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8/14/2019 Accuracy & Contingency in Estimating
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Contingency, Allowances & Escalation
in Estimating
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CONTINGENCY
Introduction three basic types of contingency
tolerance in specificationfloat in schedulemoney in budget (Thi s topic deals with thi s)
most misunderstood, misinterpreted, misapplied word in projects. Contingency means differentthings to different people
is highly subjective , inconsistently interpreted,inadequately estimated
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e n t ons "amount of money added to the estimate to allow for changes
that experience shows will likely be required "
"specific provision of money in estimate for undefined itemswhich statistical studies of historical data have shown willlikely be required"
allowances added to an estimate to represent the best judgement of undefined or uncertain items of work which it isconsidered should be provided for.... They are 'areas of space'in an estimate which help a PM to meet the project costobjectives, as they face exposure to project risk anduncertainty"
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Attributes
It is a reserve of a sum of money. It is part of the project cost estimating process
It is linked to the existence of risk - caters forevents unknown, undefined, uncertain, orunforeseeable.
It is a risk management tool - reduces impact ifrisks eventuate
Inclusion means estimate represents totalfinancial commitment :
increases probability that final cost will not exceed ourestimate
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Coverage a) Incomplete Scope Definition
Allows for incomplete scope definition.
Order-of-magnitude & budget estimates developedearly in PLC. With more scope definition, estimate
invariably increases. Contingency sum caters for increases in costs due to
present incomplete definition
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Coverage (cont.) b) Inaccuracy of Estimating Methods & Data
no method or data is perfect
Contingency is added to the estimate to cover forthese inadequacies
But Contingency should not be an excuse for poorestimating
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Coverage (cont.)
c) Identified risks Contingency may be created for identified risks. - eg.
contractor tendering, allows Contingency for: scope error interpretations, minor design changes, inaccuracy in quantification, abnormal construction problems, liabilities in the contract, unforeseen regulations, safety requirements,
equipment breakdowns, weather interruptions, labour productivity, technological change
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Coverage (cont.) d) Unidentified risks
to allow for unidentified risks: excludes unforeseeable major events (see below).
d) Items not part of contingencies Contingency should cover for scope development butnot scope changes.
Other items not considered appropriate for inclusion inContingency:
escalation, unforeseeable major events (extreme weather, earthquakes,
riots, acts of war, new government regulations, economiccollapse, .terrorist activity)
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Contingency Calculation MethodsA) Calculation by percentage add-on
C calculated as % of base estimate, based on experience& historical data. For example:incomplete scope definition in early estimates: 30% - 50%once scope fully developed: 3% - 5% inaccuracy of estimating method &/or data: 5% - 10%
Level of contingencies will depend on :organisation and the type of businesstype of estimate . (eg. order-of-magnitude estimate demands ahigh C to cover for the inherent inaccuracies of this method)PLC phase (eg estimate at concept phase = high C to allow forlimited information used to prepare an estimate)
type of project . (eg new/unproven technology High Ctype of work - eg underground work = uncertainty = High C
Variation to single % additional to base estimate is toapply different % to each major component of theestimate.
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Contingency Calculation Methods
B) Calculation by Risk Analysis contingencies by % mark-up not recommended:
dealt with in an arbitrary way (simply adding a 10%)contingency should definitely be based on an experienced reviewof uncertainties of estimate details
Allocating % insufficient unless linked to a confidence level.(i.e. level of probability that final cost will be within estimate,including C).
Nowadays, more rigorous & defendable approaches forcalculation of C typically derived from probability analysis , egCentral Limit Theorem and Monte Carlo simulation.
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Contingency Management Level of Contingency constantly monitored
& reassessed through PLC
Success of contingency management:establish procedures for proper use of Cestablish information system showing eachmanager & C under their control, C used,trends, when possible to transfer balances toother less successful areas or general reserve
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Contingency Management
2 basic ways to manage ContingencySingle account single line item account.
Disadvantages:use C first-come, first-serve basis with potentialexhaustion well before project is overcontrol likely to be responsibility of PM - but othercommitments are intense and may lead to neglect ofcontingency management.
Individual Allocations - & responsibility assignedfor their control. If expenditure exceeds C, negativevariance reported. Unexpended C can be transferredto a general contingency account.
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ALLOWANCESContingency = unforeseeable and undefined items
Allowance is for known and undefined items, foreseento be spentredefined each time an estimate is revisedallowance should only be made if "there is a better than50% chance of it happening"document the basisFollowing NOT allowances:
major scope changesweather extremes, earthquakesaccidentsacts of Godstrikes
because "these items are unpredictable, both in terms of probability and magnitude of cost impact if they do occur".
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ESCALATION
Escalation = "provision in estimated costs for continuing price level increase over time"
Often receives less attention than other smaller
items Escalation a result of two factors:
general inflation in costs, invariably upwards. specific market factors
selling price of an item is determined more by thelevel of economic activity (i.e., competition) than bythe actual costs of making the item"
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ESCALATION
Estimates may or may not allow for inflation of costs:Ignore Inflation - Estimate for feasibility - costs & revenues expected toinflate at same rate, then inflation ignoredInclude Inflation - Contractor must allow for inflation in fixed pricetender.
If significant items with volatile price patterns, seek advice
Escalation can be
1 amount for project or individual elements.
Can break down estimate into cost elements , (labour,materials), & escalation factors for each component.
Furthermore, each element broken down eg labour intovarious trades & apply escalation rates to each trade.
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ESCALATION
Two Phases2 main time periods for cost escalation
consideration:
i. From the Past
ii. Into the Future
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ESCALATION
i. From the Past Escalate historical costs to the present date of estimate. Relatively easy, typically applying cost indices
ii. Into the Future Escalation from date of estimate up to project
completion
1 simple approach: annual escalation rate x time period = total escalation rate; then total escalation rate x present estimate = total escalation costs total escalation costs + present estimate = predicted final cost.
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ESCALATIONSHORT DURATION
escalate cost estimate from base year of the estimate to, say: the date of the award of the project; or, mid-point between award & completion; or, two-thirds through project's life (allows for S-Curve profile)
LONG DURATION dissect project into annual cashflows Project estimated to cost $10M in 1991 dollars. Projected cashflows: 1993-$1m; 1994-$6m; 1995-$3m. Escalation rate of 5% pa is expected, escalated costs are:
1993 $1m x ((1.05) 2 - 1) 102,5001994 $6m x ((1.05) 3 - 1) 945,7501995 $3m x ((1.05) 4 - 1) 646,519
TOTAL ESCALATION 1,694,769
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ESCALATION
Cost IndicesIndices - use & limitations
Several cost indices exist eg. Consumer Prices Index. Limitations: Indices = averages . Unlikely to represent exact escalation of
projectIndices lack sensitivity to allow for short-term swings
report time-lag in formulation - may not be representative
Indices - example Estimate required for building a house at December 1992 : Cost of a very similar house in June 1990 was $100,000 Building Price Index: Jun 90: 102.49 Dec 92: 106.04 Estimated cost: (106.04/102.49) x $100,000 = $103,500.
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orestimating
project = uniqueness = lack of suitable precedents.
project changes due to scope changes & newknowledge
poorly defined scope = incorrect estimates.Often due to time pressure
long projects - further project extends fromoriginal estimating base, less accurate originalestimates likely to be
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PRACTICES
Do'sestimating method must fit purposeconcentrate on large-cost itemsuse a standardised approachdefine the scopeconsult other interested partieslist assumptions and exclusionsindicate the base
prepare a complete, not partial , estimate provide all relevant back-up informationallow sufficient time to prepare the estimate .
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PRACTICES
Don'ts
no arithmetic errors . Check calculations
do not work towards a preconceived number
do not accept outside estimates at face value
do not be influenced by interested parties
do not claim higher accuracy than is really available
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End of topic
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