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?
Contingency allowances support a project’s overall risk management strategy by making an allowance for any cost changes. These pre-determined sums or percentage allowances are included in the cost estimate and held on behalf of the owner to allow for unpredictable changes in the project. Where owners provide a healthy and correctly-managed contingency, this safeguards all parties in completing the project within budget.
The contingency allowance 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.
The design contingency is usually up to 10% of the overall construction cost. Whilst calculated and identified separately, the contingency amount should be an additional sum 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 based on checks and balances where owner, architect and cost consultant work together to decide when to use the contingency.
The owner holds the budget and retains it for use by the architect and designers to ensure that all desired scope is covered.
The design contingency should not be used to accomplish the original project scope unless one of these conditions applies:
- Original budget did not address the project requirements appropriately;
- Original budget did not recognise the potential for price changes in the market from the time the budget was finalised;
- Insufficient project information available when the budget was developed;
The third issue (above) is the one most likely to lead to design contingency expenditure.
In general, the design contingency is used for:
- Resolving unforeseen issues during the design period and allowing for interfaces that may be designed later in the design process;
- Providing a balance or buffer between the scope and the budget, thus reducing the need for cost-cutting that may devalue the project;
- Enhancing the project as recommended by the design team and agreed upon by the owner during the design phase, to mitigate “scope creep”. Robust design processes and firm decision-making should also be employed to reduce scope creep.
In any construction contract, a contractor may be asked to move a wall or change an opening, due to changing project requirements. The construction contingency allows this flexibility, and the owner should view this not as a lost cost, but as a tool to complete the project within budget.
Applying a one-size-fits-all, standard amount to a project can lead to cost overruns, accusations and litigation. Instead, owners need to develop an internal process to evaluate contingency needs. The allowance should be the right size, aligned with the development cost model and should avoid duplicating risks already accounted for in the design and construction contingencies. One of the main risks for owners is programme change, so this could form 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 primarily to complete the scope or to deal with unknown conditions — not for adding scope. The architect and designers should ensure documents are as complete as possible, as the contingency is not intended to address late design decisions.
Where the project has a known timescale and programme, a likely contingency for inflation or escalation can be forecast. This is usually calculated by compounding the forecast yearly index change to the mid-point of construction.