Analysis of Indirect Cost

8/10/2019 Analysis of Indirect Cost

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Selden H. Harlow

Construction Manager

C. Thoma s McCreedy

Charles T. Main International, Inc.

Prudential Center

Boston, Massachuse tts, USA

Charles T. Main International, Inc.

Prudential Center

Boston, Massachuse tts, USA

ANALYS IS OF THE INDIRECT COSTS OF PROJECT CAPITAL

INVESTMENT COST ESTIMATES

INTRODUCTION

There is a wide variance throughout the

industry in the manner of estimating the in-

direct costs of major capital investment pro-

jects of long duration.

This paper is present-

ed to (1) identify the components of total

project cost, (2) analyze the direct costs,

(3) analyze the indirect costs, (4) identify

optional direct costs that could, instead,

be categorized as indirect, and (5) recommend

a position with regard to the indirect cost

approach.

GENERAL

This paper is the result of a study con-

ducted by Charles T. Main International, Inc.

for a Federal Agency whereby conceptual esti-

mates were prepared by Main and one other

professional firm for similar advanced energy

sys tems. The results were substantially

different, both as to the makeup of Direct

Cost and the amount of Indirect Cost, and an

analysis was undertaken as reported herein.

This paper is directed toward the pre-

paration of conceptual estimates for a project

of several years duration.

For conceptual

estimating purposes, percentages are often

used to estimate indirect costs.

As the pro-

ject proceeds,

the estimate is refined and

updated and, in many cases,

actual estimates

of cost,

rather than percent factors, are

used for the indirect accounts.

All per-

centages shown herein are percentages of

total project cost except Table No. 5

which recasts the cost into percent of

Direct Cost.

COMPONENTS OF TOTAL PROJECT COST

The two major categories of total project

cost are the direct costs and all other costs

which are identified in this paper as indirect

costs.

Table No. 1 identif ies the components

of total project cost and gives approximate

percentages allocated to each component. A

detailed analysis of each of these components

follows, but it should be noted that indirects,

as defined herein, include indirect construc-

tion cost, contingency reserves, professional

services,

owner's and other charges, escala-

tion and financing costs.

TABLE NO. 1

COM P ONENTS OF TOTA L P ROTE CT COS T

Approximate Percentage

E.5

of Total Cost

1 Direct Cat

57.0

2

Indirect Construction Cost

8.2

3

Professional Services

5.2

4

Owners and Other Charges

1.0

5

contingency Reserves

5.0

6

Escalation

10.2

7

Financing Costs

13.4

Total Project Cost

100.0

Note that, in this case,

a typical coal

fired steam electric power station, the in-

direct costs amount to 43% of the total cost.

The direct costs (57%) are calculated by ex-

perienced estimators working with drawings,

estimated quantities,

and material and labor

costs drawn from current data and past exper-

ience with similar projects.

The indirects

are then calculated by applying percent

factors to the direct cost. The higher the

percent, the greater the likelihood of error.

Therefore,

we believe it is best to maximize

the items considered in the direct cost es-

timating.

ANALYSIS OF DIRECT COST

The direct cost can be divided into

three main categories:

land, materials,

and installation, which are further broken

down into the subcategories shown in Table

No. 2.

The land costs include the purchase of

the properties required for the project and

all costs associated with the acquisition of

the land, including agent's fees, title search

and property surveys, condemnations, removals,

relocations, etc.

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1.00

1.10

1.20

.21

.22

.23

.24

.25

.26

.27

.2S

.29

1.30

.31

.32

.33

.34

.35

.36

.37

.38

TABLE NO. 2

ANALYSIS OF DIRECT C OST


of Total Cost

Direct Cost

Land and Acquisition Cost

Permanent Materials and Equipment

Ma,or Purchase Order

Field Purchase Order

Furnish and Erect Contracts

Contra&or FurnIshed Materials

Freight and Special Packaging

Technica l Service Engineers

Customs and Dutiw

spare parts

Sales Taxes

Installation cost

Manual Labor Wages

Wage Related C osts (fringe benefits)

Health and Welfare

Pension Plan

Apprenticeship

Trave l and Subsistence

.X&iOS

spec1a1 Insurance costs

Industry Promotion Funds

Payroll Taxes

FICE

State Unemployment

Federal Unemployment

Payroll Premium Costs

Casual overtime

High, Tool, Mask, etc.

Workmens Compensation Insurance

Supervision (foremanshlp)

Construction Equ ipmen t forSpecialty Work

Contractors Fees

57.0

0.7

39.2

35.4

0.6

0.4

1.5

0.2

0.1

0.2

0.8

17.1

10.4

1.5

0.9

0.3

0.7

1.5

0.8

1.0

The permanent materials and equipment

include the cost of all materials permanently

incorporated in the work from whatever source

t.hey are procured. The major purchase orders

are the engineered equipment, sys tems and

materials requiring long lead times.

These are

generally procured by the engineer or the own-

er's central purchasing department.

Certain

llong lead time items such as chimneys, cooling

towers,

elevators, field assembled tanks, and

architectural features are often procured on

a furnished and erected basis.

The erection

cost portion is carried in installation cost.

The field purchase orders are for those

materials which can be purchased with less

lead time and are normally procured by the

construction manager or contractor.

These

materials usually include civ il engineering

materials such as sand, gravel , concrete and

paving materials,

and miscellaneous piping

and electrical materials purchased to supple-

ment the major purchases.

We consider all

costs associated with the procurement of

permanent materials and equipment as part

of the direct cost.

Allowances for freight,

especial packaging,

technical serv ice engineers,

(customs and duties, spare parts, and sales

taxes are included in direct cost materials.

For international projects the costs

,allowed for freight,

special packaging and

customs and duties will var y from the stan-

dards shown in Table No. 2 and special atten-

tion must be paid to these categories.

The installation portion of direct cost

j.ncludes wage costs for all manual labor,

foremanship,

all wage related costs mandated

by labor agreement, payroll taxes, construc-

tion equipment associated with certain civi l

work items to which the costs can be directly

charged, and contractor fees.

The cost o f all manual labor is estimated

in the direct accounts. The percent used in

this example includes ancillary labor for

unloading, storing and sorting materials and

equipment, general and final cleanup, and

other miscellaneous activities charged to the

direct accounts.

Also included are all fringe benef its,

payroll taxes, payroll premium costs (casual

overtime, mask, tool, high time pay, etc.)

and workmen's compensation insurance costs

which are built into the wage rate.

Con-

tractor fees, which are frequently included

in unit price estimates which are generated

in later updates of the estimate, are also

included.

Finally, for items such as earthwork,

piling, roads,

specialties (such as chimneys

and cooling towers), contractor equipment

and other overhead costs are estimated on

a lump sum or unit price basis and charged

directly to a single account.

COMPONEmS OF INDIRECT CONSTRUCTION COST

There are many items of cost associated

with any construction project which cannot

be convenient ly charged direct ly to a single

estimating account. These items are commonly

referred to as indirect costs, or distribu-

tables, in the industry.

The indirect accounts include indirect

construction cost, contingency reserve, pro-

fessional serv ices, owner's and other charges,

escalation and financing costs. For concep-

tual estimates, these items are often expressed

as a percent of the direct cost.

When detailed

construction cost

estimates

are produced later

in the project period,

many of these items can

be calculated on a unit or fixed cost basis,

but they are still considered indirects be-

cause of their multipurpose nature.

Indirect Construction Costs include

facilities,

equipment and serv ices required

to directly support the construction opera-

tions. These items are summarized in Table

No. 3.

TABLE NO. 3

COM P ONE NTS OF INDIRECT CONS TRUCTION COS TS

2.10 Field Offic e and Labor Expenses

Office Space and Equipment

Opera ting Expenses and Supplies

Communications

Safety Equipment

Inclement Weather Gear

Gmstruction Camp Operations

On-site Transportation

.20 Non-Manual Labor Wages and Benefits

.30 Tempo rary Construction Buildings

-40 Construction Tools and Equipment

Heavy Equipment

Automotive Equipment

Maintenance Costs

Small Tools

Special Equipment Rentals


of Total Cost

1.3

0.8

0.9

2.7

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NC?,

.50

.EO

.>'O

. HO

.30

TABLE NO. 3 (Continued)


of Total Cost

Temporary Facil i ties

Utility Distribution Syst ems

Trans port, Railroad, Parking , Roads

Inclement Weather Protection

Scaffolding

Expendable Supplies

Utility Charges

Fuels; Oils

and

Lubricants

G.St?S

Chemicals

Concrete Fo rm Materials

Construction Service Contracts or Costs

Testins Laboratodes

0.4

0.5

0.3

Guard service

Toilet Rental

Trash Disposal

surveying

Premium Payments (pay for non-productive time)

0.3

Showup Time

Paid Holidays

Absence or Sick Leave

Scheduled Overtime

Labor Dlsruptio

Insurance and Bonds 1.0

All Risk Builders Risk

Public Liability and Property Dam age

Vehicle PL and PD

Bid and Performance Bond Premiums

Field o ff ice and labor expense (1.3%)

includes the cost of providing the field

off ice building and furnishing and equipping

it: with offi ce equipment. This category

also includes the field off ice operating

expense, such as janitorial service, util ity

services, stationery supplies and reproduction

costs, and communications costs.

The costs

associated with the employment of construction

labor, such as safet y equipment, inclement

weather gear, and labor administrative costs

are also included in this category of indirect

construction cost. If the project is at an

isolated site requiring a construction camp,

t'he.costs of developing and operating the camp

would be included here.

The second category of indirect construc-

tion cost in non-manual labor (0.8%) which

includes the wages and benefits for inspectors

and technicians, clerks, typist s, draftsmen,

timekeepers, messengers, and such other field

personnel that are usually locally hired. It

should be noted that construction management

personnel are not included herein, but will be

covered later under Professional Services.

The cost of temporary construction build-

ings (0.9%) is included as a component of in-

direct construction cost and includes change

buildings, warehouses,

workshops and assembly

buildings,

toilet buildings, and all trailers

and buildings used by service engineers.

The cost of construction tools and equip-

ment (2.7%) is the fourth part of indirec

construction cost and includes the cost o

procuring and maintaining heavy equipment,

automotive equipment, and special equipment

rentals as required. The source of supply

of such equipment is not considered signifi -

cant for estimating purposes arid could be

owner-furnished, or leased or furnished by

contractors working on the job.

The cost of

small tools is also included, although these

are usually furnished by the contractors

who are responsible for controlling their

use. As mentioned earlier, specia lty equip-

ment required for equipment intensive work,

such as pile driving and earth work, is

included in the direct cost section of the

estimate.

Temporary facilities (0.4%) is the fif th

component of indirect construction cost and

includes the installation of temporary util-

ity distribution systems (water, air, gases,

sanitary, electricity,

etc.),

and temporary

transport facil ities, such as roads, rail-

roads,

and parking areas. Special provisions

for inclement weather protection, including

enclosures and services (heat, lights, etc.) ,

are also estimated herein.

The sixth component of indirect construc-

tion cost is the category of expendable supplies

(0.5%) and this includes charges fo r util ity

services, fuels, oils and lubricants used

during construction. The cost of other expen-

dable supplies,

such as gases and chemicals,

are also in this category, as is the cost of

concrete form materials which can be distri-

buted to the direct accounts upon completion

of the work.

Construction service contracts or costs

(0.3%), such as testing laboratories and

surveying, security services, toilet rental,

trash disposal, are estimated as a component

of indirect construction cost whether perform-

ed by service contractors, the construction

manager, or included in installation contracts.

Premium payments for

time

not worked

(0.3%) are also estimated as an indirect con-

struction cost and include such premiums as

inclement weather, showup time, paid holidays,

paid absences and sick leave, if any, and

allowances for lost time due to labor dis-

ruptions.

In the event that an accelerated sched-

ule or severe labor shortages make it desirable

to schedule overtime, the premium pay cost,

together with a factor to cover the reduction

in productivity which usually follows, is

carried as an indirect cost. The 0.3% value

used here does not represent any allowance

for scheduled overtime as this practice is

avoided whenever possible.

The cost o f insurnnce and bonds (1.0%)

is the final component of indirect construction

cost and includes the premiums paid for all

risk, builders risk coverage, public liabil-

it y and property damage, vehicle PL and PD,

and bid and performance bonds whether procured

on a project umbrella coverage policy or con-

tractor's individual policy basis.

It should

be noted that workmen's compensation coverage

is included in the direct cost.

CONTINGENCY RESERVE (5.0%)

Contingency is an allowance for costs

which may be incurred as a result of factors

which cannot be speci fical ly anticipated and,

therefore, cannot be included in the direct

accounts.

Items such as unknown site condi-

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tions, unforeseen construction problems,

minor scope changes,

estimating errors and

omissions, engineering uncertainty and var-

iances in labor productivity are included.

In recent years it has also been necessary

to consider the effects of an uncertain and

ralpidly changing economy. Wage rates and

benefits, escalation and financing costs are

all accounted for elsewhere in the estimate,

but the uncertainty with respect to these

forecasts may also be considered as part of

the contingency reserve.

Contingency does not include Force Majeure

or major scope changes.

There are many ways to estimate contin-

gency at the conceptual level. Frequently,

a higher factor is used on that portion of the

project estimate involving the civil works,

if the site conditions are uncertain. In

addition, the factor varies with the degree

of uncertainty with respect to engineering

an.d technology.

In some advanced technology

projects, a separate factor is carried for

engineering uncertainties. In this case, we

have used 5% which amounts to 8.8% of the

direct cost.

EOFESSIONAL SERVICES (5.2%)

Professional services include the follow-

ing activities:

project management, prelimin-

ary engineering,

detail engineering and design,

construction management, procurement services,

architectural design, shop inspection and

expediting. These serv ices may be performed

by the owner,

a single professional engineering

firm,

or by a combination of professional firms,

but we recommend that all professional services

be grouped together in this manner for estima-

ting purposes.

OWNER'S AND OTHER CHARGES (1.0%)

-

Allowances must be made in the project

estimate for owner's charges that are capi-

talized as part of the project.

These own-

er's charges include such categories as

general office expense, owner's field staff,

legal fees, ad valorum taxes, and capitalized

startup costs. Other charges that are esti-

mated in this category include spare parts

and special tools for operation and main-

tenance of the completed project.

PsCALATION (10.2%)

The Cost of major projects of long dura-

tion are affec ted greatly by international

economic conditions and we recommend that

the

project estimate be prepared for the cur-

rent

Y = ~ L

and the costs be escalated to meet

the project schedule.

The other option is

to calculate the escalation individually for

each component of direct cost and include

escalation as part of the direct cost. We

recommend that escalation be carried as a

line item of indirect cost where it is vis-

ible to management.

FINANCING COSTS (13.4%)

The final item in the estimate is fi-

nancing costs which include the total cost

of all financing charges that are capital-

ized as project costs.

Included are allow-

ances for funds used during construction

(AFDC) and any fund commitment fees for

international projects. To calculate AFDC,

it is necessary to prepare a cash flow match-

ing the cost and schedule and for loans at

different interest rates, separate calcula-

tions are desirable.

For conceptual estimating purposes these

financing costs are often combined into an

interest factor which is a percentage of

the total project cost.

OPTIONAL COSTS - DIRECT OR INDIRECT

Throughout the text of this paper, we have

identified project costs and indicated our

preference for treating them as direct or

indirect costs.

In Table No. 4 the i tems which we include

in the direct cost , but which could be treated

as indirects, are listed.

TABLE NC. 4

OPTIONAL COSTS - DIRECT OR INDIRECT

Approximate Percent

y&

of Total Cost

1

Freight and special packaging cost

.2

for material and equipment

2

cost of technical service engineers

.1

from manufacturers

3

customs charges, duties and sales taxes

.8

4

Spare parts

.2

5

Payroll taxes and workmens compensation

1.6

lSranCe

6

Payroll premium costs

.3

(casual OYertlme, etc.)

7

Supervision (foremanship)

1.5

8

Ancillary labor (unloading and stora ge,

.7

housekeeping, final cleanup)

9

Construction equipment for equipment

.8

Intensive work (such as earth work

and pi11ng) and for specialty erection

contracts (such as chimneys and

c001i11g towers)

10

cc,ntractor fees

1.0

7.2

SUMMARY AND RECOMMENDATIONS

We have summarized and explained the

components of capital cost estimate for a

major project. We have also identified op-

tional costs which could be considered in-

direct rather than direct cost,

To place this in perspective for objec-

tive analysis,

we have recast the estimate

with all categories shown as a percentage

of direct cost.

This enables us to compare

the total project cost if the optional costs

are in the directs,

as we recommend against

the other extreme with all optional costs

as indirects.

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Analysis of Table 5 points out the value

of minimizing the percent added for indirect

costs

Considerable time and eff ort is ex-

pended by estimators to accurately forecast

tke Direct Cost.

If the inflated multipliers

are incorrect,

the error in the estimate is

magnified.

If direct cost estimates are

inaccurate because of error or poor defini-

tfLon

the inflated multipliers again magni fy

the rhange in the estimate. Last,

and per-

haps most important,

indirect costs are dif f-

i

Analysis of Indirect Cost

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