Society of Cost Engineers – Definition of Terms

NOTE: These DEFINITIONS are generally accepted, but should be used as GUIDELINES only. The key to any good cost model is not to be rigidly held to these definitions, but to understand them and to apply them correctly. Ask a supplier to define each in their terms and make sure they are accounted for correctly.

NOTE: This page is continually being updated. If you have questions, comments, or suggestions as to needed definitions or disagreements with the content, please use the CONTACT US page, and we will attempt to address these.

ABC model*
A representation of resource costs during a time period that is consumed through activities and traced to products, services, and customers or to any other object that creates a demand for the activity to be performed.

ABC system*
A system that maintains financial and operating data on an organization's resources, activities, drivers, objects, and measures. ABC models are created and maintained within this system.

Activity*
Work performed by people, equipment, technologies, or facilities. Activities are usually described by the "action-verb-adjective-noun" grammar convention. Activities may occur in a linked sequence, and activity-to-activity assignments may exist.

Activity analysis*
The process of identifying and cataloging activities for detailed understanding and documentation of their characteristics. An activity analysis is accomplished by means of interviews, group sessions, questionnaires, observations, and reviews of physical records of work.

Activity-Based Budgeting (ABB)*
An approach to budgeting where a company uses an understanding of its activities and driver relationships to quantitatively estimate workload and resource requirements as part of an ongoing business plan. Budgets show the types, number of, and cost of resources that activities are expected to consume based on forecasted workloads. The budget is part of an organization's activity-based planning process and can be used in evaluating its success in setting and pursuing strategic goals. (See Activity-based planning.)

Activity-Based Costing (ABC)*
A methodology that measures the cost and performance of cost objects, activities, and resources. Cost objects consume activities, and activities consume resources. Resource costs are assigned to activities based on their use of those resources, and activity costs are reassigned to cost objects (outputs) based on the cost objects' proportional use of those activities. Activity-based costing incorporates causal relationships between cost objects and activities and between activities and resources.

Activity-Based Management (ABM)*
A discipline focusing on the management of activities within business processes as the route to continuously improve both the value received by customers and the profit earned in providing that value. ABM uses activity-based cost information and performance measurements to influence management action. (See Activity-based costing.)

Activity-Based Planning (ABP)*
Activity-based planning (ABP) is an ongoing process to determine activity and resource requirements (both financial and operational) based on the ongoing demand for products or services by specific customer needs. Resource requirements are compared to resources available, and capacity issues are identified and managed. Activity-based budgeting (ABB) is based on the outputs of activity-based planning. (See Activity-based budgeting.)

Activity dictionary*
A listing and description of activities that provides a common/standard definition of activities across the organization. An activity dictionary can include information about an activity and/or its relationships, such as activity description, business process, function source, whether value-added, inputs, outputs, supplier, customer, output measures, cost drivers, attributes, tasks, and other information as desired to describe the activity.

Activity driver*
The best single quantitative measure of the frequency and intensity of the demands placed on an activity by cost objects or other activities. It is used to assign activity costs to cost objects or to other activities.

Activity level*
A description of how elastic or sensitive an activity is to changes in the volume, diversity, or complexity of a cost object or another activity. Product-related activity levels may include unit, batch, and product levels. Customer-related activity levels may include customer, market, channel, and project levels.

Allocation*
A distribution of costs using calculations that may be unrelated to physical observations or direct or repeatable cause-and-effect relationships. Because of the arbitrary nature of allocations, costs based on cost causal assignment are viewed as more relevant for management decision-making. (Contrast with Tracing and Assignment.)

Amortization
It is the process of allocating the cost of an asset (equipment or machine) over a period of time. For example, if we purchase a machine worth 100,000 USD and decide we want to "amortize" it in 5 years, it means we need to recover 100,000 / 5 = 20,000 USD every year during the first 5 years. This amount (20,000 USD) needs to be included in the equipment hourly rate.

Assignment
A distribution of costs using causal relationships. Because cost causal relationships are viewed as more relevant for management decision-making, the assignment of costs is generally preferable to allocation techniques. (Synonymous with Tracing. Contrast with Allocation.)

Attributes
A label is used to provide additional classification or information about a resource, activity, or cost object. It is used for focusing attention and may be subjective. Examples are a characteristic, a score or grade of a product or activity, groupings of these items, and performance measures.

Batch
This is the number of parts produced between setups. Not to be confused with LOTS or MOQ.

Best practices*
A methodology that identifies the measurement or performance by which other similar items will be judged. This methodology is used to establish performance standards and to aid in identifying opportunities to increase effectiveness and efficiency. Best practices methodology may be applied with respect to resources, activities, cost objects, or processes.

Bill of activities*
A listing of activities required by a product, service, process output, or other cost object. Bill of activity attributes could include the volume and or cost of each activity in the listing.
Bill of Materials (BOM)
Bill of Process (BOP)

Bill of resources*
A listing of resources required by an activity. Resource attributes could include cost and volumes.

Capacity*
The physical facilities, personnel, and processes are available to meet the product or service needs of customers. Capacity generally refers to the maximum output or producing ability of a machine, a person, a process, a factory, a product, or a service. (See Capacity Management)

Capacity management*
The domain of cost management is grounded in the concept that capacity should be understood, defined, and measured for each level in the organization to include market segments, products, processes, activities, and resources. In each of these applications, Capacity is defined in a hierarchy of idle, non-productive, and productive views. (For further information, see the CAM-I capacity model in Capacity Measurement & Improvement in the References to this Glossary.)

Constraint*
A bottleneck, obstacle, or planned control that limits throughput or the utilization of capacity.

Cost center*
A subunit in an organization that is responsible for costs.

Cost driver*
Any situation or event that causes a change in the consumption of a resource or influences quality or cycle time. An activity may have multiple cost drivers. Cost drivers do not necessarily need to be quantified; however, they strongly influence the selection and magnitude of resource drivers and activity drivers.

Cost driver analysis*
The examination, quantification, and explanation of the effects of cost drivers. The results are often used for continuous improvement programs to reduce throughput times, improve quality, and reduce cost.

Cost element*
The lowest level component of a resource, activity, or cost object.

Cost management*
The management and control of activities and drivers to calculate accurate product and service costs, improve business processes, eliminate waste, influence cost drivers, and plan operations. The resulting information will have utility in setting and evaluating an organization's strategies.

Cost object*

Any product, service, customer, contract, project, process or other work unit for which a separate cost measurement is desired.

Cost object driver*

The best single quantitative measure of the frequency and intensity of demands placed on a cost object by other cost objects.

Cost pool*

A logical grouping of Resources or Activities aggregated to simplify the assignment of resources to activities or activities to cost objects   Elements within a group may be aggregated or dis-aggregated depending on the informational and accuracy requirements of the use of the data.  A modifier may be appended to further describe the group of costs, i.e. Activity Cost Pool.

Cross-subsidy*

The inequitable assignment of costs to cost objects, which leads to over costing or under costing them relative to the amount of activities and resources actually consumed. This may result in poor management decisions that are inconsistent with the economic goals of the organization.

Cycletime

Sometimes called “Engineered Cycle Time”, is the time it takes the machine or equipment to complete its process, measured “floor to floor” (referred to the part being produced, as if it fell to the floor when the process is completed) also Drop Time. The cycle time is therefore composed of:

• Load and Unload of the part into the machine or equipment
• Processing time of the part insider the machine or equipment. This processing time is composed of:
  • Value added time: when there is any transformation performed at the part
  • Non-Value added time: movements and waits that add cycle time but do not add value to the part

Dedicated Equipment

When the equipment will be subject to no change over at all, and will be producing the same part (or family of parts) during the lifetime of a project.

The investment incurred to procure these machines or equipment should be spread over the number of parts produced, in replacement of the equipment depreciation calculated based on a number of years. Used in the calculation of a machine rate. If a machine is fully dedicated then the total cost of the machine should be spread over the number of parts produced.

Example: You have a machine that costs $100,000. You have a 10-year program to produce 10,000 parts per year, or 100,000 parts over the life of the program. This would mean you need to spread the $100,000 over the 100,000 parts for $1.00 per part.

For this reason we have a 3 step test to verify the equipment is truly dedicated:

TEST 1: CAN this machine EVER be reconfigured or retooled to produce any other Parts? Yes = not dedicated.

TEST 2: At the end of the program, will the machine be useless? No = not dedicated

TEST 3: Is there a contractual agreement that NOTHING ELSE CAN NOW OR NEVER be run on this equipment? No = not dedicated

After the agreed depreciation is over (total number of parts produced as agreed), this amortization should be removed from the part price, or recalculated if the equipment needs to go through any refurbishment.

Keep in mind that if it is dedicted, at the end of the life, your company owns this equipment and has the right to pick it up and move to any location if the contract is written properly.

Depreciation

The accounting method of allocating the cost of a tangible or physical asset over its useful life or life expectancy. Typically, 7 to 10 but could be al short as 1 to as long as over 30 years.

Short run assembly equipment (mostly manual) 1 to 2 years

Injection Molding press / CNC Machine 7 to 10 years

Heavy Duty Stamping Press up to 30 or more years

Direct Labor

Any worker that runs a machine or operation to the part being produced

Direct cost*

A cost that can be directly traced to a cost object since a direct or repeatable cause-and-effect relationship exists.  A direct cost uses a direct assignment or cost causal relationship to transfer costs. (See also Indirect Cost, Tracing)

Electricity Consumption (for hourly rate calculation)

Average electricity consumption of the equipment in kWh/h. Note that the equipment maximum consumption noted in the equipment specifications is NOT the average consumption. In fact, the average consumption could be well below 50% of the equipment peak consumption.

Enterprise-wide ABM*

A management information system that uses activity-based information to facilitate decision making across an organization.

Equipment or Machine

Device used at any operation to add value to the component being worked.

NOTE: Inspection operations are NON-VALUE operations that add cost to the component

Gas consumption (for hourly rate calculation)

Average gas consumption of the equipment in m3/h. Normally used for furnaces, and can include Natural Gas, Endogas, Hydrogen, etc.

Hierarchy of cost assignability*

An approach to group activity costs at the level of an organization where they are incurred, or can be directly related to.  Examples are the level where individual units are identified (unit-level), where batches of units are organized or processed (batch-level), where a process is operated or supported (process-level), or where costs cannot be objectively assigned to lower level activities or processes (facility-level).  This approach is used to better understand the nature of the costs, including the level in the organization at which they are incurred, the level to which they can be initially assigned (attached) and the degree to which they are assignable to other activity and/or cost object levels, i.e. activity or cost object cost, or sustaining costs. 

Indirect Costs

These are the costs associated with the facility that do not fall into direct (Fixed or Variable), Labor (Direct or Indirect) or SG&A. The key with these costs is to make sure they are not double counted within one of the other categories.

“A resource or activity cost that cannot be directly traced to a final cost object since no direct or repeatable cause-and-effect relationship exists. An indirect cost uses an assignment or allocation to transfer cost.  (See Direct cost, Support costs)”*

Indirect Labor

Any worker that performs other jobs in the shop floor supporting several operations during his/her shift, but is not directly involved in the active conversion of the component into the final product. According to the SOCE, these Indirect Labor includes:

• Setters
• Shift Leaders
• Group Leaders
• Quality staff
• Logistics or material handling staff
• Purchasing staff
• Manufacturing Engineers staff

Indirect Markup

Indirect markup is a percentage or multiple of Manufacturing cost, either Machine Cost, Labor Cost or a combination of both. This is meant to capture and express all the indirect costs associated with the shop floor. This would include the category of Indirect Labor as well as the Indirect Cost.

Inspection

Inspection can be broken down into two separate categories In cycle and Quality Lab Sampling

• In Cycle refers to the OPERATOR (direct labor) inspection, measurements and verifications, visual or measure, that occur between parts being produced (within the next parts cycletime). In this case this is basically free as you are continuing to pay the Direct Labor for the entire cycle.
• Quality Lab inspections are periodic samples being sent to the quality lab for approval. These are usually called out on a process control plan. Although every attempt should be made to capture these within a Cost Model, they usually contribute very little to the end price as these charges get spread over the entire LOT.
• Sometimes there are “quality gates” which are inspection of the parts by a different operator, visually, or with gauges. These are by definition non-value operations, but add cost to the product (i.e. waste) and should be considered in the part cost, especially if they are requested by the customer. If decided to implement by the manufacturer, these should be minimized or eliminated and focus on built-in quality.