Cost Classification

Cost classification is the process of distinguishing costs into subcategories. For this purpose, a

classification method is required to categorize and prioritize costs for financial modeling. Many

different types of cost classifications can be made such as;

 Direct and Indirect Costs

 Fixed and Variable Costs

 Customer Costs

 Departmental Costs

 Manufacturing Costs

If you don’t understand the difference between the cost categories, you will have difficulties while

managing a project’s budget or operating a business.

Therefore, it is important to recognize the classification while purchasing material or estimating

project expenses.

Assume that you are a project manager of a house construction project and the client makes a

change request related to changing the perimeter walls from reinforced concrete to masonry. The

first thing you should do is to make a unit price analysis and classify the costs according to their

type. Material, labor, and machinery costs are direct costs and increases as the amount of work

increases.

On the other hand, project management and operational costs are indirect costs that don’t directly

relate to the amount of work but increase as the duration of the project increases.
Basically, costs can be divided into two major categories according to the element/nature. For

better understanding, let’s analyze each concept.

Direct Cost

A direct cost is a price that can be utterly attributed to the production of products or services. Some

costs, such as direct materials, direct labor, equipment are examples of common direct costs.

In some cases, it is possible to classify an indirect cost as a direct cost. For instance, the salary of

the manager who controls multiple concrete batch plants would be considered as an indirect cost

for each batch plant. However, that manager’s salary would be a direct cost for the department

which comprising all of those concrete batch plants.

Direct costs are often variable costs. If the manufactured units increase, direct costs increase.

Because creating more units requires more materials and resources.

Example:

Assume that, you will produce 1000 m concrete in the batch plant. You need 300 tons of cement

to produce 1000 m3 concrete and 1 ton cement costs Rs. 100. So you need Rs. 30,000 to purchase

cement. This is your direct cost. As the quantity increases direct cost increase.

The following are a few examples of direct costs

 Laborer’s wages

 Wood, Glass, Cement, Concrete, Rebar, etc.

 Handles, locks, hinges

 Direct materials

 Consumable supplies
  Freight in and out

 Sales commissions

 Royalty Payment

 Patent Holder

 Consultants

 Tools

Indirect Cost

Indirect costs are those which affect the whole company such as depreciation, accounting services,

general supplies, board salaries, and overhead costs. They are not spent just on only one product.

Overhead costs, ongoing costs, project management costs, operational costs are indirect costs.

Indirect costs are often fixed costs. But also, they can be variable.

For instance, the rental cost of your head office is a fixed cost. The quantity of manufactured units

doesn’t affect your rental price. Another example of a variable cost is your heating and cooling

expenses that can change on a monthly basis.

For cost controlling purposes, many companies try to limit their indirect costs as a proportion of

direct costs.

Example:

Going back to the same batch plant example. Assume that this month you will produce 1000 m3

concrete. If you increase the production and produce 1500 m3 concrete this does not change your

head office costs or marketing costs.

The following are a few examples of indirect costs.

 Advertisement costs

 Project management costs

 Operational Costs

 Insurance

 Depreciation

 Manager’s salary

 Indirect costs related to transport

 Administration cost

 Indirect employee’s salaries

 Security cost

 Office cost

 Selling & distribution cost

 Factory overheads

What are the Primary Differences Between Direct and Indirect Costs?

Below are some differences between direct costs and indirect costs.

 It is easy to determine direct costs considering the product or service. On the other hand, it

is not easy to identify indirect costs. Detailed analysis is required to identify indirect costs.

 Direct costs are attributable to a specific product, department, goods, or service. On the

other hand, indirect costs are attributable to multiple products or services.

 Direct costs are variable costs that change based on the quantity of a product or service.

However indirect costs are fixed costs.

Difficulties in Cost Classification

There are some costs that cannot be classified easily either direct or indirect. Some indirect costs

such as hiring a consultant or traveling expenses are sometimes categorized as direct costs

depending on the circumstances. In that case, organizations often classify them according to their

nature and usage.

Overhead costs are indirect costs that are related to direct costs.

Estimating Direct Cost

The direct cost if each bid item represents the sum of its material, labor, equipment and

subcontractor costs. The sum of bid items direct costs gives the estimated direct cost of the

contract. The direct cost of a given item can be estimated using the unit rate estimating, operational

estimating.

Unit Rate Estimation

This type of estimating is used in building work and for civil work items where the nature of work

is repetitive. It is based on the resources required and their output rates for each Cost Estimating

category of work. Working drawings and specifications are needed to determine the quantities of

materials, equipment, and labor. Current and accurate costs for these items (unit prices) are also

necessary. Because of the detail involved and the need for accuracy, unit price estimates require a

great deal of time and expense to complete properly. For this reason, unit price estimating is best

suited for construction bidding. It can also be effective for determining certain detailed costs in

conceptual budgets or during design development.

There are some disadvantages of using the unit-rate method for estimating major works. It does

not demand the examination of the program (schedule) or the method statement or the risks costs
in undertaking the work. Also, the precision and level of detail in pricing an item can give a false

sense of confidence in the resulting estimate. This method does not need having a construction

schedule.

Operational Estimating

Operational estimating, which is the recommended method for estimating civil engineering work,

requires the estimator to build up the cost of the operation based on its principles including the

total cost of construction equipment, labor and permanent/temporary materials. This method links

well with the planning and scheduling process as it embraces the total anticipated time that the

construction equipment and labor crew are involved in the operation including all idle time.

The operational estimating involves the following:

- Prepare the method statement showing the sequence, resources, timing, etc.

- Prepare an early completion program with unlimited resources.

- Revise the program by smoothing or leveling the resources.

Example 1: This question relates to the construction of a reinforced concrete basement (50 m ×

30 m × 10 m deep) built below the ground. The contractor’s estimate is required to calculate an

appropriate BOQ rate. This item is listed in the BOQ as follow:

Consider two alternative construction methods:

- Method A: open cut with battered sides (the open cut method requires additional work space to

allow for erect and strip shutter of the outer face). Accordingly, assume total volume of excavation

equals 2.5 × net volume.

- Method B: Steel cofferdam built around net perimeter of basement.

Assume the following net costs (based on quotations from subcontractors):

- Excavation open cut, Rs3/m3 .

- Disposal on site Rs 1/m3 . - Bring back and fill, Rs 1/m3 .

- Excavation within cofferdam, Rs 8/m3 .

- Sheet piling (assume 15 m deep), Rs 20/m2 .

- Mobilization/demobilization of piling rig, Rs 5000each way.

- Extract cofferdam piling, Rs 5000.

- Site overheads, 10%, head office overheads and profit, 12%.

Solution:

Method A(open cut):

Excavation quantity of open-cut = 15000 × 2.5 = 37500 m .

Disposal on site = 37500 – 15000 = 22500 m .

Bring back and fill = 22500 m .

Total net cost = 37500 × 3 + 22500 × 1 + 22500 × 1 = Rs 157,500

Method B(steel cofferdam):

Excavation quantity within cofferdam = 15000 m = 15000 × 8 = Rs 120,000.

Sheet piling mobilization/demobilization (two times) = 2 × 5000 = Rs 10,000.

Sheet piling (30 + 30 + 50 + 50) × 15 = 2400 × 20 = Rs 48,000.

Extract cofferdam = Rs 5,000. Total net cost = Rs 183,000.

Thus, based on the above, the estimator would choose the open-cut method.

Net cost of open-cut method = Rs 157,500

10% site overheads = Rs 15,750

Subtotal = Rs 173,250
12% head office overheads and profit = Rs 20,790

Total = Rs 194,040

So, the rate to be included in the bill of quantity should be = 194040/15000 = Rs 12.936/ m .

Example 2: A grout curtain is to be constructed underneath a dam. This involves drilling through

the underlying rock. The total length of the grout holes to be drilled is 21390 m distributed over

388 holes. The following table shows the work involved into five activities along with the sued

resources.

Assume that the drilling and grouting rate equals 20m/day. The drilling rig requires ½ day moving

from a hole to another. The cost of the used equipment is Rs 2300/wk/unit and the cist for grout

material is Rs 5.8/m. the week comprises of 6 days. It is required to determine the duration of each

activity. The direct unit cost using the unit rate estimating and the operational estimating.
Solution:

Calculating activities’ duration

Calculating cost using unit-rate estimating:

The drilling and grouting rate = 20m/day = 0.05 day/m

Time of moving equipment = 388 × 0.5 = 194 days = 194/21390 = 0.009 day/m

Total time = 0.05 + 0.009 = 0.059 day/m

Daily cost of equipment = 2300 / 6 = Rs 383.33

Grouting unit rate = 5.8 + 0.059 × 383.33 = Rs 28.42/m

Calculating cost using operational estimating:

Total equipment-weeks used = 19×4 + 15×2 + 11×(3+4+3) + 7 = 223 unit.week

Cost of equipment = 223 ×2300 = Rs 512900

Unit cost rate = 5.8 + 512900/21390 = Rs 29.58/m

Practice Problems:

1. A crew comprising 3 labors and 0.5 foreman is deserved to take (16 hr) 2-days to excavate

36 m3 of soil. If the average rate of labor is Rs 21/hr and foreman is Rs 24/hr. Find the unit

cost of excavation.

2. A bill of quantity of a project includes 500m2 of masonry work. The work will be done by

one crew with a production rate of 50 m2 /day and consists of:

Vendor price of 1000 bricks = Rs 160. Each 55 bricks are estimated to make one square

meter of masonry. Each one cubic meter of mortar is used to join brick area of 50 m2 and

consists of:

Quantity Material Primary Quotation from

Vendor

One cubic meter Sand Rs 15/m

6 sacks (50kg each) Cement Rs 240/ton

As a contractor, it is required to estimate the item price and the unit price. Assume all

material waste as 20% and assume overheads and markup as 20% of total cost.
3. Calculate the price of pit-run gravel delivered to the site per cubic meter (bank measure)

based on the following data:

- The pit is located 10 km from the site.

- Truck costs Rs 40/hr, including fuel and maintenance; they have 12 cubic meter (loose

material) capacity and travel at an average speed of 30 km/hr empty and 20 km/hr loaded.

- The swell factor for this material is 20% and the compaction factor is 90%.

- Trucks take 5 minutes to unload at the site.

- The loader costs Rs 80/hr and loads material at the pit at the rate of 40 m3 /hr.

- Truck driver’s wage is Rs 32/hr and the equipment operator’s wage is Rs 40/hr.

- Gravel price (loose) = Rs 40/m .

- Quantity of gravel required to fill an excavated site with dimensions 30 × 30 × 1 m3 .

- Assume overheads and markup of 10%.

4. Consider the following items of a given project.

- Site overheads = 5% of Direct cost (i.e., LE10500).

- General overheads = 5% of Construction cost.

- Profit and risk = 10% of Total cost.

It is required to:

a. Develop a balanced tender price (balanced –bid).

b. Develop an un-balanced tender price (unbalanced-bid)