1. (a) Explain the concept of cost management.
[10]
Cost management is a method of reducing operating or production expenses in order to
provide less expensive products or services to consumers. In other words, it’s the process
management used to analyse its production and streamline its operations to keep costs low
and manage expenses in the future. Cost management is the main focus of managerial
accounting that helps a firm forecast future expenditures in an effort to reach their budgeting
goals. This process is typically divided into three main phases: planning, implementation, and
final analysis. In the planning phase, expected costs are projected and approved by higher
management. Once the plan has been properly approved, the implementation phase monitors
and records the cost making sure that they keep in line with the budget. After the project is
finished, actual and budgeted costs are compared and variances are investigated in the final
analysis. If the company did not meet their budgeted numbers, management might consider
switching production materials, change plant processes, or product design in an effort to
lower costs.
The basic concept is to gather information about current operations, analyse it, and evaluate
the results. Most managerial accountants strive to: Measure the operational costs Minimize
all non-value added costs if not eliminate them; See if operations can be run more efficiently
and effectively and Create processes that will work better for future operations.
In order to have a more holistic understanding, of the cost management it is important to
provide an example. The Shesham construction Company just completed its first building
project. Here are the steps and details.
Planning – All possible costs are projected and estimated.
Implementation – All costs are recorded.
Final Analysis – Costs are compared and analysed. Variances are investigated.
Materials Budgeted Actual Variance Over/ Under Budget
Concrete $26,000 $36,000 $10,000 Over
Cement composites $15,600 $15,040 ($560) Under
Glass $12,300 $12,450 $150 Over
Metal $9,000 $8,500 ($500) Under
Ceramics $1,500 $1,500 Over
TOTAL $10,590 OVER
By going through these three phases and analysing the cost variances, Shesham Construction
Company can identify costs that should be minimized or eliminated as well as areas that the
company is not as efficient as it should be. This is the essence of managing costs.
(b) Discuss four processes involved in cost management to your project of your
choice. [15]
Cost management in project management is the process of planning, estimating, budgeting,
and controlling project costs. Cost management processes are in place to help project teams
plan and control budgets during the project life cycle. While cost management overall is a
very complicated process and a critical project management knowledge area, it can be broken
down into four processes:
1. Resource planning
While resource management is in place to plan, allocate, and schedule the resources needed
for each stage of a project, resource planning looks specifically at the costs associated with
each of these resources. Because of the complexity of this process, a work breakdown
structure (WBS) can help to simplify and provide clarity. Using your resource planning
software, identify what resources will be used to complete each item in the WBS, determine
the associated costs, and perform a cost-benefit analysis.
2. Cost estimation
Cost estimation is the process of approximating the costs associated with each of the
resources required for all scheduled activities. Cost estimating forecasts the cost of
completing a project within a defined scope. Given that scope tends to shift throughout the
life of a project, cost estimation is not a onetime process. Effective cost management
requires project managers to iterate on cost estimations whenever scope changes or change
requests are approved. These estimations provide a summation of all costs involved in
successfully finishing a project, from inception to completion.
To get a good estimate at the costs, you can use one of the following techniques:
Analogous estimating:
Estimates are based on past projects. It uses actual costs from a similar finished project to
estimate the costs of the new project. The accuracy of these estimates will depend on the
similarities between the new project and the old project.
Parametric modelling:
Estimates are based on mathematical formulas, typically following a Regression Analysis or
Learning Curve model. The accuracy of these estimates depends on the assumptions made.
Bottom-up estimating:
Estimates are based on individual work item cost and duration estimates. This involves
estimating the smallest activities and then adding them up to create an estimate for the whole
project.
3. Cost budget
Cost estimations lead directly into the cost budgets. In this step, you will determine the cost
baseline and the funding requirements for the project. A good project budget will help you
make key decisions with respect to the project schedule and resource allocation constraints.
Combine individual activity cost estimates into a total project cost, establish the timing of the
costs, and measure the progress of the project against the approximated baseline costs. These
budgets should account for everything from direct labour costs, to material costs, factory
costs, equipment costs, administrative costs, and software costs.
To determine the cost budget, consider the following techniques:
Cost aggregation:
Requires you to aggregate or combine costs from an activity level to a work package level.
The final sum of the cost estimates is applied to the cost baseline.
Reserve analysis:
Requires you to create a buffer or reserve to protect against cost overruns. The degree of
protection should be equivalent to the risk foreseen in the project. The buffer is part of the
project budget, but not included in the project baseline.
Historical data:
Requires you to think about estimates from closed projects to determine the budget of the
new project. This is very similar to analogous estimation described earlier.
Funding limit reconciliation:
Requires you to adhere to the constraints imposed by the funding limit. The funding limit is
based on the limited amount of cash dedicated to your project. To avoid large variations in
the expenditure of project funds, you may need to revise the project schedule or the use of
project resources.
4. Cost control
Good project managers will carefully monitor the cost of their projects to prevent scope
creep. This includes watching to see where actual cost has varied from estimated cost. Cost
control also involves informing the stakeholders of cost discrepancies that vary too much
from the budgeted cost. Controlling the budget requires being aware of the original budget,
approved costs, forecasted costs, actual costs, and committed costs. If there are any changes
to scope or if unforeseen risks have an impact on the approved budgets, the project manager
will need to review the level of impact and take corrective action as needed.
To effectively control project costs, consider these tools and techniques:
Earned value management:
Uses a set of formulas to help measure the progress of a project against the plan.
Forecasting:
Uses the current financial situation to project future costs. The forecast is based on budgeted
cost, total estimated cost, cost commitments, cost to date, and any over or under budgeted
costs.
To-complete performance index (TCPI): represents the level of project performance that
future work needs to be implemented to meet the budget.
Variance analysis:
Involves analysing the difference or variance between the budgeted costs and the actual costs
to indicate whether the project is on budget.
Performance reviews:
Used to check the health of a project. Includes an analysis of project costs, schedule, scope,
quality, and team morale. By learning how to estimate costs, determine budgets, and control
costs, you can be a better project manager and leader. Effective cost management will help
you get projects done on time and under budget, the golden ticket for any successful project
manager.
Project cost management tools
A work management software like Work front provides a centralized location for all project
data and information, helping you to stay aware of variances in the budget, make approvals,
track comments, and more.
References list
1. College, Kathy Schwalbe, Ph.D., PMP, Augsburg (2012). Information technology
project management (Seventh ed.). Boston, MA: Course
Technology. ISBN 9781133526858.
2. Rad, P.F. (2002). Project Estimating and Cost Management. Management
Concepts. ISBN 9781567261448. Retrieved 2015-09-14.
3. "Magic Quadrant for IT Project and Portfolio Management" . gartner.com.
Retrieved 2015-09-14.
4. "Practical Project Cost Management with Twproject | Twproject's blog". 2013-06-03.
Retrieved 2015-09-14.
