3.
COST CONCEPTS
Facilitator: Eng. Cyliacus S.N.
ARUSHA TECHNICAL COLLEGE
1 Tuesday, April 23, 2024
3.1 Fixed and Variable Costs:
Fixed Cost: Fixed costs are expenses that do not
change with the level of production or output.
Example in Engineering Project: The annual
lease cost of a piece of construction equipment,
such as a crane, is a fixed cost.
It remains constant whether the crane is used
extensively or remains idle.
2 Tuesday, April 23, 2024
3.1 Fixed and Variable Costs:
Variable Costs: Variable costs are expenses that
vary directly with the level of production or
output.
Example in Engineering Project: The cost of raw
materials, like concrete or steel, is a variable
cost.
As the construction project progresses, the
quantity of materials used and the associated
costs will vary.
3 Tuesday, April 23, 2024
3.2 Opportunity Costs:
Opportunity cost is the value of the next best
alternative forgone when a decision is made.
Example in Engineering Project: Suppose a civil
engineering firm has a piece of land that could be
used for either a commercial or residential
project.
If the firm decides to use it for a commercial
project, the opportunity cost is the potential profit
that could have been earned from a residential
project on the same land.
4 Tuesday, April 23, 2024
3.3 Economic Analysis of Project Costs:
Direct Costs:
Are expenses directly tied to the production of a
specific good or service.
Example in Engineering Project: The cost of
hiring labor for the construction of a building is a
direct cost.
It directly contributes to the construction project.
5 Tuesday, April 23, 2024
3.3 Economic Analysis of Project Costs:
Indirect Costs (Overhead Costs):
Indirect costs are expenses not directly tied to a
specific project but necessary for overall
business operations.
Example in Engineering Project: The salary of
project managers, administrative staff, and
utilities for the construction site office are
indirect costs. They contribute to the overall
functioning of the construction firm.
6 Tuesday, April 23, 2024
3.3 Economic Analysis of Project Costs:
Sunk Costs:
Sunk costs are costs that have already been
incurred and cannot be recovered.
Example in Engineering Project: If a feasibility
study for a project has already been conducted,
and the decision is made not to proceed with the
project, the cost of the feasibility study becomes
a sunk cost.
7 Tuesday, April 23, 2024
3.3 Economic Analysis of Project Costs:
Life Cycle Costing:
Life cycle costing involves considering the total
cost of ownership of a project, including initial
costs, operating costs, maintenance costs, and
disposal costs over its entire life.
Example in Engineering Project: For a water
treatment plant, life cycle costing would include
the initial construction costs, ongoing operational
costs, maintenance costs, and eventual
decommissioning costs.
8 Tuesday, April 23, 2024
3.4 FIXED, VARIABLE, AND INCREMENTAL COSTS
Fixed costs: unaffected by changes in activity level over a feasible
range of operations for the capacity or capability available.
Typical fixed costs include:
insurance and taxes on facilities
general management and administrative salaries
license fees
interest costs on borrowed capital.
Fixed costs will be affected When:
large changes in usage of resources occur
plant expansion or shutdown is involved
9 4/23/2024 2:05 PM
3.4 FIXED, VARIABLE, AND INCREMENTAL COSTS
Variable costs: associated with an operation that vary
in total with the quantity of output or other measures of
activity level.
Example of variable costs include :
costs of material and labor used in a product or
service, because they vary in total with the number of
output units -- even though costs per unit remain the
same.
Example 2.1
10 4/23/2024 2:05 PM
3.4 FIXED, VARIABLE, AND INCREMENTAL COSTS
Incremental cost: additional cost that results from
increasing output of a system by one (or more) units.
Incremental cost is often associated with “go / no go”
decisions that involve a limited change in output or
activity level.
EXAMPLE: the incremental cost of driving an
automobile might be $0.27 / mile. This cost depends on:
1. mileage driven;
2. mileage expected to drive;
3. age of car;
11 4/23/2024 2:05 PM
3.4 SUNK COST AND OPPORTUNITY COST
A sunk cost is one that has occurred in the past
and has no relevance to estimates of future costs
and revenues related to an alternative course of
action;
An opportunity cost is the cost of the best
rejected ( i.e., foregone ) opportunity and is
hidden or implied;
12 4/23/2024 2:05 PM
3.5 CASH COST VERSUS BOOK COST
Cash cost is a cost that involves payment in cash and results
in cash flow;
Book cost or noncash cost is a payment that does not involve
cash transaction
book costs represent the recovery of past expenditures over a
fixed period of time;
Depreciation is the most common example of book cost;
depreciation is what is charged for the use of assets, such as
plant and equipment; depreciation is not a cash flow;
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3.6 LIFE-CYCLE COST
Life-cycle cost: sum of all costs, both recurring and nonrecurring,
related to a product, structure, system, or service during its life
span.
Life cycle begins with the identification of the economic need or
want and ends with the retirement and disposal activities.
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3.7 PHASES OF THE LIFE CYCLE
PHASE STEP COST
Acquisition Needs Assessment Rising at increasing rate
Conceptual design Rising at increasing rate
Detailed Design Rising at decreasing rate
Operation Production/Construction Rising at decreasing rate
Operation/Customer Use Constant
Retirement/Disposal Constant
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3.8 CAPITAL AND INVESTMENT
Investment Cost or capital investment: capital (money)
required for most activities of the acquisition phase;
Working Capital: funds required for current assets needed for
start-up and subsequent support of operation activities;
Operation and Maintenance Cost includes many of the
recurring annual expense items associated with the operation phase
of the life cycle;
Disposal Cost includes non-recurring costs of shutting down the
operation;
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3.9 RECURRING AND NONRECURRING COSTS
Recurring costs: repetitive and occur when a firm
produces similar goods and services on a continuing
basis.
Variable costs are recurring because they repeat
with each unit of output.
A fixed cost that is paid on a repeatable basis is also a
recurring cost:
Office space rental
$
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3.9 RECURRING AND NONRECURRING COSTS
Nonrecurring costs: not repetitive, even though the
total expenditure may be cumulative over a relatively
short period of time;
Typically involve developing or establishing a capability
or capacity to operate;
Examples are purchase cost for real estate upon which
a plant will be built, and the construction costs of the
plant itself;
18 Dr. Mohammad Abuhaiba, PE 4/23/2024 2:05 PM
3.10 DIRECT, INDIRECT AND OVERHEAD COSTS
Direct costs can be reasonably measured and
allocated to a specific output or work activity
labor and material directly allocated with a
product, service or construction activity;
Indirect costs are difficult to allocate to a
specific output or activity
costs of common tools, general supplies, and
equipment maintenance ;
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3.10. DIRECT, INDIRECT AND OVERHEAD COSTS
Overhead consists of plant operating costs that are not
direct labor or material costs
indirect costs, overhead and burden are the same;
Prime Cost is a common method of allocating
overhead costs among products, services and activities in
proportion the sum of direct labor and materials cost ;
20 Dr. Mohammad Abuhaiba, PE 4/23/2024 2:05 PM
3.11 STANDARD COSTS
Representative costs per unit of output that are
established in advance of actual production and service
delivery;
Standard Cost Element Sources of Data
Direct Labor Process routing sheets,
standard times,
standard labor rates;
Direct Material Material quantities per unit,
standard unit materials cost;
Factory Overhead Costs Total factory overhead costs allocated
based on prime costs;
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3.12 CONSUMER GOODS AND PRODUCER GOODS AND SERVICES
Consumer goods and services: directly used by people
to satisfy their wants;
Producer goods and services: used in the production
of consumer goods and services:
machine tools,
factory buildings,
buses and farm machinery
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23 Tuesday, April 23, 2024
