Defined
Cost - When is an ‘actual cost’ really Defined Cost?
Evaluation of the interim value of a
Contract on the basis of ‘actual cost’ is becoming common practice in the
construction industry. However, the proper application of ‘actual cost’ is
frequently misinterpreted with costs being mistakenly allocated increasing the
perceived ‘actual cost’.
This can be any form of 'Target Cost', or 'actual cost' Contract but it is particularly true of NEC 3/4 Contracts and Subcontracts.
This can be any form of 'Target Cost', or 'actual cost' Contract but it is particularly true of NEC 3/4 Contracts and Subcontracts.
The following refers to NEC Option C;
- The Price for Work Done to Date; the definition is typically included at cl. 11.2 (29) ( 11.2 (31) in NEC4 ) and that may have been amended.
- Defined Cost; definitions are typically included at cl. 11.2 (23) and cl. 52 ( 11.2 (24) and Cl 52 in NEC4 ) and they may have been amended
- Disallowed Cost; the definition is typically included at cl. 11.2 (25) ( 11.2 (26) in NEC 4 ) and that may have been amended.
- The Schedule of Cost Components ( and Shorter Schedule of Cost Components if relevant, NEC 3 ) ; this can often be amended or a ‘schedule of all in rates’ may be included in the Contract superseding the ‘standard’ NEC3 form.
- Contractors share percentages and share ranges ('pain/gain'); the definition is typically included at cl. 53 ( Cl 54 in NEC 4 ) and within the Contract Data, and that may have been amended.
- There may also be a provision for this at every interim assessment.
- Many established contractors operate computer based cost tracking and cost reconciliation systems. The Schedule of Cost Components has a distinct structure for Defined Cost and seldom are the two requirements compatible without considerable adjustment. It is important to be aware that the need to undertake adjustment to report Defined Cost costs may result in error, duplication and misallocation.
- This is particularly true when it comes to the costs associated with staff, forming part of the People costs under NEC3/4; Understanding which staff 'whose normal place of working is within the Working Areas' being the key issue.
- Discounts which may be received require scrutiny. Whilst localised discounts are easily defined and credited to the actual cost account of a contract corporate discounts are not necessarily project specific and need to be investigated to ensure any credits due are accounted for in the contract’s ‘actual cost’ accounts.
- ‘Journals and accruals’ entered into contract costs may be for a variety of reasons that may, or may not, fall within the definition of Defined cost.
- The PWDD is defined as 'the total Defined Cost which the Project Manager forecasts will have been paid by the Contractor before the next assessment date plus the Fee.'
- Agreement of what accruals will be allowed and the timing of entry to cost system is crucial.
- From Cl 52 and in respect of People, Equipment and Plant/Materials - Process and procedure documentation will be reviewed to map the key processes of data flow, authorisation and control, and to identify the key risk areas;
- Existence and adequacy of control and verification processes, and
- Verification of the transactional data, from time sheets/goods received notes through to the payment of invoices.
- Specific review of staff costs, and associated payroll burdens being mindful that this detail may not be apparent on available cost systems/prints and may involve ‘journals’ for the cost of staff without individual details.
- Review of Subcontracts and payments made in accordance with those Subcontracts.
- Review of any insurance claims/payments made or other credits that may have been received for the Contract.
Conclusion of these audits have resulted in the reduction of the perceived Defined Cost of between 5 and 15% of the ‘actual
cost’ claimed, effectively eliminating any previous 'fee' or 'margin' that may have
been perceived as being already earned.
The experiences
gained from audits carried out previously have proven that elements of
perceived ‘actual cost’ claimed, and often paid on an interim basis, are often
not the same as Defined Cost in the Contract. This often only becomes an issue when nearing the end of the Contract and the perceived costs is increasingly higher than the perceived value.
Whilst the
‘standard’ definitions included in the NEC3/4 Contract are reasonably well known
the first stage of any audit, before any cost data is to be reviewed, is to establish
the relevant criteria with reference to the Contract Data of the specific
Contract to be reviewed.
Only when the 'entitlement' is clear can the audit commence to review the reported costs noting ;
Schedule of Cost Components
· Any audit or review shall
concentrate on the correct application of the various elements of cost and ;
Disallowed Cost – the 'negative value' to be deducted
from Defined Cost
Disallowed Cost is often ‘overlooked’ or not dealt with
fully during the currency of the works and can often be used as a means to
reduce the overall cost when the Contract is nearing Completion and the PWDD is
close to or exceeding the revised total of the Prices.
It is well defined but early agreement on what is, and what
is not Disallowed Cost, is paramount to avoiding this situation.
If the Contractors cost reporting system does not report
directly in the format of Defined Cost in accordance with the Schedule of Cost
Components and Disallowed Cost then ‘protocols’ for the agreement of these is
essential early in a contract. If this has not been the case then agreement is
much more difficult when it becomes apparent that ‘actual cost’ paid as part of
the PWDD on an interim basis is not actually Defined Cost and allowing for
Disallowed Cost.
