We are often asked by our clients why we need to carry contingencies on our projects and what they are for.
In the current market, funding is tight and clients are under pressure to keep funding, and therefore financing costs, as low as possible. So, what are contingency allowances?
Introduction
Contingencies are pre-determined amounts or percentage allowances included in the cost estimate, held on behalf of the Employer to allow for any unpredictable changes in the project that affect the cost. The contingency supports the overall risk management strategy for the project by making an allowance for any cost changes.
Owners or developers of construction projects should strive to provide a healthy contingency to address risk in the project. If managed correctly it will safeguard all parties in completing the project within an allowed budget.
A contingency allowance can be described as the amount, or percentage of cost, included in the project budget to cover any unpredictable changes in the work or items of the work. It serves three main purposes:
- To account for errors and omissions in the construction documents;
- To modify or change the scope or quality of the project;
- To pay for unknown conditions.
Design Contingency
The design contingency is usually in a range up to 10% of the overall construction cost. Whilst calculated and identified separately, the amount should be an additional amount held by the Owner in the project budget. The Owner holds the budget and retains it for use by the Architect and designers to ensure that all desired scope is covered.
As the project evolves, the contingency is drawn upon by the owner and transferred to the project. This should be on the basis of checks and balances where both Owner, Architect and Cost Consultant work together to decide when to use the contingency.
The design contingency should not be used to accomplish the original scope of the project unless it is clear to all concerned that the original budget:
- Did not address the project requirements appropriately;
- Did not recognise the potential for price changes in the market place from the time the budget was finalised.
- There was insufficient information available about the project at the time the budget was developed.
The last issue is the one that usually leads to expenditure from the design contingency. In general, the design contingency is used for:
- To resolve unforeseen issues during the design period and allow for interfaces hat may be designed later in the design process;
- To provide a balance or buffer between the scope and the budget, thus reducing the need for “cost cutting” that may devalue the project.
- To enhance the project as recommended by the design team and agreed upon the owner during the design phase to mitigate “scope creep”, though robust design processes and firm decision making should also be employed to reduce the scope creep.
Construction Contingency
In any construction contract, it is not unusual for a contractor to be required to move a wall or change an opening, due to changing requirements within the project. The construction contingency allows for this flexibility, but the Owner should not see this as a lost cost but as a tool to complete the project within the budget.
The use of a contingency for the construction phase varies with the type of delivery method.
Owner’s Contingency
In this case applying a one-size-fits-all, standard amount to a project can lead to cost overruns, accusations and litigation. It is highly recommended that owners develop an internal process to evaluate contingency needs. It is important to adequately establish and allowance of the right size, in harmony with the development cost model and not duplicating risks that are already considered in the design and construction contingencies. One of the main risks for the owner is changes to the programme and could be the main part of the Owner’s contingency.
Once the owner determines the contingencies, the next step is to manage them appropriately. All three parties - Owner, designer and contractor - may view the contingency differently, causing management concerns.
Contingency funds are to be used, firstly, to complete the scope or deal with unknown conditions. As discussed above, the contingency should not be used for adding scope. Designers should make sure the documents are as complete as possible and understand that the contingency is not a method for addressing late design decisions.
Inflation Contingency
Where a particular project has a known timescale and programme, it is possible to forecast a likely contingency for inflation or escalation. This is usually calculated by compounding the forecast yearly index change to the mid-point of construction. Levels of Contingency in the Estimate Development.