COST MANAGEMENT AND CONTROL IN PROJECTS:Variance, Depreciation

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Project Management MGMT627

LESSON 41

COST MANAGEMENT AND CONTROL IN PROJECTS

BROAD CONTENTS

Budget

Variances & Earned Value

ACWP, BCWS, BCWP

Cost & Schedule Variance

CPI, SPI

Variance Analysis (V/A)

Depreciation & Ethics

41.1

Budgets

The project budget, which is the final result of the planning cycle of the MCCS, must be reasonable,

attainable, and based on:

· Contractually Negotiated Costs And

· The Statement of Work.

The basis for the budget is:

· Historical Cost,

· Best Estimates, Or

· Industrial Engineering Standards.

The budget must identify:

· Planned Manpower Requirements,

· Contract Allocated Funds, And

· Management Reserve.

All budgets must be traceable through the budget "log," which includes:

· Distributed budget

· Management reserve

· Undistributed budget

· Contract changes

Management reserve is the dollar amount established by the project office to budget for all categories of

unforeseen problems and contingencies resulting in out-of-scope work to the performers. Management

reserve should be used for tasks or dollars, such as rate changes, and not to cover up bad planning

estimates or budget overruns. When a significant change occurs in the rate structure, the total

performance budget should be adjusted.

In addition to the "normal" performance budget and the management reserve budget, there also exists

the following: Undistributed budget, which is that budget associated with contract changes where time

constraints prevent the necessary planning to incorporate the change into the performance budget. (This

effort may be time-constrained.) Unallocated budget, which represents a logical grouping of contract

tasks that have not yet been identified and/or authorized.

41.2

Variance

Variance is defined as any schedule, technical performance, or cost deviation from a specific plan.

Variances are used by all levels of management to verify the budgeting system and the scheduling

system. The budgeting and scheduling system variance must be compared together because:

The cost variance compares deviations only from the budget and does not provide a measure of

comparison between work scheduled and work accomplished.

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The scheduling variance provides a comparison between planned and actual performance but does not

include costs.

There are two primary methods of measurement:

Measurable efforts: discrete increments of work with a definable schedule for accomplishment, whose

completion produces tangible results.

Level of effort: work that does not lend itself to subdivision into discrete scheduled increments of work,

such as project support and project control.

41.2.1

Variances are used on both types of measurement. In order to calculate variances we

must define the three basic variances for budgeting and actual costs for work scheduled and performed.

Archibald defines these variables:

Budgeted cost for work scheduled (BCWS) is the budgeted amount of cost for work scheduled to be

accomplished plus the amount or level of effort or apportioned effort scheduled to be accomplished in a

given time period.

Budget cost for work performed (BCWP) is the budgeted amount of cost for completed work, plus

budgeted for level of effort or apportioned effort activity completed within a given time period. This is

sometimes referred to as "earned value."

Actual cost for work performed (ACWP) is the amount reported as actually expended in completing

the work accomplished within a given time period.

Planned Value (PV) What Plan should be worth at this point in "Schedule". Also BCWS: Budgeted

amount of "Cost for work Schedule" to be accomplished Plus "Amount or level of effort for "Schedule"

to be Accomplished at a given time period.

Earned Value (EV) Physical work completed to date & with in authorized "Budget" for that.

The budget at completion is the sum of all budgets (BCWS) allocated to the project. This is often

synonymous with the project baseline. This is what the total effort should cost. The estimate at

completion identifies either the dollars or hours that represent a realistic appraisal of the work when

performed. It is the sum of all direct and indirect costs to date plus the estimate of all authorized work

remaining (EAC = cumulative actuals + the estimate-to-complete).

Using the above definitions, we can calculate the variance at completion (VAC):

The estimate at completion (EAC) is the best estimate of the total cost at the completion of the project.

The EAC is a periodic evaluation of the project status, usually on a monthly basis or until a significant

change has been identified. It is usually the responsibility of the performing organization to prepare the

EAC.

These costs can then be applied to any level of the work breakdown structure (i.e., program, project,

task, subtask, work package) for work that is completed, in-program, or anticipated. Using these

definitions, the following variance definitions are obtained:

Cost variance (CV) calculation:

A negative variance indicates a cost-overrun condition.

Schedule variance (SV) calculation:

A negative variance indicates a behind-schedule condition.

In the analysis of both cost and schedule, costs are used as the lowest common denominator. In other

words, the schedule variance is given as a function of cost. To alleviate this problem, the variances are

usually converted to percentages:

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The schedule variance may be represented by hours, days, weeks, or even dollars.

As an example, consider a project that is scheduled to spend $100K for each of the first four weeks of

the project. The actual expenditures at the end of week four are $325K. Therefore, BCWS = $400K and

ACWP = $325K. From these two parameters alone, there are several possible explanations as to project

status. However, if BCWP is now known, say $300K, and then the project is behind schedule and

overrunning costs.

Variances are almost always identified as critical items and are reported to all organizational levels.

Critical variances are established for each level of the organization in accordance with management

policies.

Not all companies have a uniform methodology for variance thresholds. Permitted variances may be

dependent on such factors as:

· Life-cycle phase

· Length of life-cycle phase

· Length of project

· Type of estimate

· Accuracy of estimate

Figure 41.1: Project variance projections

Figure 41.1 shows time-phased cost variances for a program requiring research and development,

qualification, and production phases. Since the risk should decrease as time goes on, the variance

boundaries are reduced. Figure 41.2 shows that the variance envelope in such a case may be dependent

on the type of estimate.

Figure 41.2: Methodology to variance

By using both cost and schedule variance, we can develop an integrated cost/schedule reporting system

that provides the basis for variance analysis by measuring cost performance in relation to work

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accomplished. This system ensures that both cost budgeting and performance scheduling are constructed

on the same database.

COST PERFORMANCE INDEX (CPI)

41.2.2

In addition to calculating the cost and schedule variances in terms of dollars or

percentages, we also want to know how efficiently the work has been accomplished. The formulas used

to calculate the performance efficiency as a percentage of BCWP are:

If CPI = 1.0, we have perfect performance. If CPI > 1.0, we have exceptional performance. If CPI < 1.0,

we have poor performance. The same analysis can be applied to the SPI.

Variance Analysis

41.2.3

The cost and schedule performance index is most often used for trend analysis as shown

in Figure 41.3. Companies use either three-month, four-month, or six-month moving averages to predict

trends. The usefulness of trend analysis is to take corrective action to alleviate unfavorable trends by

having an early warning system. Unfortunately, effective use of trend analysis may be restricted to long-

term projects because of the time needed to correct the situation.

Figure 41.3: The performance index

Figure 41.4 shows an integrated cost/schedule system. The figure identifies a performance slippage to

date. This might not be a bad situation if the costs are proportionately under-run. However, from the

upper portion of Figure 41.4, we find that costs are overrun (in comparison to budget costs), thus adding

to the severity of the situation.

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Figure 41.4: Integrated cost/schedule system

Also shown in Figure 41.4 is the management reserve. This is identified as the difference between the

contracted cost for projected performance to date and the budgeted cost. Management reserves are the

contingency funds established by the program manager to counteract unavoidable delays that can affect

the project's critical path.

For variance analysis, goal of cost account Manager To take action that will correct problem within

original budget or justify a new estimation.

Five Questions must be addressed during variance analysis:

· What is the problem causing the variance?

· What is the impact on time, cost, and performance?

· What is the impact on other efforts, if any?

· What corrective action is planned or under way?

· What are the expected results of the corrective action?

One of the key parameters used in variance analysis is the "earned value" concept, which is the same as

BCWP. Earned value is a forecasting variable used to predict whether the project will finish over or

under the budget. As an example, on June 1, the budget showed that 800 hours should have been

expended for a given task. However, only 600 hours appeared on the labor report. Therefore, the

performance is (800/600) × 100, or 133 percent, and the task is under running in performance. If the

actual hours were 1,000, the performance would be 80 percent, and an overrun would be occurring.

The difficulty in performing variance analysis is the calculation of BCWP because one must predict the

percent complete. To eliminate this problem, many companies use standard dollar expenditures for the

project, regardless of percent complete. For example, we could say that 10 percent of the costs are to be

"booked" for each 10 percent of the time interval. Another technique, and perhaps the most common, is

the 50/50 rule:

50/50 rule

Half of the budget for each element is recorded at the time that the work is scheduled to begin, and the

other half at the time that the work is scheduled to be completed. For a project with a large number of

elements, the amount of distortion from such a procedure is minimal. 50/50 rule eliminate the necessity

for the continuous determination of percent complete.

41.3

Depreciation

41.3.1

Depreciation is the technique used to compute "Estimated value" of any object after

few years. Some types are:

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1. Straight line depreciation same amount deprecated (reduced) from cost each year.

2. Double-declining balance First year - high "Deduction in value" Twice amount of straight line.

Each year after that deduction 40% less than previous year.

3. Sum of year depreciation If life - 5 years. Total of 1-5 is 15 first year deduce 5/15 from cost, in 2nd

year Deduce 4/15, & so on.

41.3.2

Parametric Modeling Estimation

This is the use of mathematical model to make estimation. Following are the two types of PME.

Regression Analysis: Mathematical model based upon historical information.

Learning Curve: Model based upon principal Cost/unit describes as more work, Gets completed.

41.3.3

Analogous Estimating

Estimation technique with characteristics Estimation based on past Project (historical information) less

accurate compared to bottom-up estimation Top-down approach Takes less time compared to bottom-up

estimation Form of an expert judgment.

41.3.4

Ethics

Ethics are standards of right & wrong that influence behavior. Right behavior is considered ethical &

wrong behavior is considered unethical. Major concern to both managers & employee.

A set of beliefs about right & wrong principles of conduct governing an individual or a group behavior

that is fair & just, over & above obedience to laws & regulations

Ethics guide people in dealings with stack holders & others, to determine appropriate actions. Project

Manager often must choose between the conflicting interests of stakeholders.

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