When estimating the cost for a project, product or other item or investment,
there is always uncertainty as to the precise content of all items in the
estimate, how work will be performed, what work conditions will be like when
the project is executed and so on. These uncertainties are 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
probable costs. The estimated costs of the known-unknowns is referred to by
cost estimators as cost contingency. Contingency "refers to costs that will
probably occur based on past experience, but with some uncertainty regarding the
amount. The term is not used as a catchall to cover ignorance. It is poor
engineering and poor philosophy to make second-rate estimates and then try to
satisfy them by using a large contingency account. The contingency
allowance is designed to cover items of cost which are not known exactly at the
time of the estimate but which will occur on a statistical basis."
The cost contingency which is included in a cost estimate, bid, or budget may
be classified as to its general purpose, that is what it is intended to provide
for. For a class 1 construction cost estimate, usually needed for a bid
estimate, the contingency may be classified as an estimating and
contracting contingency. This is intended to provide compensation for
"estimating accuracy based on quantities assumed or measured, unanticipated
market conditions, scheduling delays and acceleration issues, lack of bidding
competition, subcontractor defaults, and interfacing omissions between various
work categories." Additional classifications of contingency may be
included at various stages of a project's life, including design
contingency, or design definition contingency, or design growth
contingency, and change order contingency.
AACE International, the Association for the Advancement of Cost Engineering, has
defined contingency as "An amount added to an estimate to allow for items,
conditions, or events for which the state, occurrence, or effect is
uncertain and that experience shows will likely result, in aggregate, in
additional costs. Typically estimated using statistical analysis or judgment
based on past asset or project experience. Contingency usually
excludes: Major scope changes such as changes in
end product specification, capacities, building sizes, and location of the
asset or project Extraordinary events such as major
strikes and natural disasters Management reserves
Escalation and currency effects Some of the items, conditions, or events
for which the state, occurrence, and/or effect is uncertain include, but are not
limited to, planning and estimating errors and omissions, minor price
fluctuations, design developments and changes within the scope, and variations
in market and environmental conditions. Contingency is generally included in
most estimates, and is expected to be expended".
A key phrase above is that it is "expected to be expended". In other
words, it is an item in an estimate like any other, and should be estimated and
included in every estimate and every budget. Because management often thinks
contingency money is "fat" that is not needed if a project team does its job
well, it is a controversial topic. In general, there are four classes of
methods used to estimate contingency. ." These include the following:
Expert judgment Predetermined guidelines
Simulation analysis Parametric Modeling.
While all are valid methods, the method chosen should be consistent with the
first principles of risk management in that the method must start with risk
identification, and only then are the probable cost of those risks quantified.
In best practice, the quantification will be probabilistic in nature.
Typically, the method results in a distribution of possible cost outcomes
for the project, product, or other investment. From this distribution, a
cost value can be selected that has the desired probability of having a cost
underrun or cost overrun. Usually a value is selected with equal chance of
over or underrunning. The difference between the cost estimate without
contingency, and the selected cost from the distribution is contingency. For
more information, AACE International has catalogued many professional papers on
this complex topic. 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 appropriate accounts that need
it. The transfer and its reason is recorded. In risk management, risks are
continually reassessed during the course of a project, as are the needs for cost
contingency. See also
References ^ Frederic C. Jelen, James H. Black,
Cost and Optimization Engineering, Third Edition, McGraw-Hill Book Company, 1983,
pg 456-457 ^ Standard Estimating Practice Sixth
Edition, American Society of Professional Estimators, Bni
Publications, Inc, 2004, ISBN 1557014817, Pg 103
^ "Cost Engineering Terminology", Recommended Practice 10S-90, AACE
International, WV, rev. 2007 ^ Hollmann, John K., "The Monte-Carlo
Challenge: A Better Approach", 2007 AACE International Transactions, AACE
International, Morgantown, WV, 2007. ^ Uppal, Kul, Professional Practice
Guide#8, "Contingency", 2nd Edition, AACE International, Morgantown WV, 2007.
External links ACostE Association of Cost Engineers
ICEAA International Cost Estimating and Analysis Association