that is (1) tangible personal property, (2) output or result of a fabrication, manufacturing, or production process, and (3) passes through a distribution channel before being consumed or used [Business Dictionary.com]. 3) Marketing Mix: Good or service that most closely meets the requirements of a particular market or segment and yield enough profit to justify its continued existence [Business Dictionary.com]. Co‐Product Copyright 2011‐2018, AACE International, Inc. AACE International CCT Primer  Product manufactured along with a different product, in a process in which both are required in the production of another product. In comparison, a by‐ product is usually an undesirable product. Business Dictionary.com. By‐Product Output other than the principal product(s) of an industrial process, such as sawdust or woodchips generated in processing lumber. Unlike joint‐products, byproducts have low value in comparison with the principal product(s) and may be discarded or sold either in their original state, or after further processing [Business Dictionary.com]. 3. Responsibility: Owners View Costs The owner approaches cost form a holistic point of view. Owners not only consider the cost of the construction, or process, but internal supervision and overhead, implementation costs, cost of money, furniture, fixtures, equipment( FFE) and other considerations. It is the responsibility of the owner or the owner’s representative, to clearly communicate the project or process intent and the desired outcome. The owner or stakeholders have expatiations on the value received from the project and the return on their investment. Contractors, subcontractors, suppliers only consider their part of the project costs and are responsible for that alone. 4. Valuation: Valuation General: Appraising or estimating the worth of something having economic or monetary value. Business Dictionary.com Insurance: Determination of the worth of the asset to be insured or that which has been damaged or lost. Business Dictionary.com International Trade: Determination of the dutiable value of imports by the customs authorities. Opportunity Costs The cost of an alternative that must be forgone in order to pursue a certain action. Put another way, the benefits you could have received by taking an alternative action. Investopedia.com Economic decision makers needed to consider the impact of opportunity costs. An opportunity cost represents the foregone benefit by choosing one alternative over another [S&K 6th Ed. 72]. 5. Influence: There is a relationship between time and the opportunity to influence a projects cost. The more time that has elapsed, the less the chance to alter the cost. It is important to make the cost effective decisions early in a project or process to have the most influence on cost. This is known as the “Cost – Influence Curve.” Copyright 2011‐2018, AACE International, Inc. AACE International CCT Primer  Opportunity for Influence Major Rapidly Decreasing Low Influence Influence Influence Influence Expenditures Scope Definition Conceptual Pre‐Project Basic Project Production Construction Engineering Turnover Analysis Planning Data & Authorization Engineering Complete & & R&D Scoping & Start‐up Procurement Project Life Cycle 2 Copyright 2004 – 2011, AACE International 6. Legal: 1. Be able to explain how cost and schedule analysis practices might differ when applied for forensic versus traditional planning and control purposes. 2. Be able to describe some potential legal consequences that may result from using poor or unethical cost management practices (e.g., anti‐trust, claims, Sarbanes‐Oxley, etc) C. Cost Classifications: 1. Operating (Production, Manufacturing, Maintenance, etc.) vs. Capital Operating Costs – The expenses incurred during the normal operation of a facility, or component, including labor, materials, utilities, and other related costs. Includes all fuel, lubricants, and normally scheduled part changes in order to keep a subsystem, system, particular item, or entire project functioning. Operating costs may also include general building maintenance, cleaning services, taxes, and similar items [RP10S‐90]. Manufacturing Cost – The total of variable and fixed or direct and indirect costs chargeable to the production of a given product, usually expressed in cents or dollars per unit of production, or dollars per year. Transportation and distribution costs, and research, development, selling and corporate administrative expenses are usually excluded [RP10S‐90]. Maintenance Costs – The total of labor, material, and other related costs incurred in conducting corrective and preventative maintenance and repair on a facility, on its systems and components, or on both. Maintenance does not usually include those items that cannot be expended within the year purchased. Such items must be considered as fixed capital [RP10S‐90]. Copyright 2011‐2018, AACE International, Inc. AACE International CCT Primer  Capital, Fixed – The total original value of physical facilities which are not carried as a current expense on the books of accounting and for which depreciation is allowed by the US federal government, It includes plant equipment, building, furniture and fixtures, and transportation equipment used directly in the production of a product or service. It includes all costs incident to getting the property in place and in operating condition, including legal costs, purchased patents, and paid‐up licenses. Land, which is not depreciated, is often included. Characteristically it cannot be converted readily into cash [RP10S‐90]. 2. Capital vs. Expense a. Depreciation Decline in value of a capitalized asset [RP10‐S90]. A form of capital recovery applicable to a property with a life span of more than one year, in which an appropriate portion of the asset’s value is periodically charged to current operations [RP10‐S90]. b. Amortization As applied to a capitalized asset, the distribution of the initial cost by periodic charges to operations as in depreciation. Most properly applies to assets with indefinite life [RP10S‐90]. The reduction of a debt by either periodic or irregular payments [RP10S‐90]. A plan to pay off a financial obligation according to some prearranged schedule [RP10S‐90]. c. Accrual In finance, the adding together of interest or different investments over a period of time. It holds specific meanings in accounting, where it can refer to accounts on a balance sheet that represents liabilities and non‐cash based assets used in accrual‐ based accounting. These types of accounts include, among others, accounts payable, accounts receivable, goodwill, deferred tax liability and future interest expense [wikipedia.org]. Accounting method that records revenues and expenses when they are incurred, regardless of when cash is exchanged. The term accrual refers to any individual entry recording revenue or expense in the absence of a cash transaction [Entrepreneur.com]. Accrued revenue (or accrued assets) is an asset, such as unpaid proceeds from a delivery of goods or services, when such income is earned and a related revenue item is recognized, while cash is to be received in a latter period, when the amount is deducted from accrued revenues [Wikipedia.org]. Accounts on a balance sheet that represent liabilities and non‐cash based assets used in accrual‐based accounting. By using accruals, a company can measure what it owes looking forward and what cash revenue it expects to receive. It also allows a company to show assets that do not have a cash value, such as goodwill [Investopedia.com]. d. Expense Copyright 2011‐2018, AACE International, Inc. AACE International CCT Primer  Expenditures of short‐term value, including depreciation, as opposed to land and other fixed capital [RP10S‐90]. 3. Fixed vs. Variable Fixed Cost – Those costs independent of short term variations in output of the system under consideration. Includes such costs as maintenance; plant overhead; and administrative, selling and research expense. For the purpose of cash flow calculation, depreciation is excluded (except in income tax calculations). In construction this includes general and administrative costs [RP10S‐90]. Fixed Costs – Fixed costs are those cost elements that must be provided independent of the volume of work activity or asset production that they support. These can be either direct or indirect costs [S&K 6th Ed., 12]. Depreciation Property taxes Insurance Variable Costs – Those costs that are a function of production, e.g., raw materials costs, by‐product credits, and those processing costs that vary with plant output (such as utilities, catalysts and chemical, packaging, and labor for batch operations) [RP10S‐90]. Variable Costs – Variable costs are those cost elements that must be provided and are dependent on the volume of work activity or asset production that they support [S&K 6th Ed., 12]. Raw materials Utilities Royalties Packaging Marketing Catalysts and chemicals 4. Direct vs. Indirect Direct Cost – Costs of completing work that are directly attributable to its performance and are necessary for its completion. 1) In construction: the cost of installed equipment, material, labor and supervision directly or immediately involved in the physical construction of the permanent facility. 2) In manufacturing, service, and other non‐ construction industries: the portion of operating costs that is readily assignable to a specific product or process area [RP10S‐10]. Direct Cost – Direct costs are those resources that are expended solely to complete the activity or asset [S&K 6th Ed.,11]. Indirect Cost Indirect costs are those resources that need to be expended to support the activity or asset but that are also associated with other activities and assets. Indirect costs are allocated to an activity or asset based upon some direct cost element, such as labor hours, Copyright 2011‐2018, AACE International, Inc. AACE International CCT Primer  material cost or both. Indirect costs also may be referred to as “overhead costs” or “burden costs.” Costs not directly attributable to the completion of an activity. Indirect costs are typically allocated or spread across all activities on a predetermined basis. In construction, all costs which do not become a final part of the installation, but which are required for the orderly completion of the installation and may include, but are not limited to, field administration, direct supervision, capital tools, startup costs, contractor’s fees, insurance, taxes, etc. In manufacturing, costs not directly assignable to the end product or process, such as overhead and general purpose labor, or costs of outside operations, such as transportation and distribution. Indirect manufacturing cost sometimes includes insurance, property taxes, maintenance, depreciation, and packaging, warehousing and loading [RP10S‐90]. a. Activity‐Based Costing (ABC) The most significant cost accounting technique of interest to cost engineering and strategic asset management is activity‐based cost management (ABC/M) which improves upon traditional cost accounting by assigning costs to the work activities and then to the assets that drive the workload. This superior costing method based on cause‐and‐effect relationships is in contrast to simply capturing the spending expenses in cost centers and making somewhat arbitrary guesses or using broad averages (e.g., number of units produced) as to the relationship of the costs to the assets that are uniquely consuming the various types of costs. Traditional cost allocations leads to simultaneous over‐costing and under‐costing of outputs relative to their actual costs [TCM Framework, 5.1.1]. A key difference between ABC/M and the general ledger and traditional techniques of cost allocations (i.e., absorption costing) is that ABC/M describes activities using an “action‐verb‐adjective‐noun” grammar convention, such as inspect defective products, open new customer accounts, or process customer claims. This gives ABC/M its flexibility. Such wording is powerful because managers and employee teams can better relate to these phrases, and the wording implies that the work activities can be favorably affected, changed, improved, or eliminated. The general ledger uses a chart of accounts, whereas ABC/M uses a chart of activities. In translating general ledger data to activities and processes, ABC/M preserves the total reported revenues and costs but allows the revenues, budgeted funding, and costs to be viewed differently [S&K 6th Ed., 843]. b. Job Costing Order‐specific costing technique, used in situations where each job is different and is performed to the customer’s specifications. Job costing involves keeping an account of direct costs (labor, machine time, raw materials) and indirect costs (overheads) [Business Dictionary.com]. Job costing involves the calculation of costs involved in a construction “job” or the manufacturing of goods done in discrete batches. These costs are recorded in ledger accounts throughout the life of the job or batch and are then summarized in the final trial balance before the preparation of the job cost or batch manufacturing statement [Wikipedia.org]. Copyright 2011‐2018, AACE International, Inc. AACE International CCT Primer  Job costing (known by some as job order costing) is fundamental to managerial accounting. It differs from Process costing in that the flow of costs is tracked by job or batch instead of by process. Process costing is used when the products are more homogeneous in nature [Wikipedia.org]. D. Cost Types: 1. Materials: 1. Materials Types: a. Raw Raw materials are those materials used in a production or fabrication process that require a minimum amount of processing to be useful [S&K 6th Ed., 27]. Depending upon the particular process, raw materials costs can constitute a major portion of operating costs. For this reason, a complete list of all raw materials must be developed using the process flow sheet as a guide [S&K6th Ed., Chap 3]. Includes products entering the market for the first time which have not been fabricated or manufactured but will be processed before becoming finished goods. (e.g., steel scrap, wheat, raw cotton) [RP 10S‐90]. b. Bulk The steel product can be considered to be a bulk material in all of its various forms, including sheet steel, steel bars, steel pipe, and structural steel shapes, such as wide flange beams and angles. The bulk materials category is distinguished by its availability. Bulk materials in common sizes are typically readily available with minimal lead times for order and delivery [S&K 6th Ed., 27]. Material bought in lots. These items can be purchased from a standard catalog description and are bought in quantity for distribution as required. Examples are pipe, conduit, fittings and wire [RP 10S‐90]. Other types of bulk material would be gravel, select soil and sand c. Fabricated Fabricated materials are bulk materials transformed into custom‐fit items for a particular product or project [S&K 6th Ed., 27]. d. Engineered or Designed Engineered or designed materials constitute a category requiring substantial working in order to attain their final form. Design or engineered materials are also based on shop drawings [S&K 6th Ed., 27]. e. Consumables Supplies and materials used up during construction. Includes utilities, fuels and lubricants, welding supplies, worker’s supplies, medical supplies, etc. [RP10S‐90]. 2. Purchase Costs: Listed below are some items that can affect the purchase costs of materials: a. market pricing (pre‐negotiated vs. competitively bid, etc.) Copyright 2011‐2018, AACE International, Inc. AACE International CCT Primer  b. order quantity c. taxes and duties d. carrying charges e. cancellation charges f. demurrage g. hazardous material regulations h. warranties, maintenance and service 3. Materials Management Costs: Listed below are items that can affect the management cost of materials: a. delivery schedule b. packing c. shipping and freight d. freight forwarding e. handling f. storage and inventory g. agent cost h. surveillance or inspection i. expediting j. losses (shrinkage, waste, theft, damage) k. spare parts (inventory or start‐up) l. surplus materials 4. Capital Equipment: (i.e., fabricated or engineered items) Equipment that you use to manufacture a product, provide a service or use to sell, store and deliver merchandise. This equipment has an extended life so that it is properly regarded as a fixed asset [Entrepreneur.com]. a. Rent vs. lease vs. purchase: Leasing offers some of the following advantages Minimal upfront cash outlay Not a loan so it does not tie up your line of credit Maintenance agreement, service by others Possible tax advantage as the lease is an expense and may be able to reduce overall tax liability May include a purchase option Renting offers some of the following advantages Keep work progressing when there is an equipment breakdown Meet specialty job requirements Very efficient for low‐percentage utilization Short‐term peak or seasonal use Considered to evaluate equipment for purchase Fill in for equipment being repaired Can be returned at any time, not a guaranteed amount of time Maintenance is usually handled by dealer or rental yard Can conserve company capital Can have an option to buy clause [Reference Construction Contracting 6th Edition] Copyright 2011‐2018, AACE International, Inc. AACE International CCT Primer  Purchasing When deciding when to purchase and register capital equipment on your books, there are two lines of thinking [Entrepreneur.com]. The first is to purchase and install the needed equipment at a point during the year where additional volume warrants the expenditure, thereby assuring sufficient cash flow to handle the additional debt service or the outright purchase of the equipment [Entrepreneur.com]. The second is to have the equipment purchased and installed at the beginning of the business year or quarter closest to the time when you will actually need the equipment, allowing time for training and working out bugs before the equipment is placed into full production [Entrepreneur.com]. Each enterprise will need to perform its own financial analysis on the lease vs. purchase option. Many equipment suppliers have easy to use rate calculators that can give the “big” picture costs to assist the decision. b. Valuation: Reproduction Costs The cost of reproducing substantially the identical item or facility at a price level as of the date specified [RP10S‐90]. Replacement Costs The cost of replacing the productive capacity of existing property by another property of any type, to achieve the most economical service, at prices as of the date specified. (2) Facility component replacement and related costs, included in the capital budget, that are expected to be incurred during the study period [RP10S‐90]. Is the cost new of an item having the same or similar utility [S&K 6th Ed., 57]. Fair Value That estimate of value of a property that is reasonable and fair to all concerned, after every proper consideration has been given due weight [RP10S‐90]. Is the adjusted cost new of an item, giving consideration for the cost of similar items, and taking into account utility and all standard adjustments and discounts to list price [S&K 6th Ed., 57]. Market Value The monetary price upon which a willing buyer and a willing seller in a free market will agree to exchange ownership, both parties knowing all the material facts but neither being compelled to act. The market value fluctuates with the degree of willingness of the buyer and seller and with the conditions of the sale. The use of the term market suggests the idea of barter. When numerous sales occur on the market, the result is to establish fairly definite market prices as the basis of exchanges [RP10S‐90]. Copyright 2011‐2018, AACE International, Inc. AACE International CCT Primer  o Fair Market Value‐in‐Place is the amount expressed in terms of money that may reasonably be expected to exchange between a willing buyer and a willing seller with equity to both, neither under any compulsion to buy or sell, and both fully aware of all relevant facts as of a certain date, and taking into account installation and the contribution of the item to the operating facility [S&K 6th Ed., 57]. o Fair Market Value‐in‐Exchange is the value of equipment in terms of the money that can be expected to be exchanged in a third‐party transaction between a willing buyer, who is under no compulsion to buy, and a willing seller, who is under no compulsion to sell, both being fully aware of all relevant facts (also referred to as retail value) [S&K 6th Ed., 57]. o Orderly Liquidation Value is the probable price for all capital assets and equipment in terms of money that could be realized from a properly executed orderly liquidation type of sale, given a maximum time of six months to conduct such sale and adequate funds available for the remarketing campaign. (also referred to as wholesale value) [S&K 6th Ed., 57]. o Forced Liquidation Value is the value of equipment in terms of money that can be derived from a properly advertised and conducted auction where time is of the essence (also referred to as “under the hammer” or “blow‐out” value) [S&K 6th Ed, 57.]. o Salvage Value/Part‐Out Value is the value of equipment in terms of money that a buyer will pay to a seller, recognizing the component value of parts of the equipment that can be used or resold to end‐ users, usually for repair or replacement purposes [S&K 6th Ed., 57]. o Scrap Value is the value of equipment in terms of money that relates to the equipment’s basic commodity value [S&K 6th Ed., 58]. Book Value (NET) (1) Current investment value on the books calculated as original value less depreciated accruals. (2) New asset value for accounting use. (3) The value of an outstanding share of stock of a corporation at any one time, determined by the number of shares of that class outstanding [RP10S‐90]. Residual or Economic Value The value of property in view of all its expected economic uses, as distinct from its value in view of any particular use. Also, economic value reflects the importance of a property as an economic means to an end, rather than as an end in itself [RP10S‐90]. Copyright 2011‐2018, AACE International, Inc. AACE International CCT Primer  c) Operating Cost The expenses incurred during the normal operation of a facility, or component, including labor, materials, utilities, and other related costs. Includes all fuel, lubricants, and normally scheduled part changes in order to keep a subsystem, system, particular item, or entire project functioning. Operating costs may also include general building maintenance, cleaning services, taxes, and similar items [RP10S‐90]. 5. Temporary Equipment: (expensed items for construction, maintenance, etc) 2. Labor 1. Labor Wage Rate or Salary: [Review S&K 6th Edition, Chapter 4, for more detailed discussion of this topic]. a. Be able to describe the components of wage compensation. Wage Rate Labor cost per work hour where the labor cost includes only wages and not benefits, burdens, or other markups [RP10S‐90]. Labor Hour A worker hour of effort [RP10S‐90]. Labor Burden Taxes and insurances the employer is required to pay by law based on labor payroll, on behalf of or for the benefit of labor. (In the US these are federal old age benefits, federal unemployment insurance tax, state unemployment tax, and worker’s compensation) [RP10S‐90]. Labor Cost 1) Bare Labor Gross direct wages paid to the worker 2) Burdened Labor Gross direct wages paid to the worker, plus labor burden. 3) All in Labor Gross direct wages paid to the worker, plus labor burden, plus field indirects, plus general & administrative costs, plus profit [RP10S‐90]. Exempt Employees Employees exempt from overtime compensation by federal wage and hours guidelines [RP10S‐90]. Non‐Exempt Employees Employees not exempt from overtime compensation by US federal wage and hours guidelines [RP10S‐90]. b. Be able to calculate an effective wage rate allowing for: Overtime Premium Various overtime compensation structures exist based on varying workweek schedules, often based on regional practices. Copyright 2011‐2018, AACE International, Inc. AACE International CCT Primer  Other Premium Pays Shortened Shift Time Job conditions may warrant a shortened time shift. Restricted work hours resulting from existing activities that must remain open. Loss of time resulting from security checks could be another. Travel Time Consideration for workers time if the project site is remote from normal residence or hotels if on per diem. Show‐up Pay Some contracts, predominately union, would compensate workers who show up to work as scheduled but are sent home for lack of work that day. 2. Benefits and Burdens (mandated and fringe): Note: current exam and this document are US centric. Below are some typical examples of US burdens. a. Be able to describe the basic mechanics of benefits and burdens such as: Retirement (Social Security), Social Security (FICA) wages set aside for retirement [R.S.Means R012909‐ 85]. Unemployment Insurance State unemployment tax rates vary not only from state to state, but also with the experience rating of the contractor. The US federal unemployment tax rate is also carried [R.S. Means R012909‐85]. Workers Compensation Workers Compensation rates vary not only from state to state, trade to trade, but also with the experience rating of the contractor [R.S. Means R013113‐60]. Insurance Some firms and labor contracts include contributions to a medical and life insurance program. These costs usually can be calculated on an hourly, weekly, or monthly cost basis, and added to the per hour work cost [S&K 6th Ed., 35]. Paid Time Off (Sick, Vacation, Holiday) Most employees have additional benefits of time off for local and US national holidays, vacation, and sick time. Therefore, in developing a unit cost for labor, a factor is added to increase the estimated and booked cost per hour worked each week to cover PTO. In the case of a construction craft that may work for many employers during a given period, wages are usually paid into a fund managed by their union or trade organization, who then distributes the salary for PTO [S&K 6th Ed., 35]. 3. Overhead and Profit: Copyright 2011‐2018, AACE International, Inc. AACE International CCT Primer  Overhead [Review S&K 6th Edition, Chapter 4, for more detailed discussion on this topic]. A cost or expense inherent in the performing of an operation, (e.g., engineering, construction, operating, or manufacturing) which cannot be changed to or identified with a part of the work, product or asset and, therefore, must be allocated on some arbitrary base believed to be equitable, or handled as a business expense independent of the volume of production. Plant overhead is also called factory expense [RP10S‐90]. General: Resource consumed or lost in completing a process, but which does not contribute directly to the end‐product. Also called burden cost [Business Dictionary.com]. Accounting: Cost or expense (such as for administration, insurance, rent, and utility changes) that (1) relates to an operation or the firm as a whole, (2) does not become an integral part of a good or service (unlike raw material or direct labor), and (3) cannot be applied or traced to any specific unit of output. Overheads are indirect costs [Business Dictionary.com]. Utilities: Energy or water lost during delivery from the generating or production plant to the end user [Business Dictionary.com]. General and Administrative Costs (G&A) The fixed cost incurred in the operation of a business. G&A costs are also associated with office, plant, equipment, staffing, and expenses thereof, maintained by a contractor for general business operations. G&A costs are not specifically applicable to any given job or project [RP10S‐90]. Profit Gross Profit – Earnings from an on‐going business after direct and project indirect costs of goods sold have been deducted from sales revenue for a given period [RP10S‐90]. Net Profit – Earnings or income after subtracting miscellaneous income and expenses (patent royalties, interest, capital gains) and federal income tax from operating profit [RP10S‐90]. Operating Profit – Earnings or income after all expenses (selling, administrative, depreciation) have been deducted from gross profit [RP10S‐90]. Best known measure of the success of an enterprise, it is the surplus remaining after total costs are deducted from total revenue, and the basis on which tax is computed and dividend is paid. Profit is reflected in reduction in liabilities, increase in assets, and / or increases in owner’s equity. It furnishes resources for investing in future operations, and its absence may result in the extinction of the firm. As an indicator os comparative performance, however, it is less valuable than return on investment (ROI). In economics, total cost must include a cost to cover the normal profit for the firm. Also called earnings, gain, or income [Business Dictionary.com]. a. Indirect Labor (Home Office, Administrative and Similar Costs) Copyright 2011‐2018, AACE International, Inc. AACE International CCT Primer  The labor needed for activities that do not become part of the final installation, product or goods produced, but that are required to complete the project. b. Small Tools Small tools and consumables are required to perform the work but not part of the final installation. Generally derived by a percentage of the material cost. 4. Union: ‐ Non‐Union Union An organization of wage earners formed for the purpose of serving the members’ interests with respect to compensation and working conditions [RP10S‐90]. Open Shop An employment or project condition where either union or non‐union contractors or individuals may be working. Open shop implies that the owner or prime contractor has no union agreement with workers [RP10S‐90]. Hint: Be able to explain the cost differences between union and open shop labor. Based on union wages or open shop wages (Davis Bacon) * The Davis Bacon Act of 1931 is a US federal law which established the requirement for paying prevailing wages on public works projects. All US federal government construction contracts, and most contracts for US federally assisted construction over $2,000, must include provisions for paying workers on‐site no less than the locally prevailing wages and benefits paid on similar projects. 2. Subcontract: be able to explain the cost implications of the following issues: 1. Reimbursable vs. non‐reimbursable costs Reimbursable expenses are amounts expended by an employee for and on behalf of the firm, and refundable under the firm’s rules [Business Dictionary.com]. 2. Overhead and Profit (including contract administration and legal costs) See above for detailed description. 3. License, fees or royalties. 4. Bonds (bid, payment, or performance) Performance bonds are essentially an insurance policy that the work will be completed. The rates offered to a contractor are based on how financially sound and capable a contractor has demonstrated themselves to be. Actual rates vary from contractor to contractor, and from bonding company to bonding company. Care should be taken to ascertain the bonding capacity of a contractor prior to award. Bid Bonds – A bond that guarantees the bidder will enter into a contract on the basis of the bid [RP10S‐90]. Copyright 2011‐2018, AACE International, Inc. AACE International CCT Primer  Payment Bond – A bond that is executed in connection with a contract and which secures the payment of all persons supplying labor and materials in the prosecution of the work provided for in the contract [RP10S‐90]. 5. Retention (Retainage) Usually refers to a percent of contract value retained by the purchaser until work is finished and testing of equipment is satisfactorily completed [RP10S‐90]. 6. Performance Guarantees See bonds above 7. Bonus – Penalty – A contractual arrangement between a client and a contractor wherein the contractor is provided a bonus, usually a fixed sum of money, for each day the project is completed ahead of a specified schedule and/or below a specified cost, and agrees to pay a similar penalty for each day of completion after the schedule date or over a specified cost up to a specified maximum either way. The penalty situation is sometimes referred to as liquidated damages [RP10S‐90]. 8. Liquidated Damages An amount of money stated in the contract as being the liability of a contractor for failure to complete the work by the designated time(s). Liquidated damages ordinarily stop at the point of substantial completion of the project or beneficial occupancy by the owner. Also can apply to contract defined output performance [RP10S‐90]. 3. Cost of Money: be able to describe these costs: 1. Escalation The provision in actual or estimated costs for an increase in the cost of equipment, material, labor, etc., over that specified in the purchase order or contract due to continuing price level changes over time. Inflation may be a component of escalation, but non‐monetary policy influences, such as supply‐ and‐demanded, are often components [RP10S‐90]. Escalation is a technique to accommodate price increases or decreases during the life of the contract. An escalation or de‐escalation clause is incorporated into the contract so that the purchaser will compensate the supplier in the event of price changes. These escalation and de‐escalation clauses help to shield both the supplier and the purchaser from unpredictable cost changes. Without such clauses, suppliers would include contingency amounts that might later be found to be unrealistically high [S&K 6th Ed., 74]. 2. Inflation A persistent increase in the level of consumer prices, or a persistent decline in the purchasing power of money, caused by an income in available currency and credit beyond the proportion of available goods and services. Normally derives from government monetary policy, whereby government debt can be repaid more cheaply [RP10S‐90]. Copyright 2011‐2018, AACE International, Inc. AACE International CCT Primer  Inflation is a rise in the price level of a good or service or market basket of goods and/or services. Inflation does not occur by itself but must have a driving force behind it. There are four effects that can result in inflation either by themselves or in combination with other effects. These four are: 1) Money Supply – is influenced by the central bank of a country. 2) Exchange Rate – can impact inflation by influencing the price of imported goods and services. 3) Demand‐Pull Inflation –is when excessive quantities of money are chasing a limited amount of goods and services resulting in what is essentially a “seller’s market” as sellers receive premium prices. 4) Cost‐Push Inflation – takes place when product producers encounter higher costs and then push these costs along to others in the production chain through higher prices. These higher costs may be for labor, material, or any other item with a significant cost element [S&K 6th Ed., 73]. 3. Currency Exchange Rates – Currency changes can have a significant cost impact both on those inside the country as well as those outside the country. Currency prices are set in markets around the world and change on a constant basis as the result of daily trading fluctuations and moves by central banks. Therefore, the currency fluctuations in one country or many countries can have an overall impact on earnings. Financial assets held in one country can witness a significant decline in value if that countries currency is devalued by the central bank. Protecting against currency variations is complicated and can be accomplished through currency futures hedging or valuing contracts against very stable currencies, to cite two examples [S&K 6th Ed., 74]. 4. Risk and Uncertainty: Be able to describe these costs: Project‐Specific Risks are uncertainties (threats or opportunities) related to events, actions, and other conditions that are specific to the scope of a project (e.g., weather, soil conditions, etc.). The impacts of project‐specific risk are more or less unique to a project. The historically inconsistent project‐specific nature of the risk‐to‐impact relationship favors the use of more deterministic methods of quantification such as expected value calculations. A risk taxonomy designation used to classify project risks for the purpose of selecting a quantification method (i.e., contingency determination) [RP10S‐90]. 1. Contingency An amount added to an estimate to allow for items, conditions, or events for which the state, occurrence, or effect is uncertain and that experience shows will likely result, in aggregate, in adding costs. Typically estimated using statistical analysis or judgment based on past asset or project experience. Contingency usually excludes: 1) Major scope changes such as changes in end product specification, capacities, building sizes, and location of the asset or project; 2) Extraordinary events such as major strikes and natural disasters; 3) Management reserves; and 4) Escalation and currency effects. Some of the items, conditions, or events for which the state, occurrence, and or effect is uncertain include, but are not limited to, planning and estimating errors and omissions, minor price fluctuations (other than general escalation), design developments and changes within the scope, and variations in market and environmental conditions. Contingency is generally included in most estimates, and is expected to be expended [RP10S‐90]. Copyright 2011‐2018, AACE International, Inc. AACE International CCT Primer  To an estimator, contingency is an amount used in the estimate to deal with the uncertainties inherent in the estimating process. The estimator regards contingency as the funds added to the originally derived point estimate to achieve a given probability of not overrunning the estimate (given relative stability of the project scope and the assumptions upon which the estimate is based). Contingency is required because estimating is not an exact science. One definition of an estimate is that it is the expected value of a complex equation of probabilistic elements, each subject to random variation within defined ranges. Since the value assigned to each individual component of an estimate is subject to variability, the estimate total itself is also subject to variation [S&K 6th Ed., 118]. 2. Allowance Resources included in estimates to cover the cost of known but undefined requirements for an individual activity, work item, account or sub‐account [RP10S‐ 90]. Allowances are often included in an estimate to account for the predictable but indefinable costs associated with project scope. Allowances are most often used when preparing deterministic or detailed estimates. Even for this class of estimate, the level of project definition may not enable certain costs to be estimated definitively. There are also times when it is simply not cost‐effective to quantify and cost every small item included with the project. To account for these situations, an allowance for the costs associated with these items may be included in the estimate. Allowances are often included in the estimate as a percentage of some detailed cost component. Some typical examples of allowances that may be included in a detailed construction estimate are: Design allowance for engineering equipment Material take‐off allowance Overbuy allowance Unrecoverable shipping damage allowance Allowance for undefined major items The specific allowances and values will usually depend on specific organization estimating procedures and experience [S&K 6th Ed., 115]. 3. Reserve An amount added to an estimate to allow for discretionary management purposes outside of the defined scope of the project, as otherwise estimated. Use of management reserve requires a change to the project scope and the cost baseline, while the use of contingency reserve funds is within the project’s approved budget and schedule baseline [RP10S‐90]. b. Pricing [Review S&K 6th Edition, Chapter 2, for more detailed discussion on this topic]. 1. Cost vs. Pricing: be able to explain the difference Cost In project control and accounting, it is the amount measured in money, cash expended or liability incurred, in consideration of goods and/or services Copyright 2011‐2018, AACE International, Inc. AACE International CCT Primer  received. From a total cost management perspective, cost may include ant investment of resources in strategic assets including time, monetary, human, and physical resources [RP10S‐90]. Price The amount of money asked or given for a product (e.g., exchange value). The chief function of price is rationing the existing supply among prospective buyers [RP10S‐90]. 2. Price Strategy: Pricing Strategies must be developed for each individual situation. Essentially two situations frequently appear when one is pursuing a project. In each case, there are specific but different business objectives [S&K 6th Ed., 22]. Type I Situation The objective is to win the project and execute it profitably and satisfactorily according to contractual agreements. Type II Situation is an example of a “must win” situation where the price is determined by the market forces. This case refers to a company that is trying to get a foothold into and industry. In such cases the profit may not be as important as obtaining the new business acquisition. Pricing – Method adopted by a firm to set its selling price. It usually depends on the firm’s average costs, and on the customer’s perceived value of the product in comparison to his or her perceived value of the competing products. Different pricing methods place varying degree of emphasis on selection, estimation, and evaluation of costs, comparative analysis, and market situation [Business Dictionary.com]. Pricing Strategy – Price planning that takes into view factors such as a firm’s overall marketing objectives, consumer demand, product attributes, competitor’s pricing, and market and economic trends [Business Dictionary.com]. Market Pricing – Worth of a job based on the current (going) compensation rate for comparable benchmark jobs in the labor market [Business Dictionary.com]. Market Penetration Pricing –Strategy adopted for quick achieving a high volume of sales and deep market‐penetration of a new product. Under this approach, a product is widely promoted and its introductory‐price is kept comparatively lower. This strategy is based on the assumption that (1) the product does not have an identifiable price‐market segment, (2) it has elasticity of demand (buyers are price sensitive), (3) the market is large enough to sustain relatively low profit margins, and (4) the competitors too will soon lower their prices [Business Dictionary.com]. Demand‐Oriented Pricing – Method in which price of a product is changed according to its demand higher price when the demand is strong, lower price when it is week [Business Dictionary.com]. Predatory Pricing – Practice of temporarily selling below survival prices or giving goods away to undermine or eliminate the existing competition. Predatory pricing is an abuse of dominant position, and is illegal in several countries [Business Dictionary.com]. Copyright 2011‐2018, AACE International, Inc. AACE International CCT Primer  At Cost Pricing – In slow construction cycles, contractors often price jobs at or just below cost to keep their workforce employed and active in the market. However, contracts awarded in this case often suffer from extensive change order requests to make the project profitable. c. Estimating [Review S&K 6th Edition, Chapter 9, for more detailed discussion on this topic]. 1. Definition of a Cost Estimate A cost estimate is defined as “a compilation of all the costs of the elements of a project or effort included within an agreed upon scope.” To a contractor, this is the cost that will most likely be incurred in completing the project as defined in the contract documents. The contractor’s cost includes its own internal costs, as well as those of its subcontractors, suppliers, and third parties [S&K 6th Ed., Chap 9]. A predictive process used to quantify, cost, and price the resources required by the scope of an asset investment option, activity, or project. As a predictive process, estimating must address risks and uncertainties. The outputs of estimating are used primarily as inputs for budgeting, cost or value analysis, decision making in business, asset and project planning, or for project cost and schedule control processes [RP10S‐ 90]. 2. Basic Steps of Estimating Take‐Off Measuring and cataloging the quantities of work derived from the scope documents [S&K 6th Ed., Chap 9, 112]. Costing Using the take‐off and the information presented in the scope documents to assign cost values to the elements of work previously cataloged [S&K 6th Ed., Chap 9, 113]. Pricing Determining the amount to be charged to the owner/client so as to fully include direct and indirect cost items, as well as contingency and profit [S&K 6th Ed., Chap 9, 113]. 3. Basic Cost Estimating Terminology Addendum (Addenda) A written change or graphic instrument issued before the date bids are opened. An addendum may interpret or modify the bidding documents by making additions, deletions, clarifications, or corrections [RP10S‐90]. Allowances Additional resources included in estimates to cover the cost of known but undefined requirements for an individual activity, work item, account, or subaccount [S&K 6th Ed., Chap 9, 115; RP10S‐90]. Alternate Copyright 2011‐2018, AACE International, Inc. AACE International CCT Primer  A request from the owner for the cost of adding or deleting an item or work element from the basic bid. The cost of adding an item is usually known as an additive alternate, while the cost of deleting an item is known as a deductive alternate [S&K 4th Ed., 1‐2]. Bid Documents The advertisement for bids, instructions to bidders, information available to bidders, bid form with all attachments, and proposed contract documents (including all addenda issued before the receipt of bids) [S&K 4th Ed., 1‐2]. Change Order A document requesting a change or correction; a written change made by the architect / engineer to the contract drawings and/or specifications aster the contract award. Generally, a change order must be approved by the owner/ client and the contractor before it becomes a legal change to contract [RP10S‐ 90]. Contingency An amount added to the estimate to allow for changes that experience shows will likely be required. This may be derived through statistical analysis of past‐ project cost or by applying experience gained on similar projects. Contingency usually does not include changes in scope or unforeseeable major events such as strikes or earthquakes [S&K 6th Ed., Chap 9]. An amount added to an estimate to allow for items, conditions, or events for which the state, occurrence, or effect is uncertain and that experience shows will likely result, in aggregate, in additional costs. Typically estimated using statistical analysis or judgment based on past asset or project experience. Contingency usually excludes: 1) Major scope changes such as changes in end product specification, capacities, building size, and location of the asset or project. 2) Extraordinary events such as major strikes and natural disasters; 3) Management reserves; and 4) Escalation and currency effects. Some of these items, conditions, or events for which the state, occurrence, and/or effect is uncertain include, but are not limited to, planning and estimating errors and omissions, minor price fluctuations (other than general escalation), design developments and changes within the scope, and variations in market and environmental conditions. Contingency is generally included in most estimates, and is expected to be expended [RP10S‐90]. Contract Documents The contract forms, general and specific conditions, drawings, specifications, and addenda describing the project scope and contract terms [S&K 6th Ed., Chap 9, 110]. Cost The amount a contract item is known or estimated to cost the contractor [S&K 6th Ed., Chap 9]. Cost Index Copyright 2011‐2018, AACE International, Inc. AACE International CCT Primer  A number that relates the cost of an item at a specific time to the corresponding cost at some arbitrarily specified time in the past. A cost index is useful in taking known past costs for an item and relating them to the present. [S&K 6th Ed., Section2]. Direct Cost Costs that can be directly attributed to a particular item of work or activity [S&K 6th Ed., Chap 1, p 11]. Costs of completing work that is directly attributable to its performance and are necessary for its completion. In construction: the cost of installed equipment, material, labor and supervision directly or immediately involved in the physical construction of the permanent facility [RP10S‐90]. Distributable Cost A cost item that is spread over other cost items rather than managed as a separate account [S&K 4th Ed., 1‐2]. Escalation Provision for an increase in the cost of equipment, material, labor, etc, over the costs specified in the contract, due to continuing price‐level changes over time [S&K 6th Ed., Chapters 7, 9, & 10]. The provision in actual or estimated costs for an increase in the cost of equipment, material, labor, etc., over that specified in the purchase order or contract resulting from continuing price level changes over time. Inflation may be a component of escalation, but non‐monetary policy influences, such as supply‐and‐demand, are often components [RP10S‐90]. Field Costs Indirect costs of engineering and construction associated with the project’s field site rather than with the home office [S&K 6th Ed., Chap 9; RP10S‐90]. General Conditions A specific portion of the contract documents. They state the responsibilities and relationships of all parties to the contract, as well as any conditions applicable to the contract [S&K 6th Ed., Chap 2]. Indirect Costs In construction, all costs that do not become a final part of the installation. They include, but are not limited to, field administration, direct supervision, capital tools, start‐up costs, contractor’s fees, insurance, and taxes [S&K 6th Ed., Chap 1, p 11; RP10S‐90]. Labor Burden Taxes and insurance costs based on labor payroll that the employer is legally required to pay on behalf of or for the benefit of laborers. (In the US, these include federal old age benefits, federal unemployment insurance tax, state unemployment insurance tax, and workers’ compensation) [RP10S‐90]. Labor Cost The base salary, plus all fringe benefit costs and labor burdens associated with labor, that can e definitely assigned to one item of work, product, process area, or cost center [S&K 6th Ed., Chap 4]. Copyright 2011‐2018, AACE International, Inc. AACE International CCT Primer  a) Bare Labor‐ Gross direct wages paid to the worker. b) Burdened Labor – Gross direct wages paid to the worker, plus labor burden. c) All In Labor – Burdened Labor plus general & administrative cost, plus profit [RP10s‐90]. Mark‐Up As variously used in construction estimating, such percentage applications as general overhead, profit, and other indirect costs. When mark‐up is applied to the bottom of a bid sheet for a particular item, system, or other construction price, any or all of the above items (or more) may be included, depending on local practice [S&K 6th Ed., Chap 11; RP10S‐90].