Cost contingency
When estimating the cost for a project, product or other 2. Extraordinary events such as major strikes and nat-
item or investment, there is always uncertainty as to the ural disasters
precise content of all items in the estimate, how work will
be performed, what work conditions will be like when 3. Management reserves
the project is executed and so on. These uncertainties are 4. Escalation and currency effects
risks to the project. Some refer to these risks as “known-
unknowns” because the estimator is aware of them, and
based on past experience, can even estimate their proba- Some of the items, conditions, or events for which the
ble costs. The estimated costs of the known-unknowns is state, occurrence, and/or effect is uncertain include, but
referred to by cost estimators as cost contingency. are not limited to, planning and estimating errors and
omissions, minor price fluctuations (other than general
Contingency “refers to costs that will probably occur escalation), design developments and changes within the
based on past experience, but with some uncertainty re- scope, and variations in market and environmental con-
garding the amount. The term is not used as a catchall ditions. Contingency is generally included in most esti-
to cover ignorance. It is poor engineering and poor phi- mates, and is expected to be expended".[3]
losophy to make second-rate estimates and then try to
satisfy them by using a large contingency account. The A key phrase above is that it is "expected to be expended".
contingency allowance is designed to cover items of cost In other words, it is an item in an estimate like any other,
which are not known exactly at the time of the estimate and should be estimated and included in every estimate
but which will occur on a statistical basis.”[1] and every budget. Because management often thinks
contingency money is “fat” that is not needed if a project
The cost contingency which is included in a cost esti- team does its job well, it is a controversial topic.
mate, bid, or budget may be classified as to its gen-
eral purpose, that is what it is intended to provide for. In general, there are four
[4]
classes of methods used to esti-
For a class 1 construction cost estimate, usually needed mate contingency. .” These include the following:
for a bid estimate, the contingency may be classified as
an estimating and contracting contingency. This is in- 1. Expert judgment
tended to provide compensation for “estimating accu-
racy based on quantities assumed or measured, unantic- 2. Predetermined guidelines (with varying degrees of
ipated market conditions, scheduling delays and accel- judgment and empiricism used)
eration issues, lack of bidding competition, subcontrac- 3. Simulation analysis (primarily risk analysis judg-
tor defaults, and interfacing omissions between various ment incorporated in a simulation such as Monte-
work categories.”[2] Additional classifications of contin- Carlo)
gency may be included at various stages of a project’s life,
including design contingency, or design definition contin- 4. Parametric Modeling (empirically-based algorithm,
gency, or design growth contingency, and change order usually derived through regression analysis, with
contingency (although these may be more properly called varying degrees of judgment used).
allowances).
AACE International, the Association for the Advance- While all are valid methods, the method chosen should
ment of Cost Engineering, has defined contingency as be consistent with the first principles of risk management
“An amount added to an estimate to allow for items, con- in that the method must start with risk identification, and
ditions, or events for which the state, occurrence, or effect only then are the probable cost of those risks quantified.
is uncertain and that experience shows will likely result, In best practice, the quantification will be probabilistic in
in aggregate, in additional costs. Typically estimated us- nature (Monte-Carlo is a common method used for quan-
ing statistical analysis or judgment based on past asset or tification).
project experience. Contingency usually excludes: Typically, the method results in a distribution of possible
cost outcomes for the project, product, or other invest-
ment. From this distribution, a cost value can be selected
1. Major scope changes such as changes in end product that has the desired probability of having a cost underrun
specification, capacities, building sizes, and location or cost overrun. Usually a value is selected with equal
of the asset or project chance of over or underrunning. The difference between
1
2 3 EXTERNAL LINKS
the cost estimate without contingency, and the selected
cost from the distribution is contingency. For more infor-
mation, AACE International has catalogued many profes-
sional papers on this complex topic.[5]
Contingency is included in budgets as a control account.
As risks occur on a project, and money is needed to pay
for them, the contingency can be transferred to the appro-
priate accounts that need it. The transfer and its reason is
recorded. In risk management, risks are continually re-
assessed during the course of a project, as are the needs
for cost contingency.
1 See also
2 References
[1] Frederic C. Jelen, James H. Black, Cost and Optimiza-
tion Engineering, Third Edition, McGraw-Hill Book Com-
pany, 1983, pg 456-457
[2] Standard Estimating Practice Sixth Edition, American So-
ciety of Professional Estimators, Bni Publications, Inc,
2004, ISBN 1557014817, Pg 103
[3] “Cost Engineering Terminology”, Recommended Prac-
tice 10S-90, AACE International, WV, rev. 2007
[4] Hollmann, John K., “The Monte-Carlo Challenge: A Bet-
ter Approach”, 2007 AACE International Transactions,
AACE International, Morgantown, WV, 2007.
[5] Uppal, Kul (editor), Professional Practice Guide
(PPG)#8, “Contingency”, 2nd Edition, AACE Interna-
tional, Morgantown WV, 2007.
3 External links
• ACostE Association of Cost Engineers
• ICEAA International Cost Estimating and Analysis
Association
3
4 Text and image sources, contributors, and licenses
4.1 Text
• Cost contingency Source: http://en.wikipedia.org/wiki/Cost%20contingency?oldid=640777607 Contributors: Xezbeth, Stephenb, Kkmur-
ray, Hu12, RichardVeryard, Amgadpasha, Neparis, Pxma, Pikamander2, Jkhcanoe, Poli08, Apegna, Yobot, Gshills, Vince Lego Vinny and
Anonymous: 7
4.2 Images
4.3 Content license
• Creative Commons Attribution-Share Alike 3.0
