Cost estimation is a process of estimating (predicting) the cost of a cost object. A cost object is anything we are interested in estimating or calculating a cost for. Examples of cost objects include products, services, projects, activities, business units, product lines, customers, suppliers, and so on. Before we discuss common cost estimation methodologies and tools, we need to understand the reasons for cost estimation.

1. Why do we estimate costs in accounting?

We estimate costs to evaluate alternative courses of action. Each activity results in the trade-off between benefits and costs. Before we take action, we can estimate the anticipated benefits and costs of that action.

In business decision making, managers commonly estimate costs in:

• Profit planning
• Budgeting
• Project management
• Product research and development (R&D) and design
• Process redesign
• Bidding (defense, construction, drilling)
• Other (e.g.,litigation)

Managers need to estimate costs for many decisions which impact organizational profits. For example, managers need to estimate the cost of outsourcing production relative to manufacturing products or providing services in-house. The decision to purchase or lease an asset also involves cost estimation.

Budgeting process involves estimating revenues and costs. Managers need to estimate the cost of resources necessary to support projected operations.

Project managers use cost estimation to better manage project return on investment (ROI) and receive better quality project outcomes. Project planning includes the development of a project budget and cash flows, procurement costs, quality costs, and the cost of various resources required to complete project tasks.  Project managers use cost estimation, for example, to keep project costs within the budget.

Cost estimation is commonly used in estimating project costs in construction, defense, and energy industries. Cost estimates are used in federal contract bidding.

Cost estimation can be used for many other purposes. Cost estimates can be used to evaluate individual performance. Process redesign also requires cost estimation to see whether process reengineering is less costly than developing a new process. Litigation is another good example where cost estimation tools are often used to forecast litigation case outcomes, including associated costs.