COST ESTIMATION

AND BUDGETING
Chapter 8

Copyright ©2016 Pearson Education, Inc.

 CHAPTER 8
LEARNING OBJECTIVES
After completing this chapter, you should be able to:
1. Understand the various types of common project costs.
2. Recognize the difference between various forms of
project costs.
3. Apply common forms of cost estimation for project
work, including ballpark estimates and definitive
estimates.
4. Understand the advantages of parametric cost
estimation and the application of learning curve models
in cost estimation.

Copyright ©2016 Pearson Education, Inc. 8-2

 CHAPTER 8
LEARNING OBJECTIVES
After completing this chapter, you should be able to:
5. Discern the various reasons why project cost estimation
is often done poorly.
6. Apply both top-down and bottom-up budgeting
procedures for cost management.
7. Understand the uses of activity-based budgeting and
time-phased budgets for cost estimation and control.
8. Recognize the appropriateness of applying contingency
funds for cost estimation.

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 PMBOK CORE CONCEPTS

Project Management Body of Knowledge (PMB0K)

covered in this chapter includes:
1. Plan Cost Management (PMBoK 7.1)
2. Estimate Costs (PMBoK 7.2)
3. Determine Budget (PMBoK 7.3)
4. Control Costs (PMBoK 7.4)

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 COST MANAGEMENT

 Cost management has been defined to

encompass data collection, cost accounting, and
cost control.
 Cost accounting and cost control serve as the
chief mechanisms for identifying and maintaining
control over project costs.
 Cost estimation processes create a reasonable
budget baseline for the project.

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 COMMON SOURCES OF PROJECT COST

Labor
Materials
Subcontractors
Equipment & facilities
Travel

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 TYPES OF COSTS
direct costs are expenses that directly go into producing
Direct Vs. Indirect goods or providing services while indirect costs are general
business expenses that keep you operating like officers
salaries and rent.

Recurring Vs. Nonrecurring Aintervals

recurring cost is one that occurs at regular
and is expected. ... A non-recurring
cost is one that occurs at irregular intervals
and is not generally expected.
Fixed Vs. Variable Variable costs vary based on the amount of output
produced. Variable costs may include labor, commissions,
and raw materials. Fixed costs remain the same regardless
of production output. like rental payments,
Normal Vs. Expedited
Regular costs - preferred and occur when progress can be made by normal work
hours and purchasing agreements. Expedited costs occur when the project must be
conducted faster than normal and overtime for workers and/or extra charges for
rapid delivery from suppliers are necessary.

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 COST CLASSIFICATIONS
(TABLE 8.2)

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 COST ESTIMATION
Ballpark estimates are created when information or time (or both) are scarce and are
targeted at plus or minus 30%.

Ballpark (order of magnitude) ±30%

Comparative ±15%
are based on the assumption that historical data can be used as a frame of reference
for current estimates on similar projects

Feasibility ±10%
are made after completion of the preliminary design work following initial scopedevelopment
upon receiving quotes from suppliers and subcontractors

Definitive ±5%
can be completed only after the completion of most design work, at a point when the scope
and capabilities of the project are quite well understood

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 LEARNING CURVES

Each doubling of output results in a reduction in time

to perform the last iteration.
Yx = aX b
Where:
Yx = time required for the x unit of output
a = time required for the initial unit of output
X = the number of units to be produced
b = learning curve slope = log(learning %)/log(2)

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 UNIT LEARNING CURVE
LOG-LINEAR MODEL
(FIGURE 8.5)

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 SOFTWARE PROJECT ESTIMATION –
FUNCTION POINTS

Function Point Analysis is a system for estimating the

size of software projects based on what the software
does.

Function Points are a standard unit of measure that

represents the functional size of a software
application.

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 SOFTWARE PROJECT DEVELOPMENT
ACTIVITIES AS A FUNCTION OF SIZE
(FIGURE 8.6)

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 COMPLEXITY WEIGHTING TABLE
FOR FUNCTION POINT ANALYSIS
(TABLE 8.4)

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 FUNCTION POINT CALCULATIONS
FOR RESTAURANT REORDER SYSTEM
(TABLE 8.5)

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 PROBLEMS WITH COST ESTIMATION

Low initial estimates

Unexpected technical difficulties

Lack of definition

Specification changes

External factors

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 CREATING A PROJECT BUDGET
(FIGURE 8.7)

WBS

Project
Plan The budget is a plan
that identifies the
Scheduling Budgeting resources, goals, and
schedule that allows a
 Top-down firm to achieve those
goals.
 Bottom-up
 Activity-based costing (ABC)
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 ACTIVITY-BASED COSTING

Projects use activities & activities use resources.

1. Assign costs to activities that use resources.
2. Identify cost drivers associated with this activity.
3. Compute a cost rate per cost driver unit or
transaction.
4. Multiply the cost driver rate times the volume of
cost driver units used by the project.

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 SAMPLE PROJECT BUDGET
(TABLE 8.6)

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 SAMPLE BUDGET TRACKING PLANNED
AND ACTUAL ACTIVITY COSTS
(TABLE 8.7)

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 EXAMPLE OF A TIME-PHASED BUDGET
(TABLE 8.8)

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 CUMULATIVE BUDGETED COST OF THE
PROJECT
(FIGURE 8.8)

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 BUDGET CONTINGENCIES

The allocation of extra funds to cover uncertainties and

improve the chance of finishing on time

Contingencies are needed because:

1. Project scope may change
2. Murphy’s Law is present
3. Cost estimation must anticipate interaction costs
4. Normal conditions are rarely encountered

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 BENEFITS TO CONTINGENCY
FUNDING

1. Recognizes future contains unknowns

2. Adds provision for company plans for an

increase in project cost

3. Applies contingency fund as an early warning

signal to potential overdrawn budget

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 SUMMARY

1. Understand the various types of common

project costs.
2. Recognize the difference between various forms
of project costs.
3. Apply common forms of cost estimation for
project work, including ballpark estimates and
definitive estimates.
4. Understand the advantages of parametric cost
estimation and the application of learning curve
models in cost estimation.

Copyright ©2016 Pearson Education, Inc. 8-25

 SUMMARY

5. Discern the various reasons why project cost

estimation is often done poorly.
6. Apply both top-down and bottom-up budgeting
procedures for cost management.
7. Understand the uses of activity-based
budgeting and time-phased budgets for cost
estimation and control.
8. Recognize the appropriateness of applying
contingency funds for cost estimation.

Copyright ©2016 Pearson Education, Inc. 8-26

Copyright ©2016 Pearson Education, Inc. 8-27