Costs to complete

Costs to complete represent the projected expenditures required to finalize a project or contract that is currently underway. This financial estimation is a crucial component within Project Management Accounting, enabling organizations to forecast the total financial outlay of a project from its current stage to its conclusion. Accurately determining costs to complete is essential for financial planning, managing project budgets, and making informed business decisions. This metric helps stakeholders understand the remaining financial commitment and potential profitability of ongoing work.

History and Origin

The concept of estimating costs to complete has evolved with the complexity of large-scale projects and long-term contracts. As businesses began undertaking multi-year construction, manufacturing, and service agreements, the need for continuous financial oversight beyond initial budgeting became apparent. Early forms of contract accounting and cost control mechanisms laid the groundwork for modern cost-to-complete estimations. The widespread adoption of formal project management methodologies, such as those advocated by the Project Management Institute (PMI), further solidified the importance of regular cost forecasting. Project cost estimation, including costs to complete, is a fundamental aspect of these frameworks, emphasizing proactive financial management throughout a project's lifecycle. Best practices for cost estimating have been documented by government bodies, such as the U.S. Government Accountability Office, highlighting the long-standing emphasis on robust financial projections for public and private sector projects.

Key Takeaways

Costs to complete quantify the future financial outlay needed to finish an ongoing project or contract.
They are vital for accurate financial reporting, particularly for long-term projects.
Accurate costs to complete help identify potential cost overruns or savings early in a project's lifecycle.
This metric is distinct from total project cost, focusing only on remaining expenditures.
Effective estimation of costs to complete supports sound decision-making regarding project continuation or modification.

Formula and Calculation

The calculation of Costs to Complete (CTC) is typically expressed as:

CTC = EAC - AC

Where:

( CTC ) = Costs to Complete
( EAC ) = Estimate at Completion: The total projected cost of the project when finished.
( AC ) = Actual Cost: The total cost incurred on the project to date.

Alternatively, if a new estimate for the remaining work is made, the formula can be:

CTC = \text{New Estimate for Remaining Work}

The Estimate at Completion (EAC) itself can be calculated using various methods depending on the assumptions about future performance. Common formulas for EAC in earned value management include:

EAC based on Budget At Completion (BAC) and Cost Performance Index (CPI):
$EAC = \frac{BAC}{CPI}$
Where ( BAC ) is the Budget at Completion (the total planned cost for the project) and ( CPI ) is the Cost Performance Index (( EV / AC ), where ( EV ) is Earned Value). This formula assumes that future performance will continue at the same efficiency as past performance.
EAC considering both CPI and Schedule Performance Index (SPI) (less common for CTC directly, but impacts EAC):
$EAC = AC + \frac{BAC - EV}{CPI \times SPI}$
This method assumes that future cost performance will be influenced by both cost and schedule efficiency.

The selection of the appropriate EAC formula impacts the calculated costs to complete, with more sophisticated methods incorporating factors like past performance and anticipated changes.

Interpreting the Costs to Complete

Interpreting costs to complete involves assessing the financial health and future resource needs of a project. A consistently updated and realistic costs to complete figure is a cornerstone of effective cost control. If the costs to complete are significantly higher than initially projected, it indicates potential cost overruns for the overall project, which could impact the expected profit margin. Conversely, if the costs to complete are lower than anticipated, it may suggest efficiencies or initial over-estimation.

Analysts and project managers use this metric to compare against remaining available cash flow or remaining budget allocations. A favorable comparison suggests the project is on track financially, while an unfavorable one signals the need for corrective actions, such as re-evaluating scope, negotiating with suppliers, or allocating additional contingency reserves.

Hypothetical Example

Consider a construction company, BuildIt Right Inc., undertaking a $10 million commercial building project with an initial expected duration of 24 months. After 12 months, the project manager needs to assess the costs to complete.

Initial Budget (BAC): $10,000,000
Actual Cost (AC) to date: $6,000,000
Earned Value (EV) to date: The project is assessed to be 50% complete based on the value of work performed. So, ( EV = 50% \times $10,000,000 = $5,000,000 ).

First, calculate the Cost Performance Index (CPI):

CPI = \frac{EV}{AC} = \frac{\$5,000,000}{\$6,000,000} \approx 0.83

A CPI of 0.83 indicates that for every dollar spent, only $0.83 worth of work was earned. The project is over budget.

Next, calculate the Estimate at Completion (EAC) assuming future work will continue at the current CPI:

EAC = \frac{BAC}{CPI} = \frac{\$10,000,000}{0.83} \approx \$12,048,193

Finally, calculate the Costs to Complete (CTC):

CTC = EAC - AC = \$12,048,193 - \$6,000,000 = \$6,048,193

Based on current performance, BuildIt Right Inc. will need approximately $6,048,193 more to finish the project, bringing the total estimated cost to over $12 million, significantly exceeding the initial $10 million forecast. This signals a cost variance that requires immediate attention.

Practical Applications

Costs to complete are crucial in several practical financial and operational contexts:

Financial Reporting and Auditing: For long-term contracts, especially in construction or defense, accounting standards like ASC 606 (Revenue from Contracts with Customers) require companies to recognize revenue over time based on the progress towards completion. Accurately determining costs to complete is integral to applying methods such as the percentage-of-completion method for revenue recognition. PwC provides guidance on how ASC 606 impacts revenue recognition.³
Progress Billing: Companies often bill clients based on the percentage of work completed. Reliable costs to complete figures directly support these billing cycles by providing a robust basis for measuring progress.
Investment Decisions: For investors, understanding the costs to complete on a company's major projects can offer insights into its future profitability and cash flow projections. Significant unanticipated increases in costs to complete can erode investment returns.
Capital Allocation: For internal management, costs to complete help inform decisions about allocating remaining capital and resources. Projects with unexpectedly high costs to complete may require a re-evaluation of their strategic importance or even a decision to halt the project.
Risk Management: Unforeseen issues, such as supply chain disruptions, labor shortages, or design changes, can drastically increase costs to complete. Major infrastructure projects, for instance, frequently face such challenges, leading to substantial cost overruns, as seen with the California High-Speed Rail project.²

Limitations and Criticisms

While costs to complete provide valuable insight, their accuracy depends heavily on the reliability of the underlying forecasts and assumptions about future events.

Optimism Bias: Project managers and stakeholders may exhibit optimism bias, underestimating future costs or overestimating efficiencies. This human tendency can lead to consistently lower-than-actual costs to complete figures, setting unrealistic expectations. Academic research, such as that by Bent Flyvbjerg, has extensively documented the systematic underestimation of costs in large projects, often attributing it to strategic misrepresentation rather than mere error.¹
Scope Creep: Changes or additions to the project scope that are not adequately accounted for can inflate actual costs far beyond the initial costs to complete.
Unforeseen Events: Natural disasters, economic downturns, regulatory changes, or technological failures can introduce costs that were impossible to risk management to foresee or quantify, rendering previous estimates of costs to complete obsolete.
Data Quality: The accuracy of costs to complete relies on meticulous tracking of actual costs incurred and realistic assessments of work remaining. Poor data collection or estimation practices can undermine the usefulness of this metric.
Dynamic Environments: In highly dynamic environments, where requirements or technologies change frequently, providing a firm costs to complete figure can be challenging, as the 'completion' target itself may be a moving target.

Costs to Complete vs. Estimated Costs

The terms "costs to complete" and "estimated costs" are related but refer to different aspects of project finance.

Feature	Costs to Complete	Estimated Costs
Focus	Remaining expenses from the current point to finish.	Total projected cost for an entire project from start.
Timing	Calculated during the project's execution phase.	Developed during the planning phase.
Purpose	Monitor ongoing financial commitment and progress.	Secure initial funding, plan overall budget.
Changes over time	Will vary as work progresses and performance changes.	Serves as a baseline; changes indicate variances.

While "estimated costs" (often referring to the total project estimate at the outset) establish the initial financial baseline, "costs to complete" provide an ongoing, dynamic assessment of the financial resources still required. Changes in costs to complete reflect variations from the initial plan, whether due to efficiency gains, schedule variance impacts, or unforeseen challenges.

FAQs

What happens if the actual costs to complete exceed the estimate?

If actual costs to complete significantly exceed the estimate, it indicates a cost overrun for the project. This requires an investigation into the causes (e.g., scope changes, inefficiencies, unforeseen problems) and may necessitate a revised budget and potential renegotiation with clients or stakeholders.

How often should costs to complete be re-estimated?

The frequency of re-estimation depends on the project's size, complexity, and duration. For large, long-term projects, it may be done monthly or quarterly. For smaller, shorter projects, it might be done less frequently, or at key milestones. Regular updates are crucial for maintaining effective cost control and accurate financial reporting.

Can costs to complete be negative?

No, costs to complete cannot be negative. Costs to complete represent future expenditures; therefore, they will always be zero (if the project is complete) or a positive value. A negative result in calculation would indicate an error in the input values (e.g., actual cost exceeding the estimate at completion).

Is costs to complete the same as "Cost to Go"?

Yes, "Costs to Complete" and "Cost to Go" are often used interchangeably in project management to refer to the estimated expenses required to finish the remaining work on a project.