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Week 2: Financial Plan - Discussion

Cost Components (graded)

This week we will continue to use the Indoor Theme Park Case from the Week 1 Discussion, in which we discussed the project cost components and our estimateassumptions. This week we will discuss some of the "hidden" project costs and their importance in our project budget. Here are some questions we will address during ourdiscussion this week.

Define overhead costs in relation to a project, and explain why it is important to the project manager. Referencing the Indoor Theme Park project case, how should overheadbe estimated for the new theme park project?

How is estimating done in your company, and how are overhead costs included?

Click here to review the Indoor Theme Park Project scenario.

Responses

Response Author Date/Time

Cost Allocations Professor Orr 5/11/2013 7:30:47 AM

I'm also interested in how the costs w ill be allocated. Also, w hat are the pros and cons of the different methods, given this is a new product?

Regards,

Susan

RE: Cost Allocations Varune Ramoutar 5/12/2013 3:36:48 PM

Since this is a new product then I believe a bottom up approach would be better for determining the budget which is formulated from the cost

allocations. Each WBS would be broken down into smaller more defined work packages. Cost for executing each of these work packages wouldthen be formulated. These work package costs would then be summed to give the cost allocation for each of the WBS areas. The sum of the cost of

all the WBS areas plus overhead, contingencies and indirect costs should then give the overall cost of the project.

I believe that it is better to use this approach because since this is a new product there would not be much historical data on cost, schedule etc. for it.Thus the bottom up approach would be advantageous in this case.

RE: Cost Allocations Joel Khan 5/13/2013 6:20:22 AM

I think that since the orgnization is creating a new product and resources w ould be limited a top-dow n approach w ould be best to provide the best balance to effort. The top

dow n approach to resource planning uses rough order of magnitude sizing w ith very little detail to estimate resource needs. The bottom up approach uses project planning

techniques to create task based estimates.

Unlike bottom up resource planning that requires a detailed project plan and supporting project management softw are, top dow n resource planning can be implemented early in

the project cycle using simple tools. The visibility provided by the top dow n approach is more than adequate to support the level of portfolio planning required to maximize

returns from the the investment of R&D and other resources.

Reference: http://w w w .slideshare.net/sopheon/topdow n-vs-bottomup-resource-planning-w hich-is-better

RE: Cost Allocations Maria Ventura 5/13/2013 9:41:38 AM

Hello class,

According to my research, there are three Method of Allocating Costs:-Direct Method -Step Down Method -Reciprocal Method

Direct Cost AllocationStrengths:1. Easy to Calculate2. Easy to Implement

Weaknesses:1. Misstates Opportunity Costs2. Does not charge service departments for the use of other service departments

====

Step-Down Allocation

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Strengths:1. Reduces the subsidization of service department use of other service departments

Weaknesses:1. Misstates Opportunity Costs2. Some service departments are not charged for the use of other service departments.3. Selection of which department is allocated first results in different cost allocations.

====

Reciprocal Method

Strengths:1. Theoretically correct method of allocating costs2. Closest measurement of opportunity cost

Weaknesses:1. Seldom Used because math is misunderstood2. Assumes all costs are variable, fixed costs should be allocated based on expected use, which introduce problems we have alreadydiscussed.

Source: http://ocw.mit.edu/courses/sloan-school-of-management/15-521-management-accounting-and-control-spring-2003/lecture-notes/web_class9.pdf

Thank you//

RE: Cost Allocations Chukie Okunzua 5/15/2013 12:11:57 PM

Though this project is "not all too familiar" many of the components of the project have similiarity with known projects. Thecomponent similiarities will be in building construction, rides installation and support facilities like snack bar and restaurants. I suggestusing a parametric estimate approach using a combination of analogy projects and function of systems. The parametric approachis recommended because the design features are just being set and an estimate is quickly needed to make a decision.A bottom to top appraoch will be time consuming at this stage and will require detailed design. A parametric estimate will provide topmanagement a reasonable guide to make their decision

RE: Cost Allocations Cauretta Bell 5/15/2013 7:11:37 PM

The goal here is to provide yourself w ith an advantage as the project manager.As the PM and taking the bottom up approach should allow the PM to see the unexpected items

that might be a problem later in the project.

RE: Cost Allocations Esperanca Rosa 5/13/2013 12:59:21 PM

Hi class,Allocating budgets to cost items

According to the website “epixanalytics.com”, I will use a similar model to allocate the budget and contingency set for the project as a whole. Theyshould be distributed back among the cost items to set budgets for each project component. This knowledge will help the project manager to keep an eyeon how the project is progressing. Their approach is to distribute back the budget and contingency costs so that the figures associated with each cost itemhave the sameprobability of being exceeded. Using this approach will give each cost item the same chance of coming in within its budget figure or its(budget + contingency) figure and will avoid controllers of some cost items being given almost impossible targets to meet and others easy targets. Thismethod of distributing budget and contingency costs among cost items is demonstrated in the following example, using a cost model Example: Allocation of cost budget among cost components

Retrieved from:

http://www.epixanalytics.com/modelassist/CrystalBall/Model_Assist.htm#Extra_example_models/Project/Allocating_budgets_to_cost_items.htm

Regards,

Esperanca

RE: Cost Allocations Philip Effiong 5/14/2013 8:33:48 AM

Project budget is a detailed, time-phased estimate of all resource costs for your project. You typically develop a budget in stages — from an initial rough estimate to a

detailed estimate to a completed, approved project budget.

Project’s budget includes both direct and indirect costs.

Direct costs include the following:

· Salaries for team members on your project

· Specific materials, supplies, and equipment for your project

· Travel to perform work on your project

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· Subcontracts that provide support exclusively to your project

Indirect costs fall into the following two categories:

· Overhead costs: Costs for products and services for your project that are difficult to subdivide and allocate directly. Examples include employee benefits, office

space rent, general supplies, and the costs of furniture, fixtures, and equipment.

You need an office to work on your project activities, and office space costs money. However, your organization has an annual lease for office space, the space

has many individual offices and work areas, and people work on numerous projects throughout the year. Because you have no clear records that specify the

dollar amount of the total rent that’s just for the time you spend in your office working on just this project’s activities, your office space is treated as an indirect

project cost.

RE: Cost Allocations Herminio Dionisio 5/14/2013 7:48:30 PM

Once the WBS has been draw n, cost allocation can be done in tw o different w ays. One is the top dow n cost allocation method and the other one is the bottom up cost allocation method.

The top dow n cost allocation is a method w here the cost of the total project has been determined and is allocated to the top package of the WBS diagram. The w ork packages below are

then forced to accept the appropriate costs so that the total cost of each branch cannot exceed the total cost of the package above w hich has a low degree of accuracy in cost

allocation. In practice, both methods may have to be used. The bottom up cost allocation is better because the decomposition of tasks into smaller sub tasks are easy to manage and

allocate, and w ill give a higher degree of accuracy compared to top dow n cost allocation method. The overhead cost is alw ays included on your f inal cost. It can only be included w hen

pricing on design, production, process and bids are made. One critical factor that must be considered also is the answ er to the question "w hat if" that is w hy most projects includes a

contingency cost or the management reserve. It may not be a part of the project cost baseline, but included in the total budget for the project.

RE: Cost Allocations Cauretta Bell 5/19/2013 8:51:50 PM

I can see w hy companies w ould use the top dow n approach to ensure that the project stays on track. When there are linited funds the company w ould have to look at trend

analysis reports and other similar project to verify the appropriate amount for the propective project. Using the top dpw n approach the organizations have forced the PM to

make some tough discussion or for the job to be incomplete.

RE: Cost Allocations Dwayne Grant 5/15/2013 6:58:12 PM

Project costing is a method of estimating for the bidding process, and it also involves the tracking of scheduled milestones. The one thing you would need todo is calculate the actual cost and any variances that exist on the project. There are certain project costs that must be considered, and they are directmaterials and expenses and conversion costs. One method is called the step down method, and it is the method of one department allocating costs toanother department in sequential order. The next method is called the direct method and it is the most widely used, and it ignores the fact that servicedepartments may support other services departments.

RE: Cost Allocations Bruce Foley 5/15/2013 11:27:34 PM

I think the Top-Dow n approach w ould be the best method for this project because the company is familiar w ith the costs involved in building a theme park. The new intangible w ould be

putting it into the indoor setting. This new aspect w ould be the only "new " aspect is of building inside w ould be the new task added in an already established WBS. The company w ould

then task this to a construction PM w ho is familiar w ith that type of project, w hich w ould then make each functional group familiar w ith their phase of the project w hich w ould help to

control cost also.

RE: Cost Allocations Mary Hart 5/17/2013 9:07:38 PM

Modified:5/17/2013 9:09 PM

The cost estimating could be done using the Top-down or Bottom-up method.

The Top-down cost estimating ( or Analogues estimates):-Is used when few details are known about the project. - Is usually less accurate, but it is cheaper to produce analogous estimates.- Is more reliable when previous projects done are very similar, and the preparers have expertise in building estimates.

The Bottom-up cost estimating:-Is used when most of the details are known about the project.- The cost are aggregated into an overall budget.- Is usually more reliable, but it costs more to produce because they take longer to create.

Based on the advantage and disadvantage of each method,I find that the Top-bottom method is the most suitable method to use in the new-product projectcost estimating.

RE: Cost Allocations Serge Ndongo 5/18/2013 2:42:08 PM

Good point Mary!

I w ould say that the Bottom-up method is more eff icient and more reliable. Therefore it is the preferable method to use regardless of the high costs associated w ith it.

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Maturity of Products and Eff iciency Impacts on Allocation SystemsProfessor Orr

5/13/2013 11:30:40 AM

Good points! One of the problems w ith costs is that w ith these allocation systems (by sales volume or revenue), older mature/high volume products get a larger allocation (proportionately) than

new er low volume products because economies of scale are not considered by direct allocations. Also, eff iciency may not be rew arded. For example, marketing costs for new er products tend to

be higher, especially during the launch phase, w hile established products may be on a relatively low maintenance-marketing program. How w ould you w ork around this?

Regards,

Susan

RE: Maturity of Products and Efficiency Impacts on Allocation Systems Serge Ndongo 5/13/2013 2:55:17 PM

Good question Dr. Orr. In order to answer your question it is important to remember that a newer product needs to be known in the market andsubsequently demands heavy marketing to succeed. But to reach a certain level on sales, it takes time, money and resources. Even with high marketingmethods and costs, it could go either ways in the end as the customers may or may not meet the expectations of the intended owner/provider of theproduct. In comparison to an old product, this one already has an established and well known reputation in the market. The company does not have to fightharder anymore as the product is doing fine and will at a certain point of time frame be sold. That is one of the reasons why older mature/ high volumeproducts get larger allocation than newer low volume products. The company basically plays it safe!

RE: Maturity of Products and Efficiency Impacts on Allocation Systems Varune Ramoutar 5/13/2013 8:02:26 PM

One of the ways a new product can get a high allocation is if it is a definite game changer for the market and will definitely capture market

share e.g. when the iphone first came out. A market and cost analysis will have to be done and must be used to justify to management thatthe new product is a definite game changer and the required resources must be allocated in order to produce the right amount of product to

capture the market. This does not mean make a profit in the immediate term but the allocation must be given such that sufficient market is

captured and enough interest in the product is generated so that it makes a profit in the near future. Good examples of up coming gamechangers are:

Samsumg YOUM http://technovisitors.blogspot.com/2013/03/samsung-youm-future-smartphone-with.html

Google Glass - http://www.google.com/glass/start/what-it-does/

RE: Maturity of Products and Efficiency Impacts on Allocation Systems Tanika Thomas 5/13/2013 9:01:07 PM

Examine value chain and cut cost by combining steps to reduce the cost of production. I think of prescription anddevelopment of new drugs. When new medicine is released to the market it carries a high cost with a patent toprotect the cost. As soon as the patent expires the market is flooded with generic brands at a cheaper cost. Ibelieve one way to reduce these cost is to maximize previous research and stop starting from scratch, combinesteps/resources to reduce the overhead expenses. Also check for reduce cost in package and marketingtechniques to reduce the initial cost to the market.

RE: Maturity of Products and Efficiency Impacts on Allocation Systems Joel Khan 5/14/2013 8:54:18 AM

Products in their introduction and grow th phases consume cash. Mature (and sometimes declining) products generate cash that can be distributed to shareholders or reinvested to develop the new products

that may eventually become the mature cash cow s.

So, from a high level strategic perspective, a company needs a product mix of new and mature products: the mature products provide current cash; new products, use current cash, but are the source of

future cash generation.

Reference: https://w w w .google.com/url?

sa=t&rct=j&q=&esrc=s&source=w eb&cd=6&cad=rja&ved=0CFcQFjAF&url=http%3A%2F%2Ffaculty.msb.edu%2Fhomak%2Fhomahelpsite%2Fdocuments%2F02%2520Homa%2520Note%2520-

%2520Product%2520Fundamentals%2520r082406.pdf&ei=oU6SUYiUA42_yw HFyYGw CQ&usg=AFQjCNGqMydp6pkKQMimna_o9URutQfuow &sig2=3hK196vFE6GM0mDw Gc4azg&bvm=bv.46471029,d.aWc

Reliability of Trend Analysis Professor Orr 5/14/2013 10:13:12 AM

Good responses. Some overhead estimating methods use trends, but what might make trend analysis unreliable?

Regards,Susan

RE: Reliability of Trend Analysis Nishan Ragoonanan 5/14/2013 11:07:24 AM

Trend analysis can be unreliable for a few reasons

1. They got the model w rong, so even though statistically things f it, it's not a true representation of w hat's actually going on w ith overhead costs.

2. The data being used is old or dated and no further studies have been done to utilize more recent data or determine the factors that now contribute to overhead costs.

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RE: Reliability of Trend Analysis Mary Hart 5/14/2013 9:50:51 PM

Modified:5/14/2013 9:53 PM

I would add that a trend analysis may be unreliable when estimating overhead as follow:

- Different geographic location, as in a different State or country from original location of trend data. - Trend data variation from year to year, due to inflation adjustment and other factors.

RE: Reliability of Trend Analysis Cauretta Bell 5/17/2013 8:44:09 PM

Those are great examples of w hy trends could be unreliable. Trends could be unreliabe w hen trying to forecast sales. There might be different circumstances that

might come into factoring w hy trends could be false.

1. events that are happening

2. w eather could take into account

RE: Reliability of Trend Analysis Maria Ventura 5/14/2013 7:11:21 PM

Hello class,

According to the article provided by the "U.S. Department of Energy", Trend analysis allows a firm to compare its performance to other firms in the industry.It is an estimating technique for current, in-progress work, and is also used to explain quantitatively how a project is progressing.

Since trend analysis's techniques can be used at almost any stage of project development and can even be used to update cost estimates developed usingother techniques, sometimes it may lead to trend analysis be unreliable. Due to incompatibilities between the techniques or technologies used on eachprojects being compared. Technology always changing, the analysis could be not as accurate because there are more efficient ways completing certaintasks on future projects which could effect the outcome a little differently

The article states that withing Trend Analisis method; during a long project activity, productivity rates may vary with less than optimal productivity occurringas project activity begins.Thus trend analysis estimates should consider the current stage and remaining stage of a project activity carefully beforeextrapolating current productivity or cost values.

Source: Cost Estimating Guide - this domain - U.S. Department of Energyhttps://www.directives.doe.gov/directives/0413.3-EGuide-21

Thank you//

RE: Reliability of Trend Analysis Varune Ramoutar 5/14/2013 8:18:32 PM

Nice post Nishan and Maria.

I would like to add that trend modeling might not predict certain events that could trigger significant cost changes e.g. the occurrence ofsevere weather events that could damage agricultural products, or geopolitical events like wars, or rapid decrease in price of one commodity

due to a new better alternative product coming onto the market. The trending models may not take these type of events into account and thus

they could become unreliable.

RE: Reliability of Trend Analysis Esperanca Rosa 5/14/2013 11:30:17 PM

Hi class,

The trend analysis could be unreliable because of the type of product or service. According to the website “project-management-knowledge.com”, the concept of reliability is one which can prove to be of paramount importance to the project management teamand or the project management team leader, as errors in reliability can cause productivity to decline significantly. Specially speaking,reliability refers to the probability and the likelihood that a given product will perform in the way and or manner it was intended toperform in the efforts that have been deemed required of that given product within or under a specific period of time required.Moreover, products that have a high level of reliability are preferred for a wide and varied number of reasons such as when productreliability is higher and or greater it allows for less wasted energy and less redundancy, and allows more members of the projectteam to focus on additional aspects of the project sooner. On the other hand, products with lower reliability will cause more wastedenergy, and consequently more redundancy.

Regards,

Esperanca

Retrieved from:

http://project-management-knowledge.com/definitions/r/reliability/

RE: Reliability of Trend Analysis Philip Effiong 5/15/2013 7:53:03 AM

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Forecasting and project management benefit from trend analysis data, but it must be used wisely for maximum positive results. A trend analysis involvescollecting data and trying to identify patterns that may be repeated. This technique attempts to predict future results based on the patterns that appear.However, a trend analysis is never a perfect predictor of the future and designing business strategies dependent on these patterns can sometimes bedetrimental.

There are no guarantees in the world of business. Even a well designed trend analysis may identify only anomalies, not real patterns.

Depending on the quality of your data and the vagaries of happenstance and coincidence, you might identify a pattern that is not really a trend. Makingstrategy decisions while assuming your results are true can be a costly and dire mistake.

RE: Reliability of Trend Analysis Huyen Bui 5/15/2013 10:27:24 PM

Trend analysis can be unreliable because there are nothing absolute in the w orld of business. The trend analysis may only identify anomalies not the real patterns.

Also the patterns have affected by the internal and external factors. Seasonality, change of demographic, climate w ould cause a sudden change in trend

RE: Reliability of Trend Analysis Herminio Dionisio 5/16/2013 6:04:13 PM

Forecasting future trends in costs from historical cost experience is of primary importance. In periods of either rising or declining costs, an adequate cost analysis must include some

evaluation of the trends. In cases involving production of recently developed, complex equipment, even in periods of relative price stability, trend analysis of basic labor and materials

costs should be undertaken and in contracts extending over a period of several years, trend analysis should be made of overhead forecasts for life of the contract. Some of those that

must be considered in your trend analysis are the escalation cost of materials and labor influenced by the economic, labor forces and government regulations, w hich are some under

force majeure.

RE: Reliability of Trend Analysis Dwayne Grant 5/18/2013 5:20:19 PM

First of all a trend is a general pattern, and not a formula or constant like the ones used in math and science. This is the part of the project were we attemptto use historical data and mathematical calculations. The goal is to try to try to determine any possible variance from the established baseline. So, probablythe most important reason the data from the trend analysis would be unreliable is that no two projects are alike. We can’t use historical data because someor all of the data may not be applicable to the current project. The next thing we need to do is determine is the data reliable, or is it outdated as far as costor relevance. Trending is a skill used by project managers, but should not be the basis for acceptance or rejection of a project. When analyzing the viabilityof a project multiple analysis techniques should be used in determining the financial feasibility of a project.

Solutions for Potential Incompatibilities: Trend Analysis and Projects Professor Orr 5/15/2013 7:47:10 AM

These are good comments. What solutions are there to the incompatibilities betw een trend analysis and projects?

Regards,

Susan

RE: Solutions for Potential Incompatibilities: Trend Analysis and Projects Nishan Ragoonanan 5/15/2013 4:44:17 PM

I think one solution to the incompatibility is the use of some range or three point estimate. Whilst the trend analysis is good at giving us some historical basis for making a judgement it

cannot be treated w ith absolute terms especially w hen it comes to money so for those areas w here w e believe the trend analysis to be not so accurate, w e must utilize a different metric

than the trend. This can take the form of a three point estimate w here w e use the most likely, most optimistic and pessimistic costs for an item and apply a beta distribution to determine the

most likely cost for an item or cost allocation for a project.

RE: Solutions for Potential Incompatibilities: Trend Analysis and Projects Esperanca Rosa 5/15/2013 6:22:08 PM

Hi class,

What solutions are there to the incompatibilities between trend analysis and projects?

There are some solutions to the incompatibilities between trend analysis and projects. According to the website “projectmanagement-knowledge.com”, sometimes it is necessary to identify trends during project management. Trend Analysis is the process of identifying trends.This is the part of project management where historical data is utilized, given and set of mathematical parameters, and then the processed inorder to determine any schedule, or scope. Thus, these parameters are modeled after data from certain reporting periods, and utilized duringthe PM process to project how much variance a project manager can expect if the project is not adjusted in any way during estimated periodof time. Moreover, the intent is for specific trend to be anticipated and necessary adjustments can be made during the PM process in orderto maximize the full potential of desired outcomes. Finally, utilizing historical data is a proven method to be able to identify these trends.Trend Analysis is a mathematical scientific approach and eliminates potential error by utilizing precise calculations in order to provide thegreatest accuracy. It is the most dependable and efficient method for anticipating possible future behavior and desire outcome of a specificproject.

Retrieved from:

http://project-management-knowledge.com/definitions/t/trend-analysis-technique/

Best Regards,

Esperanca

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RE: Solutions for Potential Incompatibilities: Trend Analysis and Projects Philip Effiong 5/16/2013 5:44:10 AM

The process of identifying trends is called Trend Analysis. This is the part of Project Management where historical data is utilized, given a set ofmathematical parameters, and then processed in order to determine any possible variance from an established baseline of given constraints such asBudget, Cost, Schedule, or Scope. These parameters are modeled after data from certain reporting periods, and utilized during the Project Managementprocess to project how much variance a project manager can expect if the project is not adjusted in any way during an estimated period of time. The intentis for a specific trend to be anticipated and necessary adjustments can be made during the Project Management process in order to maximize the fullpotential of desired outcomes. Utilizing historical data is a proven method to be able to identify these trends.

RE: Solutions for Potential Incompatibilities: Trend Analysis and Projects Herminio Dionisio 5/16/2013 6:52:28 PM

Modified:5/16/2013 6:54 PM

With the use of the mathematical scientif ic approach w hich is the trend analysis, those parameters from the historical data are proven methods and are being utilized to determine any

possible variance from an established baseline. In some cases w here incompatibilities betw een trend analysis and project are encountered, the best solution that any organization can do

to assure that any unforeseen problems and risks w ill be taken cared of in the event it may occur, a force majeure clause must be included and stipulated in the contract and is not a part

of any management reserve or contingency reserve of a project f inal budget.

Pros and Cons of Activity Based Costing Professor Orr 5/16/2013 12:00:42 PM

Allocating by some percentage is probably the most common method, but it has its downside. The alternative is ABC (Activity Based Costing). What are the prosand cons?

Regards,

Susan

RE: Pros and Cons of Activity Based Costing Serge Ndongo 5/16/2013 4:14:15 PM

The major advantage of Activity Based Costing, ABC, is the ability to estimate the cost of individual products and services precisely. By transferring

overhead costs to individual units of products or services, ABC helps identify inefficient or non-profitable products or activities that eat into the profitability of

efficient processes or highly profitable products.

The major disadvantage of Activity Based Costing, ABC, is that although activity based costing is a scientific approach, the method of implementation is

complex, time consuming, and costly. The process of data collection and data entry requires substantial resources, and remains costly to maintain.

RE: Pros and Cons of Activity Based Costing Maria Ventura 5/16/2013 6:04:10 PM

Hello class,

First of all, Activity based costing (ABC) is a managerial accounting system that estimates the cost of products and services by assigning overhead costs to direct costs. This

costing method assigns the cost of each activity in an organization to all products and services according to the actual consumption of the activity resource by the product or

service.

Activity based costing uses a number of different cost drivers to absorb different overheads, w hereas traditional absorption costing only uses one, for example labour hours,

machine hours or per

unit. In activity based costing f ixed overhead costs may include machine set-up costs. These costs w ill not be incurred on a per unit basis but w ill be incurred each time the

machine has to be set-up. It w ould not, therefore, be sensible to allocate costs per unit since that is not how the cost is incurred. It is, how ever, better to use the number of

set-ups for this particular cost to allocate costs to units.

This allow s for an organization to precisely estimate the cost of its individual products and services for the purposes of identifying and eliminating those w hich are unprofitable

and low ering the prices of those w hich are overpriced.

Source: http://w w w .finsoul.com/abc-costing-or-activity-based-costing/

Thank you//

RE: Pros and Cons of Activity Based Costing Chukie Okunzua 5/16/2013 10:08:17 PM

Activity based costing helps improve the business process by identifying which process are doing well and the one that are not performing. It helpspin point activities that are non value adding and helps in effective allocation of resources. ABC can be helpful in fixing the price of products orservices that are excessive.A disadvantage of the ABc is that it is not possible to divde some overhed cost on a per product usage basis. it is impossible for employeesto dedicate 100% of their time to an activity and not all productive activities add value a product or process.. Paying too much attention to detailscan detract from looking at the biggeer picture.

RE: Pros and Cons of Activity Based Costing Nishan Ragoonanan 5/17/2013 3:05:17 PM

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Activity based costing as you have all said is a more accurate view of product cost, allocating overhead costs fairly to products or products across the chain of an

organization, giving the benefit of greater costing accuracy as compared to Traditional Costing w hich ignores overhead costs of an organization. The disadvantage

of activity based costing is the resource requirement required for implementation, w hich can be expensive for some companies to implement. Whilst providing a

better understanding of overhead costs and their allocation to a project, it can also be easily misinterpreted by some users.

http://smallbusiness.chron.com/traditional-costing-vs-activitybased-costing-33724.html

RE: Pros and Cons of Activity Based Costing Herminio Dionisio 5/18/2013 12:11:01 PM

A very simple definition, Activity based costing (ABC) is a method of assigning costs to products or services based on the resources that they consume. The basis for activity based

costing (ABC) is that projects consume activities, and activities consumes resources. It begins w ith the identif ication of activities that make use of resources, and assigns costs to them

through the use of WBS w ork package. Costs are initially assigned to activities w hich is the discrete tasks that need to be completed to deliver the project and then assigned to projects

based on each project's use of resources. Many companies w ere not prepared to give up their traditional cost control mechanisms because of the diff iculty lay in translating the theory

into action, but have also many satisf ied customers for ABC show ed them the true cost of certain parts that saved them millions of dollars in the case of the American car manufacturer

the Chrysler.(Excerpt from The Economist, Activity based costing Jun 29, 2009)

RE: Pros and Cons of Activity Based Costing Joel Khan 5/18/2013 11:55:02 PM

Advantages

The major advantage of activity based costing is the ability to estimate the cost of individual products and services precisely. By transferring overhead costs to individual units of products

or services, ABC helps identify ineff icient or non-profitable products or activities that eat into the profitability of eff icient processes or highly profitable products.

Disadvantages and Limitations

The major disadvantage of activity based costing is that although activity based costing is a scientif ic approach, the method of implementation is complex, time consuming, and costly. The

process of data collection and data entry requires substantial resources, and remains costly to maintain.

ABC reports do not conform to generally accepted accounting principles (GAAP), and as such, f irms follow ing ABC need to maintain tw o cost systems and accounting books, one for

internal use and another for external reports, f ilings, and statutory compliance. This is a cumbersome duplication of efforts.

A primary disadvantage of ABC is that it is not possible to divide some overhead costs such as the chief executive's salary on a per-product usage basis. Similarly, employees rarely

devote 100% of their w orking hours to productive activities, and not all productive activities add value to the product or process of the f irm. For instance, the ABC method fails to account

for the time employee takes part in a f irst aid aw areness campaign, leading to substantial ‘cost leaks.’ There is no meaningful w ay to assign such 'business sustaining' costs to products

on a proportionate basis, and products and services share such costs equally.

Finally, too much attention to detail and control might obscure the bigger picture or make the f irm lose sight of strategic objectives in a quest for small savings, making the f irm “penny w ise

and pound foolish.” For instance, ABC might identify one distribution channel as non-remunerative, or an inspection as non-value adding. Such channeling or processes might be non-

profitable, but placed in the f irst place to achieve some other strategic objectives.

reference: http://w w w .brighthub.com/off ice/f inance/articles/78752.aspx

RE: Pros and Cons of Activity Based Costing Dwayne Grant 5/19/2013 4:42:21 PM

I hear activity based costing was developed as a continuous improvement initiative of accounting information systems, and it has been determined that ABCprovides more accurate cost estimates of the product or service activities than traditional costing. Activity Based costing works under that assumption thatproducts consume activities and activities consume resources. The problem with costing is that at the end of the day it is an estimate of the costassociated with a project, and no project estimate can be calculated with complete certainty.

Http://pmstudent.com/activity-based-costing-in-project-management

RE: WK2 Bruce Foley 5/16/2013 11:59:51 PM

Modified:5/17/2013 12:07 AM

If new er products introduce a proven concept into a different setting, I then think they are a more secure gamble to launch and therefore are more deserving of a larger marketing budget in order to

get them on track. Just because the idea is innovative in and of itself is not enough to w arrant a larger marketing budget in my opinion.

Getting the Information to Estimate Overhead Costs Professor Orr 5/17/2013 7:59:46 AM

More good points. Let's get back to our central theme of trying to pin down overhead costs for our project and determining how they can be estimated. Where mightthe information come from?

Regards,

Susan

RE: Getting the Information to Estimate Overhead Costs Huyen Bui 5/17/2013 6:19:49 PM

I w ould say the best source for the information is from the historical data, if it's the NPD (new product development) project, the PM can refer to similar existing product for more

information.

But once again, information should be searched from several sources. Can be bottom up (base on the experience of team members on the previous project), current trend analysis etc.

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Then estimate by using average all of those factors for the most accurate budget.

RE: Getting the Information to Estimate Overhead Costs Tanika Thomas 5/17/2013 9:35:54 PM

Information can also come from previous personal experiences and knowledge. As stated tonight in class as the examplefor underwater aquarium project would have no previous data to reference but previous experience working with underwatercould be very beneficial in obtain estimation. This is too add what my previous classmates stated in regards to historicaldata, research and now personal experience and knowledge.

RE: Getting the Information to Estimate Overhead Costs Chukie Okunzua 5/17/2013 10:51:03 PM

Overhead is estimated as a percentage of labor cost. The percentage used depends on organization and the type of business it does.Historical data can help organizations establish a perentage range.The range may be stated as order of magnitude, budget or definitive..

RE: Getting the Information to Estimate Overhead Costs Herminio Dionisio 5/18/2013 12:43:39 PM

The most common mistake is allocating overhead as a percentage of job cost. The problem w ith allocating overhead per dollar of direct cost is that most overhead costs are not driven by

dollar volume. They typically are driven by several other things. The problem w ith mis-allocating overhead costs is that you end up over-estimating the cost of some jobs and under-

estimating the costs of others. Most contractors allocate their overhead improperly. One of the contributors to mis-allocated overhead costs is the burying of job related expenses in the

administrative overhead area of your income statement. The liability insurance, w orkers compensation insurance and payroll taxes and even equipment get assigned to the overhead

bucket. This practice is dangerous on several levels and should be avoided. You need to allocate the direct and indirect overhead to each project. (Excerpt from How to Allocate

Overhead to Projects by Ron Roberts from the article The Common Method is Almost Alw ays Wrong)How to Allocate Overhead to Projects - ForConstructionPros.com

www.forconstructionpros.com/.../how-to-allocate-overhead-to-projects

Overhead Project Costs and Production Costs Professor Orr 5/18/2013 1:20:11 PM

It might be useful to think in terms of overhead costs associated with the project, and costs associated with subsequent production.

Thoughts?

Regards,

Susan

RE: Overhead Project Costs and Production Costs Varune Ramoutar 5/18/2013 2:23:16 PM

Overhead costs are costs that a company incurs regardless of production or a project it is involved in. It is the costs that are required for the company

to function but cannot be directly related or charged to any specific project or product of the company. Examples of overhead costs includeadministrative cost like preparing account statements, preparing of tax statements, payroll production, human resources functions, insurance costs,

general utility costs like electricity, water and gas.

Overhead can be divided onto 2 categories direct overhead and indirect overhead.

Direct overhead are overhead costs that can be allocated in a logical manner associated to the support of a specific projects or work packages e.g. a

department may be providing clerical support for 4 projects. The clerical support can be logically assumed to be 25% support for each project.

Indirect overhead are costs that cannot be directly or logically associated e.g. tax preparation or marketing.

Ref: Ref: Nicholas, John M.; Steyn, Herman (2012-09-10). Project Management for Engineering, Business, and Technology (Kindle Location 8064).Taylor and Francis. Kindle Edition

RE: Overhead Project Costs and Production Costs Tanika Thomas 5/18/2013 8:01:18 PM

I totally agree that overhead cost should include subsequent production/expense. In reference to the community centerproject, the budget was set for construction as well as operation for a number of years. If this was not done, then thelikelihood of the building serving it's purpose would have lost all value.

The costs of a constructed facility to the owner include both the initial capital cost and the subsequent operation andmaintenance costs. Each of these major cost categories consists of a number of cost components.

The capital cost for a construction project includes the expenses related to the inital establishment of the facility:

Land acquisition, including assembly, holding and improvementPlanning and feasibility studiesArchitectural and engineering designConstruction, including materials, equipment and laborField supervision of constructionConstruction financingInsurance and taxes during construction

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Owner's general office overheadEquipment and furnishings not included in constructionInspection and testing

The operation and maintenance cost in subsequent years over the project life cycle includes the following expenses:

Land rent, if applicableOperating staffLabor and material for maintenance and repairsPeriodic renovationsInsurance and taxesFinancing costsUtilitiesOwner's other expenses http://pmbook.ce.cmu.edu/05_Cost_Estimation.html

RE: Overhead Project Costs and Production Costs Mary Hart 5/18/2013 9:00:16 PM

Modified:5/18/2013 9:00 PM

In order to determine overhead cost, the best source for this data is a firm’s accounting system. The organization´s accounting system must be capable ofseparating project-related costs (direct cost) from non-project-related costs (indirect cost). This process is referred to as cost accounting.

Direct cost consists of the salary and wages paid to staff for work performed on client projects (direct labor) along with any sub-consultants, materials andother expenses specifically incurred for a client project. If an item of expense is a direct cost, it is never part of a firm’s overhead.

Indirect cost consists of that portion of a firm’s payroll not associated with client projects such as vacation, sick, general office time, etc. (indirect labor),along with benefits, taxes, heat, light, rent and other non-project-specific expenses. These indirect costs form what is sometimes referred to as the overheadpool.

The policy of estimating overhead costs of a project may vary depending on the type of organization and subsequent production as: project based, project-led, or Core -operations-led organization.

For example: in a project based organization the overhead cost is made up of those items of a firm’s cost which are not assigned directly to a specific clientproject because they are either common to all projects (rent) or they would be far too difficult, or expensive to track and allocate back to each project.

Reference:http://www.wahby.com/articles/overhead_defined.htm

RE: Overhead Project Costs and Production Costs Bruce Foley 5/18/2013 10:28:55 PM

There w ill be overhead cost associated w ith all aspects of the build.A few of the Overhead Costs w ill include the permit needed to erect the structure that w ill house the indoor park, the

climate control system cost to now maintain the indoor facility at a constant temperature, and also the plans that must be commissioned for the w iring of the building.

RE: Overhead Project Costs and Production Costs Chukie Okunzua 5/18/2013 10:30:44 PM

We can view overhead in terms of project and production if cost is approached from the point of life cycle cost. In this case w e are not looking only at the initiation stage that the project

represent both also all the events that lead to end products. Life cycle cost is a comprehensive approach in production project management.

RE: Overhead Project Costs and Production Costs Herminio Dionisio 5/19/2013 3:06:12 PM

Overhead costs are perhaps the most common form of indirect cost and can be one of the more complex in estimating. Overhead costs include all sources of indirect materials, utilities,

taxes, insurance, property and repairs, depreciation on equipment, and health and retirement benefits for the labor force. Tracking and linking these costs to projects is not nearly as

straightforw ard as applying direct costs, and the procedures used vary by organization. Some organizations charge a f lat rate for overhead costs, relative to the direct costs of the

project. Some organization use a percentage multiplier to add administrative and overhead indirect costs to the proposal. The most common range for such indirect multiplier rates is from

20% to over 50% on top of the direct costs. Other f irms allocate indirect costs on a project by project basis, based on individual analysis. Whichever approach is preferred, it is important

to emphasize that all project cost estimates include both direct and indirect cost allocations.

RE: Overhead Project Costs and Production Costs Huyen Bui 5/19/2013 9:35:45 PM

Costs are divided into three major categories of direct materials, direct labor, and overhead. Direct materials and labor are easy to calculate because they are the core activities and

substance of w hat your business does. If you are in construction then your direct materials are steel and concrete. Direct labor is the labor used to construct w hatever it is you are

building. These costs are traceable. Overhead, on the other hand, is not so easily f igured out. Overhead consists of every other activity or material that you use to do

business. Overhead is your business’s indirect costs and is not easily managed. Figuring out indirect costs is one of the biggest challenges in cost allocation and there are tw o

methods that are used to allocate overhead in today’s business w orld.