This important book was among the three books launched by Engr. Johnson Awoyomi in February this year at Lagos. We intend to carry chapter two of the book here because of its significance to the topic, which is Cost Engineering and Cost Control, especially, in Medium and Large Projects
CHAPTER 2: ELEMENTS OF COST
ELEMENTS OF COST
2.1 Introduction
The typical elements of a cost are depicted in Figure 2 1. Cost is any resource invested or spent in an asset –monetary or non-monetary, including time, effort, or other resource expenditure. Resources are any consumables 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, money, and human capital. It should be noted that a resource becomes a cost when it is invested or consumed in an activity or project.
2.2 Direct and Indirect cost
Cost can be classified as direct or indirect. Direct costs are the ones that directly impact the outputs of production, and they include – labour (carpenters, welders, bricklayers, masons, etc.), material (steel, wood, cement, pumps, long lead items, etc.), equipment (cranes, etc.) and subcontractors, while indirect costs include – taxes, general conditions, risks, and overheads.
2.2.1 Direct cost
These are the costs that can be directly attributed to a particular item of work or activity, as shown in Figure 2 2. These costs are for material, labour, equipment, and subcontracted elements that remain in place after the contractor departs. In manufacturing, they are costs expended on labour and materials that are required to produce an item. They represent the materials in the manufactured item and labour that immediately converts materials to final form. Thus, direct costs are the kind of costs that can be clearly and unambiguously allocated to a specific work item.
(1) Labour Costs
This is the total of the actual amounts paid to field personnel who perform actual work – e.g., Carpenter, bricklayers, welders, and masons. Labour costs can be broken into two main components (a) Basic wage – the hourly wage rate multiplied by the number of hours worked and (b) Labour burden, which includes: the Statutorily required items such as taxes, insurance, etc. The fringe benefits are often negotiated between employers and employees, either individually or collectively. The Labour burden portion is not always treated as a direct cost element since it is seldom directly proportional to actual hours worked and is usually allocated according to company practice unless the contract dictates otherwise.
What is Labour Burden?
Labour Burdens are taxes and insurance costs based on labour payroll that the employer is legally required to pay on behalf of or for the benefit of labourers. In the United States, these include social security, federal unemployment insurance tax, state unemployment tax, and workers’ compensation. In Nigeria, it includes FIRS Tax, Insurance, Pensions, etc.
Labour Costs and Mark-ups
The Labour Cost is the Base salary, plus all fringe benefits and burdens associated with the labour, which can be assigned to one item of work, product, process area, or cost centre. As variously used in construction estimating, Mark-up is a percentage application as general overhead, profit, and other indirect costs.
The following are the kinds of benefits that direct labourers enjoy in the course of their engagement:
• Social Security: This is a US statutory Federal program designed to bring eventual retirement, medical survival, and other benefits to employees or their beneficiaries. It is funded equally and jointly based on a per pay period by both the employees and the employers.
• Unemployment Insurance: Insurance coverage, usually mandated by law, is designed to protect workers during times of unemployment in most states in the US. It is employer-paid. This is non-existent in Nigeria as at the time of writing this book.
• Worker’s Compensation Insurance: this is a statutory program designed to protect employees who are killed, injured, or suffer health problems due to job-related accidents or conditions. This exists in Nigeria with large multinationals.
• Vacations: For Nigeria, this is included inside the conditions of services and is paid annually when the staff proceeds on vacation. For salaried employees in the USA, this cost item is included in the annual salary amount, while for hourly wage employees, considered an added cost, assuming that they will be physically on the job at all times. It is paid to a union vacation fund on union jobs or an added cost on open shop jobs. To determine open shop vacation cost, the Vacation cost = (Number of days’ vacation) x (Daily wage rate).
• Medical Insurance: This cost is borne in whole or in part by the employer depending on the kind of employment contract and is also found in the developing nations. Other Insurance packages, which may include either group life or accident insurance, are handled similarly to medical insurance.
Other Benefits that labour enjoys even in the developing nations include pension plans (paid monthly to retired staff till death), on-duty training, or off-duty education assistance.
This is usually included in the prices of materials or parts incorporated into a project. It is often referred to as “commodity” or “bulk” materials. Bulk Materials (Commodities) are materials bought in lots. These items can be purchased from a standard catalogue description and are bought in large quantities (through soliciting material prices or quotations from manufacturers and suppliers for distribution as required). Examples are pipes (non-spooled), conduits, fittings, and wire cables. The contractors may include delivery charges as part of direct cost and taxes as direct or indirect costs.
These refer to the cost of equipment used to accomplish work such as backhoes, cranes, and bulldozers, not the equipment installed permanently. If leased, the cost includes the cost of lease and fuel costs. And if owned by the contractor, costs include owning costs – investment, insurance, depreciation, and operating costs (fuel, maintenance, and repairs). The operators’ costs are included separately by most contractors as direct labour costs even though they are part of operating costs.
Engineered Items: The equipment costs should not be confused with “engineered equipment or items.” The engineered items are typically long lead items characterized by detailed engineering datasheets. These are items that are purchased for a particular purpose and are engineered to unique specifications instead of commodity materials. This typically includes tagged items and materials that require detailed engineering datasheets. Examples are pumps and compressors.
These are the costs of subcontractors’ services for performing a specific portion or specialty of work that a general contractor does not self-perform with its forces. Examples include Catering services and specialized studies like underwater studies.
In construction, all the costs which do not become a final part of the installation constitute what we term as indirect costs. The examples of indirect costs are: (a) field administration costs encompassing salaries for supervision and engineering; (b) buildings such as the project office, warehouses, and shops; (c) major equipment such as hoisting equipment and a concrete batch plant; (d) temporary construction such as access roads and rail spurs; (e) general expense items including office supplies, utilities, signs, and taxes. Also included are risks, specifically profit and contingency. In manufacturing, indirect costs are costs that are not directly assignable to the end product or process. Examples are overhead and general-purpose labour or costs of outside operations, such as transportation and distribution. The major sub-components of indirect costs are general requirements, risk, overheads, and (usually) taxes, as shown in Figure 2 3.
Figure 2‑3: Elements of Indirect Costs
(1) Taxes and Workmen’s Compensation
These vary significantly from location to location, and the tax-exempt status of the owner—tax-exempt means you are not required to pay tax. There are various kinds of taxes being charged and are usually separated to facilitate accounting. For example, various kinds of Taxes are being charged in Nigeria – Statutory wage taxes by FIRS, Property Taxes, Value-Added Tax (VAT), Petroleum Profit Tax (PPT). In other economies like the USA, the Workmen’s Compensation form part of the tax included.
(2) General requirements and conditions
This part comes from the Contract section stipulating legal responsibilities and relationships of contracting parties. It may include procedures for acceptance of work, change orders, termination, and other such items. It also includes the cost of items that one has to furnish to perform a given contract as a whole.
General Conditions cover the items that normally cannot be charged to a specific work element and typically may include (based on conventions as applicable to the organizations) supervision, temporary facilities, office trailers, toilets, utilities, permits, photographs, small tools, and clean up. Project-specific items typically generate project indirect costs often stipulated in Supplementary General Conditions or other technical specifications.
Distributable costs: These are the items that are spread over or allocated to other cost items, such as labour costs or labour hours, rather than managed as a separate account. Examples of distributable costs include – small tools such as hammers and conduit benders, fasteners, and protective clothing.
Field costs: These are the indirect costs of engineering and construction associated with a field site rather than a home office.
(3) Risks
There are usually two types of risks – Systemic Risk and Project Specific Risks. The systemic ones cover how the project system attributes, such as defining the scope, estimating biases, using technology, and culture. This drives the most risk in the early stages of a project. Project Specific Risks include risks resulting from attributes, conditions, and activities in a specific project. These may not be readily identifiable until later in the project definition. Examples include Niger Delta or North-East projects of Nigeria – where project-specific risk factors come to play due to the location and restlessness attributable to those areas. This risk type is vital because its nature determines how its impact can be analyzed and estimated.
Risks have two primary components – Profit and Contingency.
Profit: is regarded as the amount of money included by a contractor in the estimate as compensation for risks, efforts, and endeavors to undertake a project. It is usually a residue of money left after a contractor has met all direct and indirect costs. The amount of profit to be added is a very subjective and individual matter. It usually depends on some considerations such as competition, how badly one needs the project, market, and local economy. Some years ago, when I was a cost engineer in a contractor’s organization, we often reduced our profit to the barest value to win a bid – each time, we were desperately looking for a job. In some cases, we bided at cost with zero profit because the experience will go into our corporate CVs.
To be continued