White Paper 2014-09

How to Manage Properly Your Project Contingency

Throughout Project Execution
Setting up a contingency element as part of the project cost is nowadays a common practice in project management. It can be derived by
various methods including advanced statistical (Monte Carlo) methods. However, because it is so intrinsically linked to profit
recognition, the contingency element is not always properly managed throughout project execution, leading to unpleasant surprises for
the organization. This paper exposes good practices and some typical shortcomings that are commonly observed.
The update of the contingency needs to be done on the
basis of the same approved process, taking into account
the progress of the project:
Events which have now occurred should not have
Contingency is a unique cost element that is added to the
any uncertainty element in the contingency model,
project base cost to cater for uncertainties. It is much
more effective to cost a project based on likely costs and
Uncertainty on the other elements should be readd a single contingency element than pad every cost
evaluated,
estimate which would result in a very uncompetitive
New risks or opportunities should be introduced
costing. That is why most project organizations compute
as required based on the latest knowledge of the
a single contingency element, which then needs to be
project team.
managed throughout the project
Notwithstanding
the
process
until reaching a zero value at
chosen to determine contingency,
Release of contingency by senior
completion (where there is no
it should generally decrease as the
management should only be the
remaining uncertainty).
project progresses, because it
result of an appreciation on the
Contingency
is
key
for
addresses future risks. As the
residual risk of the project moving
management because any partial
related activities happen, the risks
forward, not on the poor estimate
release will directly influence the
materialize or not, but in any case
of past costs
projects profit recognition. It is
they
disappear
from
the
therefore of foremost important
contingency. When using the
to be prudent and follow certain rules when it comes to
Monte Carlo based method, contingency calculation is
recognizing that some of the contingency can be
done on the basis of the Estimate to Complete, and this
released.
basis naturally decreases as project progresses.

Introduction on the concept of

Contingency and its importance

How the Contingency is calculated

Contingency is a very particular cost element.
Contingency is reforecast using the relevant project risk
management process. This tricky cost element attracts a
lot of attention from management, so that the
contingency update needs to be supported by a clear and
shared risk management process.
In the project industry there are typically two approaches
to contingency evaluation
A simple approach where opportunities & risks are
listed; their impact is estimated, as well as their
probability. The contingency is then the sum of the
risk impacts weighted by their probability;
A more complicated approach using a Monte Carlo
simulation on the basis of a simplified cost model
of the project, with the uncertainties indicated for
each high level budget element, and added to the
contribution of specific discrete events.

Project Value Delivery, 2014

2014-09 rev 0b

Contingency Ownership and Release

Strategy
Contingency is normally owned not by the Project
Manager but by its management; and it plays a significant
role
in
the
provisions that are
authorized
At any time it is not
accounting-wise at
permissible to release
the company level,
contingency below the
thus
significantly
calculated contingency
influencing
the
as per the
companys financial
organizations
result by pushing
approved process.
profit recognition in
the future.
Changes to the
contingency can significantly affect both the project
result and the organizations financial result, on a short
term basis.

Discover more on:

www.ProjectValueDelivery.com

Page 2 of 2

The established practice is to recalculate project

contingency at least every quarter for long projects, and
more often on smaller projects. As mentioned above, the
calculated contingency diminishes with the project
progress. However for different reasons, senior
management might not want to release the contingency
down to the level that has been calculated by the project.
There is often an element of discretionary contingency
that remains to cover areas such as client/supplier
relationship/behaviour issues, differences in judgment,
other broader organizational/Portfolio issues, etc. The
evidence supporting the contingency needs to be
objective and verifiable, not based on managements
feel for the situation or on unsupported
representations. Anyway, this tends to increase the
prudence on the contingency element. The figure shows
this effect (in the usual case of a project where a
significant part of the cost and risk is towards the end, in
the construction phase).
Cost Control has little influence on the contingency
component as it is in the hands of senior management,
except to point out situations where the calculated
contingency is significantly lower than the contingency
retained by senior management, requiring a release.
Releases of contingency will be accompanied by
significant changes to the Estimate At Completion
project margin.

often a too strong temptation to pull money from the

contingency to compensate for additional costs. If the
organization is not careful this might lead to
uncomfortable situations where the project might be
naked, i.e. have a too low contingency to effectively be
able to cover for foreseeable risks. A typical example is
given here:
At any time it is not permissible to release contingency

below the calculated contingency as per the

organizations approved process. Should this happen by
oversight, it should be immediately highlighted by the
Project Manager. The organizations risk management
framework will have been approved by financial
auditors and should not be tampered with. This
would create significant compliance risks for
the organization.
Conclusion
Contingency management during project
execution is a key strategic issue because it
impacts directly the short term performance of
the project. Sometimes the temptation to
recognize contingency prematurely is simply
too high. Project Managers and organizations
must enforce the necessary discipline, or the
project might find itself in a difficult situation
later on. Proper processes and discipline are
essential to avoid surprises in that respect.

Common traps when it comes to

contingency release
It is not a recommended practice to release contingency
to compensate for higher costs compared to the budget.
Contingency should only be used to compensate for
exceptional events that are external and beyond the
normal control of the Project Manager. Beyond those
exceptional events, release of contingency by senior
management should only be the result of an appreciation
on the residual risk of the project moving forward, not
on the poor estimate of costs that have already been
committed or spent. Unfortunately we observe that it is

Project Value Delivery, 2014

Find all these

principles of Project
Cost Control exposed
in a comprehensive
manner in our new
Handbook,
Practical Project Cost
Control for Project
Managers
(now published, available
in Paperback and Kindle versions!)
[all links to Amazon.com]

2014-09 rev 0b