Guide to Costing

Deputy heads may support the following:

• establishing and maintaining appropriate governance and oversight structures to enable the production of credible costing information and support engagement with key stakeholders
• ensuring that costing exercises apply the GC’s costing process, that resulting costing information is credible, and that relevant costing information is disclosed for decision-making

Refer to relevant policy instruments for a complete list of deputy head responsibilities, such as subsection 4.1 of the Policy on Financial Management and subsection 4.1 of the Policy on the Planning and Management of Investments.

Chief financial officers may support the following:

• ensuring that their organization’s costing capacity is aligned with the level of complexity, risk and materiality of the initiatives
• coordinating the collection and retention of costing information and the provision of tools required to develop credible costing information
• ensuring due diligence in the application of the costing process and challenging the credibility of the costing information where necessary
• ensuring that key costing information, including the cost impact of key assumptions and the level of uncertainty and risk associated with the initiative, is disclosed by way of a chief financial officer attestation

Refer to relevant policy instruments for a complete list of chief financial officer responsibilities, such as subsection 4.2 of the Policy on Financial Management and section 3 of the Guideline on Chief Financial Officer Attestation for Cabinet Submissions.

Senior departmental managers may support the following:

• ensuring that the appropriate resources (for example, people, tools, time) are assigned to develop and deliver credible costing information in a manner that is consistent with the level of complexity, risk and materiality associated with the initiatives
• encouraging collaboration with stakeholders throughout the development of the costing exercise
• ensuring that the key costing information (for example, quality of the data, impact of key assumptions and cost drivers, level of uncertainty and risk, quality assurance and validation efforts) is disclosed to the deputy head and chief financial officer, when applicable, to support obligations for accountability and strategic decision-making

Refer to relevant policy instruments for a complete list of the responsibilities of senior departmental managers, such as subsection 4.3 of the Policy on Financial Management.

In certain circumstances these responsibilities could apply to the roles of senior designated officials, as outlined in subsection 4.1 of the Directive on the Management of Procurement.

The manager of a program or investment (that is, the director or manager) may support senior departmental managers by:

• ensuring that costing practitioners have the information needed to develop credible costing information (for example, documentation, data and evidence, ground rules)
• engaging departmental costing expertise, costing practitioners and other stakeholders early and often throughout the initiative, so that costing practitioners have sufficient time to develop credible costing information
• ensuring that the development of costing information is clearly assigned in alignment with delivering results and includes establishing a work plan and schedule
• ensuring that key costing information is documented and communicated, including the quality of the data, impact of key assumptions and cost drivers, level of uncertainty and risk, and quality assurance and validation efforts

In certain circumstances these responsibilities may apply to the role of project and programme sponsors, as outlined in subsection 4.1.12 of the Policy on the Planning and Management of Investments.

Costing practitioners may support the manager of a program or investment by:

• ensuring that the roles and responsibilities and work plan for costing exercises are outlined in a manner that supports the delivery of results
• identifying and engaging stakeholders, including subject matter experts, early and often to establish assumptions, gather data and identify risks
• applying the costing process to produce credible costing information that supports the transparent disclosure of financial risk for decision-making
• clearly and concisely documenting the steps that were taken to develop the costing information
• ensuring that key costing information and detailed costing information are communicated

Since costing practitioners operate out of many different areas and may have different roles, they are defined as any individual who performs work related to costing. For example, the manager of a program or investment may also be a costing practitioner.

Credible costing information is the result of a rigorous and repeatable process that includes the participation of a wide range of stakeholders.

Process-driven costing information ensures that:

• the purpose and deliverables of the costing exercise are well defined
• there is agreement on ground rules, assumptions and data sources
• stakeholders are engaged throughout the costing exercise
• errors are identified and corrected throughout the costing exercise
• the results of the costing exercise are clearly communicated to stakeholders

Credible costing information has a defined scope that considers all cost elements related to the decision that the costing information supports. Costing exercises should include clearly defined boundaries in terms of time and scope and all related costs, such as inflation, internal services and life-cycle costs.

Comprehensive costing information ensures that:

• the boundaries of the costing exercise can be communicated to decision-makers and stakeholders
• all relevant cost elements are included in the costing exercise

Figure 1 shows the evolution of costs over the life cycle of a project or programme.

Figure 1 - Text version

Figure 1 is a line graph. Time is indicated on the X-axis and cost is indicated on the Y-axis. The four lines on the graph represent the following phases: planning, acquisition, operations and sustainment, and disposal. The lines show when the costs for each phase occur and how they grow and decline over time.

Credible costing information is supported by evidence and uses data as the basis for costs. Actual or historical data, which can include information in an organization’s financial system of record, is the foundation of evidence-based costing.

Evidence-based costing information ensures that:

• subjectivity in a costing exercise is reduced
• the costing information has a traceable source that can be examined and assessed by stakeholders and reviewers
• data analysis can be used to improve the application of costing techniques

Credible costing information considers the cost impacts of uncertainty and risk.

Risk-assessed costing information ensures that:

• costing exercises are more reliable as the uncertainty associated with the underlying data and assumptions has been considered
• contingency amounts:
  • provide confidence that the estimate or budget is sufficient for the initiative or activity
  • are based on an uncertainty and risk assessment
• financial risk is transparently disclosed to stakeholders and decision-makers

Credible costing information is comparable to past performance, similar initiatives or activities, or recognized benchmarks. Validated costing information ensures that decision-makers and other stakeholders have confidence that the costing information is reasonable.

Credible costing information is chronicled in sufficient detail such that an independent party could reproduce the results of the costing exercise.

Documented costing information ensures that:

• reviewers can understand how the costing information was produced
• the details of the costing exercise are transparent and traceable, including costs that were not included in the costing exercise
• the costing information can support scrutiny and audits
• information (for example, assumptions, ground rules and data sources) is stored in a location that is accessible to current and future costing practitioners
• lessons learned are recorded and used to inform best practices for future exercises

These criteria for credible costing relate to various policy areas in the GC.

For example, the criteria support the development of rough order of magnitude (ROM), indicative, and substantive cost estimates for programme or project approvals and expenditure authorities, as outlined in the Directive on the Management of Projects and Programmes. Moreover, ensuring costing information is credible supports other policy objectives, such as:

• ensuring oversight and sound stewardship of public resources, as identified in the Policy on Internal Audit
• making risk disclosure assertions, as explained in the Guideline on Chief Financial Officer Attestation for Cabinet Submissions
• using costing information to identify indicators, collect data and conduct evaluations, as outlined in the Directive on Results

The purpose of the costing exercise is influenced by the decision that the costing information will support. Establishing a purpose and plan helps determine:

• which stakeholders to engage
• the cost elements to be established by the costing exercise
• the time frame covered by the costing exercise
• how to deliver the costing information

The plan for the costing exercise should include:

• reviewing lessons learned from previous costing exercises
• completing a work plan for each step of the costing process
• establishing a schedule to meet deadlines and communicate progress and delays
• specifying which stakeholders will be consulted and agreeing on how they will be engaged
• specifying and assigning responsibilities (stakeholders may need to be consulted)

The scope of activities that are included in the costing exercise should be defined in consultation with stakeholders.

A cost breakdown structure (CBS) defines the scope by breaking down an initiative or activity into cost elements that will need to be assessed. A CBS should be selected or developed at the outset of a costing exercise.

A CBS is a hierarchical structure in which overarching or “parent” cost elements are subdivided into independent “children” cost elements. The sum of the children cost elements should amount to the value of the parent cost element. In this way, a costing exercise can capture costs comprehensively and prevent double counting. The subdivision should stop at the lowest level that adds value for the purpose of comparison or data analysis.

A CBS should be consistent across similar initiatives or activities. A consistent CBS organizes the gathered data and allows comparison, even if the initiatives or activities have different sizes or complexities. In instances where an initiative or activity already has a work breakdown structure (WBS) used for project management, the CBS is usually developed in conjunction with the WBS so that the breakdown of cost elements aligns with the planned tasks.

Ground rules and assumptions establish the baseline conditions of a costing exercise. Ground rules and assumptions are necessary components of every costing exercise.

Ground rules are a prescribed set of conditions that provide guidance to the direction of a costing exercise. They often become constraints that define the boundaries and scope of the costing exercise. For example, a ground rule for a construction project may be that all materials are to be procured in Canada, which means that a costing exercise is limited to forecasting costs for domestic materials.

Assumptions are the underpinning hypotheses upon which a costing exercise is built and from which the costing requirements are drawn. Assumptions use evidence to make judgments to fill the gaps between input data and the results of the costing exercise. Assumptions are deemed to be true in the absence of facts and supported by data when possible. An example of an assumption might be that a new digital service can be delivered using existing information technology infrastructure.

Ground rules and assumptions enable the determination of costs when evidence and data may not be available for all cost elements. Ground rules and assumptions should be documented so that the basis of a costing exercise can be clearly demonstrated. Furthermore, documentation helps costing practitioners ascertain when the ground rules, assumptions and subsequent results are no longer valid, and provides a clear rationale for revisiting a costing exercise.

Evidence and data are required to determine costs. The data used in a costing exercise should be the best available. In the absence of actual or historical data, qualitative evidence from subject matter experts can be transformed into data by using robust qualitative and quantitative research techniques, as described in Further considerations.

After data is collected, it should be normalized for consistency and comparability. Normalization adjusts for differences between the historical data and the initiative or activity that is the subject of the costing exercise. Some common forms of normalization are adjustments to the value of money over time (for example, inflation) and differences in purchase location (for example, foreign exchange or regional price differences).

Data that is collected and normalized should be stored in an accessible location for future use. Contextual information associated with the data should also be saved so that the data can be interpreted correctly in the future.

This step applies costing approaches to the gathered data and evidence to determine costs.

A deterministic estimate, sometimes known as a point estimate, should be established using one of the costing approaches.

A deterministic estimate is a single value that:

• represents the total expected cost of an initiative or activity within a range of potential outcomes
• does not consider the uncertainty and risk associated with the cost elements

The uncertainty and risk associated with the cost elements should also be determined to identify the range of cost impacts and their associated likelihood.

Cost uncertainty stems from fluctuations in costs that will occur. The exact impact of cost uncertainty is unknown due to imperfect information. An example of cost uncertainty is the future foreign exchange rate for materials or services procured in foreign currency.

Cost risk is something that may or may not occur and that may increase or decrease cost. An example of cost risk is the cost impact of a potential mechanical breakdown in a manufacturing environment.

A cost uncertainty and risk analysis helps assess whether an estimate for an initiative or activity is realistic. The analysis quantifies the cost impact of the uncertainty and risk associated with the initiative or activity. The results of this analysis are more useful to decision-makers than a deterministic estimate alone because the results communicate the range of potential costs and the likelihood and impact of cost fluctuations.

Sensitivity analysis is a related tool that can be applied to show how individual cost elements or assumptions influence the overall cost.

In general, an initiative or activity has greater cost uncertainty during the early stages when there is less information available. As the initiative or activity matures, the uncertainty associated with the estimated costs decreases. For example, an initiative at the Memorandum to Cabinet stage will have many more unknowns than an initiative at the Treasury Board submission stage.

Figure 3 illustrates this concept for a project or programme using the cone of uncertainty, where over time, two distinct costing trends are noted:

1. uncertainty decreases (represented by the narrowing boundaries) as requirements become more concrete and risks either materialize or are mitigated
2. estimates change (represented by points A through E) as the level of effort to achieve objectives is better understood and some risks materialize

Figure 3 - Text version

Figure 3 is a graph. Time is indicated on the X-axis and cost is indicated on the Y-axis. There are two bands: one that represents the upper cost-estimate boundary and another that represents the lower cost-estimate boundary. Cost estimates at different phases are labelled as follows:

• A: cost estimate at conception phase
• B: cost estimate at identification phase
• C: cost estimate at definition phase
• D: cost estimate at implementation phase
• E: cost estimate at close-out phase

Over time, the space between the bands narrows. The upper and lower cost-estimate boundaries practically meet at E, the cost estimate at close-out phase.

Uncertainty and risk can be assessed qualitatively or quantitatively according to the complexity of the costing exercise and the availability of data and evidence. For complex cost estimates, quantitative statistical methods, such as Monte Carlo or methods of moments analysis, should be used to determine cost uncertainty and risk.

Cost uncertainty and risk should be considered for every costing exercise. The level of effort associated with assessing cost uncertainty and risk should be proportional to the complexity, risk, and materiality of an initiative or activity. Costing exercises should present a range of potential cost outcomes based on an uncertainty and risk analysis, as well as on a deterministic estimate, unless the range is insignificant. If the range is insignificant, the rationale for not assessing cost uncertainty and risk should be documented.

For example, in many cost accounting applications, the data and evidence used to determine costs is very reliable and provides confidence that there is little uncertainty or risk in the results.

One response to a cost uncertainty and risk assessment is contingency, which is sometimes included in a cost estimate. Contingency should be based on a cost uncertainty and risk analysis, as well as on the risk tolerance of decision-makers, which can vary by initiative or activity. As a response to cost uncertainty and risk, contingency may not reduce the residual risk completely, but it should provide confidence to decision-makers that the initiative or activity can be implemented.

Figure 4 is an S-curve that demonstrates the estimated cost range of a project or programme at a specific point in time. A point along the S-curve identifies a confidence level that describes the probability that a project or programme will finish at or below a given cost. The range of potential cost outcomes is based on the uncertainty and risk faced by the project or programme. This information can be used to inform a given risk-adjusted cost estimate and contingency and help make decisions about trade-offs.

Figure 4 - Text version

Figure 4 is a graph. Cost is indicated on the X-axis and confidence level is indicated on the Y-axis. The confidence level refers to the likelihood that the actual cost will be equal to or less than the cost estimate.

There are two points indicated on the S-curve:

• deterministic estimate
• risk-adjusted cost estimate

The space between the deterministic estimate and the risk-adjusted cost estimate along the X-axis represents the risk-adjusted contingency. The space along the X-axis after the risk-adjusted cost estimate represents the potential financial impact if the actual cost exceeds the risk-adjusted cost estimate.

The space along the Y-axis above the risk-adjusted cost estimate represents the likelihood that the actual cost will exceed the risk-adjusted cost estimate.

Assuring and validating a costing exercise provides confidence in the rigour of the application of the costing process and the quality of the results. The level of effort employed in this step should be consistent with the level of effort required for the costing exercise.

Quality assurance provides confidence that:

• the results are trustworthy in that they reflect the ground rules, assumptions and requirements of the costing exercise
• there are no calculation errors

Validation ensures that the results reflect the real world by demonstrating that the results are reasonable when compared to past performance, comparable or historical examples, independent estimates, or recognized benchmarks.

Some activities that can form part of this step are:

• checking for calculation errors and inconsistencies
• assessing whether the costing process was applied appropriately
• reviewing and challenging the assumptions used to generate the results
• comparing the data and results from similar initiatives, activities or data sources
• cross-checking the costing exercise against recognized benchmarks or authoritative sources and explaining material differences
• performing an independent estimate

For Cabinet submissions, the chief financial officer attestation, as outlined in the Guideline on Chief Financial Officer Attestation for Cabinet Submissions, forms an important part of this step.

Effective communication is crucial to the success of a costing exercise as it explains the results to audiences unfamiliar with the initiative or activity, thereby promoting informed decision-making and the transparent disclosure of financial risk. Communication tools may include briefing notes and slide decks that incorporate visuals, such as figures 1, 3, and 4 of this guide.

The costing process and results should be documented. One common form of documentation is a cost report. A cost report describes the costing process, ground rules, assumptions, data sources and results. Its audience may include future costing practitioners and those responsible for challenge functions, evaluations, and audits.

A cost report also ensures that lessons learned can be captured and retained to improve future costing exercises, as well as periodic reviews of the implementation of the costing process across an organization.

The documentation should communicate any limitations of the analysis and uncertainty or subjectivity about source data and assumptions.

The following are three types of costing approaches, which apply costing techniques to produce credible costing information.

There are two primary techniques used to determine the cost of a cost element.

Parametric technique

A parametric technique applies statistical analysis to data from similar initiatives and activities to develop a cost estimating relationship (CER) that is used to generate costing information. A CER is an equation that determines the numerical value of a given cost element using an established relationship with one or more independent cost drivers. The relationship may be mathematically simple, such as a proportion, ratio or rate, or it may involve a complex equation or method, such as a regression analysis. CERs should be applicable to the cost element and appropriate for the range of data being considered.

A parametric technique in costing relies on data from many initiatives or activities. In general, a parametric technique should be applied when there is data available from several historical initiatives, activities or cost elements that have relationships based on cost drivers. A parametric technique is often used when an initiative or activity has progressed beyond the early stages and detailed information is known about cost drivers.

The costing practitioner should document the related mathematical methods, statistics, assumptions, normalization processes and data sources used for this technique.

Figure 5 shows the cost estimating relationship between a cost driver and cost. The graph shows that the cost driver has a direct influence on cost such that an increase in the quantity of the cost driver results in an increase in cost.

Figure 5 - Text version

Figure 5 is a scatter plot graph. A cost driver is indicated on the X-axis and cost is indicated on the Y-axis.

The scatter plot is populated with dots that represent data points and a line of best fit. The line is positively and strongly correlated with the data points, which tightly surround the line of best fit in an upward fashion.

Costing practitioners often use data from other initiatives and activities and apply analogous or parametric techniques in order to determine cost. However, at times, actual data about costs or trends can be used to determine future costs for the same initiative or activity. In these cases, the analogous or parametric technique may also be known as extrapolation from actuals.

An example of extrapolation from actuals using an analogous technique is an assumption that the cost to perform an activity in the future will be the same as the cost of the activity in the past. An example of extrapolation from actuals using a parametric technique is an “estimate at completion” from earned value management.