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32 Cost Engineering Vol. 43/No. 12 DECEMBER 2001

REVIEW DRAFT: The Total Cost Management (TCM) Framework

Section 8.3 Cost Estimating and Budgeting (October 17, 2001)

Bernard A. Pietlock, CCC, Co-Chair, AACE Cost Estimating Committee; Douglas W.

Leo, CCC, Co-Chair, AACE Cost Estimating Committee; John K. Hollmann, PE CCE

OBJECTIVE OF THE TOTAL COST MANAGEMENT

(TCM) FRAMEWORKThe AACE Technical Board is developing what is being called theTotal Cost Management (TCM) Framework. The Framework willbe a process map and associated text that provides an overview ofthe scope of all the various sub-processes or functionsof cost engineering and illustrates how all these sub-processes arerelated to each other using process management conventions.

The Framework introductory sections are in final revision process(re: Cost Engineering, March 2001).

PREFACE TO SECTION 8.3 COST ESTIMATINGAND BUDGET ING:The Framework will lay out the various practices that cost engi-

neers use or interface with in a process map format. Section 8.3 ofthe Framework provides the process map for cost estimating andbudgeting. This section has already undergone a formal "peer"review with the lead effort being provided by the Cost EstimatingCommittee chaired by Bernard A. Pietlock, CCC and Douglas W.Leo, CCC.

At this time, we are soliciting comments from AACE members onthe TCM Framework, section 8.3 "Cost Estimating andBudgeting". Comments must be submitted using the enclosedcomment form, and must be accompanied by a signed releaseform (both found elsewhere in this issue). Please make your com-ments as specific as possible. The review material is also availablein the "technical" section of AACE's Web site at www.aacei.org. Allcomments must be received by February 15, 2002. At the end ofthe comment period, the Technical Board will address each com-ment and revise this section as appropriate.

8.3 Cost Estimating and Budgeting

8.3.1 DescriptionCost estimating is the predictive process used to quantify, cost, and price1

the resources required by the scope of an investment option, activity, or

project. Budgeting is a sub-process within estimating used for allocatingthe estimated cost of resources into cost accounts (i.e., the budget)against which cost performance will be measured and assessed. The budg-et is the baseline for the cost control process (see Sections 3.2 and 7.2).

Cost estimating is a process used to predict uncertain actual costs. In thatregard, a goal of cost estimating is to minimize the uncertainty of the esti-mate given the level and quality of scope definition. The outcome of costestimating normally includes both an expected cost and a probabilisticcost distribution. As a predictive process, historical reference cost data(where applicable) can improve the reliability of cost estimating. Cost esti-mating, by providing the basis for budgets, also shares a goal with costcontrol of maximizing the certainty of the actual cost outcome.

The cost estimating process is generally applied during each phase of theasset or project life cycle as the asset or project scope is defined, modi-fied, and refined. As the level of scope definition increases, the estimat-ing methods used become more definitive and produce estimates with

increasingly narrow probabilistic cost distributions. The specific estimatingtools and techniques used vary widely depending upon the life cyclephase, the type of asset or project, and the level of definition of scopeinformation available. The analysis, development, and maintenance of esti-mating tools and techniques are steps that are considered part of the esti-mating process.

The cost estimating process is typically performed concurrent to or itera-tively with the asset and project planning and evaluation processesdescribed in Chapters 4 and 8. Concurrent approaches are used becausethe breakdown of scope into controllable items and activities and the sub-sequent quantification of resource requirements are planning tasks forwhich cost estimating skills and knowledge add value. Because costs areoften dependent on time duration, the estimation of the time duration ofactivities (see scheduling in Section 8.2) is best considered concurrentlywith costs. Iterative approaches are used because outcomes of a cost

estimate often lead to changes in scope or plans.

While some steps of the cost estimating process are mechanistic andconducive to semi-automation (e.g., determinations of quantities by com-puter-aided design tools, and so on), estimating is a predictive process fowhich judgment and experience add value. Effective cost estimatingrequires an understanding of the work being planned. In some industriessuch as engineering and construction, cost estimating is a recognized dis

cipline because of the specialized knowledge required. In all industries,many individuals contribute to the performance of the estimating process

8.3.2 Process Map for Cost Estimating and BudgetingAt its core, cost estimating involves the application of techniques (i.e., cost-ing) that convert quantified technical and programmatic information (i.e.inputs) about an asset or project into finance and resource information (i.e.,outputs). The outputs of estimating are used primarily as inputs for busi-ness planning, cost analysis and decisions or for project cost and schedulecontrol processes. The process is supported by tools and data that are cre-ated and maintained to support the various types of estimates that needto be prepared during the life cycle of the asset or project. Figure 8.3.1illustrates the process map for cost estimating and budgeting. Sections8.3.3 and 8.3.4 describe the inputs and outputs in more detail.

8.3.3 Inputs to Cost Estimating and Budgeting.1 Scope Definition. The investment option (see Section 4.1) or projectscope (see Section 8.1) is defined with enough supporting information tosupport the classification of estimate to be prepared (see Section 8.3.5.1)

.2 Technical Deliverables. The scope definition is supplemented with documents, databases, and other detailed technical information to supportquantification of the scope. These deliverables are the output of workdefining processes (e.g., engineering, design, and so on) that are outsideof the TCM process.

.3 Work Breakdown Structure. The work breakdown structure (seeSection 8.1) provides the overall organization of project work to be esti-mated.

.4 Chart or Code of Accounts. Coding structures that support the cost

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Cost Engineering Vol. 43/No. 12 DECEMBER 2001 33

1Refer to section 8.3.5 for descriptions of these and other tools and techniques for estimating and budgeting.

accounting process (see Sections 6.1 and 10.1) are provided. Each stake-holder with cost accounting and cost control responsibilities may havetheir own chart of accounts; coordination may require that stakeholdersmap their accounts with each other so that cost information can beexchanged. Budgeting allocates estimated costs to the proper costaccounts. There may also be a separate chart or code of accounts for cat-aloguing information in a cost estimating database; this chart may differfrom that used for cost budgeting and accounting.

.5 Historical Cost Information. The development and maintenance of costestimating tools and data are often, but not always, based on feedback ofactual asset (see Section 3.2) and project (see Section 7.2) cost perform-ance information.

.6 Estimate Information. Information from previous estimates for this assetor project (or from other assets or projects as applicable) supports thedevelopment and maintenance of cost estimating tools and databases.

8.3.4 Outputs from Cost Estimating and Budgeting.1 Cost Control Baseline. A tabulation of costs in accounts that are opti-mized for cost accounting and cost control purposes. For some controlmethods, the costs are time-phased by account or group of accounts. Ascost performance measures are made, they are assessed against the costbaseline (see Sections 3.2 and 7.2).

.2 Resource Requirements. Quantities of resources such as labor, materi-al, and equipment are outputs of the estimating quantification processand costing algorithms. The resource requirements are used as a basis forresource planning (see Section 8.4) and procurement (see Section 8.7).

.3 Cost Information for Analyses. Investment Decision Making (seeSection 4.2), Value Engineering (see Section 8.5), Risk Analysis (seeSection 8.6), and Procurement Planning (see Section 8.7) all require costinformation from the estimating process as their input. Risk Analysis istypically performed concurrently with estimating. Risk analysis yields con-tingency costs used in estimating.

.4 Estimate Basis. Because cost estimates are approximations based invarying degree upon assumptions and interpretations of scope and plans,stakeholders are prone to misunderstanding what a cost estimate repre-sents. Communicating the basis of an estimate reduces misunderstand-ings, error and misuse. The estimate basis is also used in change man-agement (see Section 7.2) to understand scope content of changes. Theestimate basis generally includes a description of the scope, methodolo-gies, references and defining deliverables used, assumptions and exclu-

sions made, and some indication of the level of risk and uncertainty.

.5 Refined Scope Development. Results and learnings from the estimat-ing process often lead to modifications and refinements in the scopedescription, implementation plans, and WBS (see Sections 4.1 and 8.1.)

.6 Refined Plan and Schedule. Results and learnings from the estimatingprocess often lead to modifications in asset or project work plans andschedules (see Sections 4.2 and 8.2.). The estimate and schedule are gen-erally developed concurrently or iteratively.

.7 Estimate Information. Information from the estimate supports thedevelopment and maintenance of cost estimating tools and databases.

8.3.5 Tools, Techniques, and Sub-Processes for CostEstimating and BudgetingAt the core of the estimating process is the costing step and that stepalways involves the use on an estimating algorithm or formula. The algo-rithm transforms project technical and programmatic descriptive information into cost and resource terms. These estimating algorithms are oftenreferred to as cost estimating relationships (CERs). In its simplest form, aCER will appear as:

Cost Resource = Factor x Parameter

where: Cost Resource = $ (labor, material, total etc.), or time

(labor hours, equipment rental hours, etc.)Factor = a unit cost factor in terms of costresource/parameter unit

Parameter = quantification of a scope item

In mathematical terms, the CERs are either stochastic in nature (based onconjectural cost relationships and statistical analysis), deterministic (basedon conclusive, definitive cost relationships), or some combination of theseThe stochastic approaches are often called parametric estimating andanalysisand the deterministic approaches are often called definitive, detaiunit cost, or line-item estimating. Parametric algorithms can be highly com-plex. As successive estimates are prepared over the course of a projectslife cycle, the estimating techniques tend to go from stochastic (e.g., order-

Two-way arrows represent concurrent/iterative with other processes

Quantification ofScope Content

(take-off)Costing

Develop and MaintainCost Estimating Data

Develop andMaintain Cost

Estimating Toolsand Techniques

Pricing andBidding

Budgeting

Cash FlowAnalysis

Estimate Review

Figure 8.3.1 Process Map for Cost Estimating and Budgeting

ScopeDefinition

and WBS (4.1 & 8.1)

TechnicalDeliverables

ScheduleDurations

(8.2)

ResourceQuantities

(8.4)

BusinessRequirements& Objectives

(3.1 & 7.1)

Chart ofAccounts

(6.1 & 10.1

HistoricalCost Information

(3.2 & 7.2)

Cost ControlBaseline

(3.2 & 7.2)

EstimateBasis

(3.2 &7.2)

Simulation andOptimization

HistoricalCost Information

(3.2 & 7.2)

Chart ofAccounts

(6.1 & 10.1)

Estimate Information

Schedule(8.2)

Cost Informationfor Analysis

(4.2, 8.5, 8.6, 8.7)

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of-magnitude, conceptual, etc.) to deterministic (e.g., detailed, definitive,etc.) with increasingly narrow probabilistic cost distributions.

Basic estimating algorithms are often adjusted by the application of fac-tors or indice ratios to make the result match the current estimate situa-tion. Factors, as drawn from project history or a standard database,almost always reflect conditions from past experience that do not matchthose in the current estimate situation. The conditions that may vary fromthe database basis include time differences, escalation and inflation,exchange rates, labor rates, labor productivity, material mark-ups, locationfactors, environmental impacts, and taxes, duties, and fees. Parametersor quantity measures used reflect idealized models that do not preciselymatch actual technical or programmatic conditions. The conditions that

may vary from the measurement basis include waste and spoilageallowance, accuracy of measurement (take-off) allowance, and specifica-tion, function, or content differences.

The tools and techniques and sub-processes (including costing) of costestimating and budgeting include:

.1 Classification of Cost Estimates. Given the goals of reducing uncer-tainty in the estimating process and improving communication of esti-mate results, it is desirable to establish standard estimate classificationsfor the enterprise. The classification system will define the specific inputinformation needed to produce a desired estimating outcome quality ateach phase of the asset or project life cycle. Classification schemes helpdefine the requirements for scope definition and they will indicate esti-mating methodologies appropriate to that scope definition (RecommendPractices 17R97and 18R97provide classification methods recommendedby AACE International).

.2 Cost Estimating Algorithm Development. Stochastic estimatingmethodologies often require that custom algorithms be developed andmaintained to support the estimating process. These algorithms are com-monly based upon statistical analyses or modeling of historical or othercost information. The algorithms are needed to convert scope quantifica-tion input to appropriate cost output.

.3 Cost Estimating Database Development. All estimating algorithms aredependent upon having data such as labor and material unit rates, indiciesand factors, equipment costs, and other resource rate and other cost fac-tor information. The type of data that is used in the algorithm to convertscope quantification input to cost output is specific to the algorithm andestimating methodology used. The data may be obtained from publishedsources or it may be developed in-house. Published sources must be ana-lyzed to determine adjustments needed to make the data applicable tothe enterprises situation. The quality of databases is a key determinate ofestimate output quality.

.4 Quantification. The scope definition of an investment or a project is gen-erally described in various planning and technical documents, databases,or other deliverables. To cost and price the scope, information in the scopedocuments must first be quantified in terms or formats required by theestimating algorithms. For example, an algorithm that estimates the costof developing software programs may require the number of lines of soft-ware code as an input. Likewise, a construction estimating algorithm mayrequire the linear meters of pipe as an input. The output of quantification isreferred to as a take-offwhen the quantities are measured from a drawing.

.5 Costing - Estimating Algorithms. Costing includes the core technique ofestimating which is the translation of quantified technical and program-matic scope planning information into expressions of the resource andfinancial investment or expenditure required to effect the plan. The trans-lation is done with a mathematical algorithm. Costing does not in itselfconsider business concerns of how work is to be charged, billed, markedup, or otherwise accounted for by various stakeholders (see pricingandbudgeting). Life Cycle Costingis costing applied to the entire life cycle of

the asset including creation or modification, operation or use, and decom-missioning or retirement to support investment option development anddecision making.

.6 Simulation and Optimization. The factors and parameters in an estimat-ing algorithm may have a range of possible values that could occur, or thatcould be selected from within the scope. For estimating, simulation refersto methods used to apply alternate factor and parameter combinations inthe estimating algorithm - these methods result in a distribution of possi-ble outcomes. Optimization refers to simulation methods that have a goalof finding an optimum output. These techniques are valuable for valueengineering (see Section 8.5) to optimize scope decisions in terms ofcost. They are also used for evaluating cost risk (see in Section 8.6).

.7 Pricing and Bidding. Pricing includes charging techniques that variousstakeholders in the plan (bidders, contractors, etc.), apply to costings toallow for overhead and profit, to improve cash flow, or to otherwise address

market conditions and serve their business interests. Because a budgetmay include cost information obtained from outside parties (e.g., bidders),it is important to understand the nature of cost obtained from pricedsources. For example, contractors often unbalancean estimate or bid byallocating costs to those items for which payment will be obtained early ina project. Activity based costingcalls for minimizing arbitrary or unbalancedallocations so that optimum cost decisions or control may be obtained.

.8 Budgeting. Budgeting includes the sub-process for allocating the esti-mated cost of asset or project items into cost accounts against whichcost performance will be measured and assessed. Budgeting results in abaseline for cost control performance assessment (see section 7.2). Thecost accounts used from the chart of accountsmust also support the cost

accounting process (see Sections 6.1 and 10.1). Budgets are often time-phased in accordance with the schedule or to address budget and cashflow constraints.

.9 Cash Flow Analysis. To serve as a basis for earned value and othermethods of cost control (see Sections 3.2 and 7.2), the budget is time-phased to determine expected rates of cost expenditure for each accounor group of accounts. As rates of investment are often constrained by theenterprise for financial reasons, the estimate and schedule are usuallydeveloped concurrently. The rate of investment may alternatively examinethe rates of cost commitment (i.e., obligation made to expend) or actuacash disbursement.

.10 Estimate, Budget, or Bid Review. Estimates are typically complexcompilations of input from multiple stakeholders. To assure the quality ofan estimate (or budget or bid), a review process is called for. The reviewseeks to assure that the estimate reflects the asset or project goals andscope, is suitable for cost accounting and control purposes, serves the

stakeholders financial requirements, and that all parties agree on andunderstand its content and probabilistic nature. Prior to the review, theestimate basisis documented to support the review and, after the reviewit is updated as needed to support subsequent change managementprocesses. The estimate should be benchmarkedagainst or compared tohistorical experience and/or past estimates of the enterprise and of com-petitive or comparable enterprises to assess its appropriateness, com-petitiveness, and to identify improvement opportunities.

8.3.6 Key Concepts for Cost Estimating and BudgetingThe following concepts and terminology described in this and other chapters and sections are particularly important to understanding the cost esti-mating and budgeting process of total cost management:

.1 Activity Based Costing (ABC). (see Section 4.2.) Cost management andcontrol is improved when all costs are attributed or budgeted to the item

or activity causing or driving the expenditure rather than through arbitraryor non-causal allocations.

.2 Algorithm and Cost Estimating Relationship (CER). (see Section 8.3.5)

.3 Budgeting. (see Section 8.3.5.8)

.4 Chart or Code of Accounts. (See Section 8.3.3.4)

.5 Contingency. (see Section 8.6.) Every project cost estimate shouldinclude distinguishable contingency costs somewhere in the estimateContingency is an amount added to an estimate to allow for unknownitems, conditions, or events that experience shows will likely occur.

.6 Cost Accounting. (see Sections 6.1 and 10.1). Accounting provides themeasure of commitments and actual expenditures. The process, toolsand systems an enterprise uses to handle cost performance measure-ment information will often drive the chart or code of accountsand con-strain how cost may be estimated and budgeted. Accounting also serves

financial reporting purposes in addition to cost control purposes..7 Cost Control Baseline. (see Section 8.3.4.1)

.8 Costing and Life Cycle Costing. (see Section 8.3.5.5)

.9 Estimate Basis. (see Section 8.3.4.4)

.10 Pricing. (see Section 8.3.5.7)

.11 Scope. (see Sections 4.1 and 8.1). The estimate and budget mustreflect the scope of the asset or project.

.12 Quantification and Take-off. (see Section 8.3.5.4)

.13 Uncertainty. A cost estimate or budget is always an approximationTherefore, understanding the probabilistic characteristics of the estimateis essential. Measures of uncertainty (range, confidence intervals, and soon) are often key determinates of estimate quality.