Last edited 14 Oct 2016

Operational costs for built assets

Operational costs are cost incurred in the day-to-day operation of an organisation (sometimes referred to as revenue account expenditure).

Operational costs might include:

Wages.
Utilities.
Maintenance and repairs.
Rent.
Sales.
General and administrative expenses.

It is important to distinguish between operational costs and capital costs as there are significant accounting and taxation issues which stem directly from how a particular item of expenditure is treated. It can affect whether a particular transaction is subject to capital gains tax as opposed to income tax, as well as the possible entitlement to capital allowances, and, of course, there is the matter of how such treatment affects profitability.

Whilst operational costs are cost incurred in the day-to-day operation of an organisation, capital costs are costs associated with one-off expenditure on the acquisition, construction or enhancement of significant fixed assets including land, buildings and equipment that will be of use or benefit for more than one financial year.

Whilst it is generally relatively straight forward to identify expenditure to acquire or construct fixed assets, distinguishing between enhancements and operational costs such as repairs, maintenance, or replacement can be difficult. Very broadly, enhancements should either:

Significantly lengthen the life of the asset.
Significantly increase the value of the asset.
Significantly increase usefulness of the asset.

The capital cost of developments can include:

Land or property acquisition.
Commissions.
Statutory fees.
Consultant fees directly associated with the development.
Materials, plant and equipment.
Labour.
Fixtures and fittings.
Project insurance, inflation, taxation and financing.
Internal costs directly associated with the development.

In a commercial setting, accounting practice permits certain items of expenditure, which may appear to be operational in nature, to be capitalised. Furthermore a company's profitability can be enhanced or degraded according to how some items of expenditure are treated.

On a new development It is common practice to capitalise many items, such as consultants fees, which, on the face of it, would appear to be short term in nature. This is permitted under accountancy rules as such fees are an integral part of the development budget and so may be included in the total capital cost of a scheme. By treating such fees as an “asset” and placing their value onto the balance sheet, a company is enhancing its profitability as these fees would otherwise have to be set against the income of the company in question.

NB Capital allowances are tax deductible amounts which relate to specific categories of expenditure, most typically plant and equipment, and fixtures and fittings. By definition not all capital expenditure qualifies for capital allowances, for example, consultants fees or Land Duty Stamp Tax.

In construction, capital costs and operational costs can be considered to be associated with separate, distinct stages, with capital costs during acquisition and construction, and then a 'handover' to operational costs when the client takes possession of the completed development.

Capital costs and operational costs can be seen as competing needs, with higher capital costs often resulting in lower operational costs, as a higher quality asset may have lower maintenance and repair costs, lower utilities costs, and so on. Whilst sometimes the division between capital and operational costs can be one of necessity, based on the resources available to the client at the time, it can be a calculated decision based on assessment of whole-life costs.

Whole life costs consider all costs associated with the life of a building including:

Acquisition.
Fees
Construction.
Insurance, inflation and financing.
Fixtures, fittings and equipment.
Relocation.
Operation.
Disposal.

Whilst it is often tempting to seek savings in the early stages of a project, the relative benefit of this tends to be outweighed by the long-term impact.

This is sometimes demonstrated by the following rough assessment of the typical costs of an office building over 30 years in the ratio:

0.1 to 0.15 for design costs (ref OGC Achieving Excellence Guide 7 - Whole-Life costing).
1 for construction costs.
5 for maintenance and building operating costs during the lifetime of the building.
200 for the cost of operating the business during the lifetime of the building.

Ref. Report of the Royal Academy of Engineering on The long term costs of owning and using buildings (1998).

However, this has been criticised as misleading, not least because the construction industry accounts for around 7% of GDP, implying a much more significant proportion of business costs than the ratio suggests. Other ratios of construction costs to operational costs to business costs have suggested figures as low as 1:0.6:6 for some types of buildings. However, the usefulness of these ratios is questionable, other than if they are calculated based on actual figures for specific businesses.