price changes, final accounts & project close out procedure presenter vincent juma wesonga...

Price changes, Final accounts & Project close out procedure

Presenter Vincent Juma WesongaB50/71958/2008

Definition of price in the context of a contract

A contract price is the price listed in the contract for the good or services to be received in return.

In contract law, the contract price is a material term. The contract price as the price for the good or services to be received in the contract determines whether a contract may exist. If the contract price is not included, then upon litigation the court may hold that a contract did not exist.

In litigation, the contract price is a factor for determining damages upon a party forsaking its contractual obligations. The contract price as a point of reference may help determine the expectancy interest of the party suffering damages as well as the reliance interest along with damages under promissory estoppel .

Methods of dealing with price changes in various contract arrangements (Fixed Price Contract, fluctuating contract); merits and demerits

Lump Sum; Typically used with Design-Bid-Build method of project procurement.

A lump sum contract, sometimes called stipulated sum, is the most basic form of agreement between a supplier of services and a customer. The supplier agrees to provide specified services for a specific price. The receiver agrees to pay the price upon completion of the work or according to a negotiated payment schedule. In developing a lump sum bid, the builder will estimate the costs of labor and materials and add to it a standard amount for overhead and the desired amount of profit.

Lump Sum

The Stipulated Sum contract may contain a section that stipulates certain unit price items. Unit Price is often used for those items that have indefinite quantities, such as pier depth. A fixed price is established for each unit of work.

Lump Sum

Requirements: Good project definition. Stable project conditions. Effective competition essential when bidding. Much longer time to bid and award this type of

project, Minimum scope changes due to higher mark-

ups than occurred at bidding.

Lump Sum

Advantages: Low financial risk to Owner. High financial risk to Contractor. Know cost at outset. Minimum Owner supervision related to quality

and schedule. Contractor should assign best personnel due to

maximum financial motivation to achieve early completion and superior performance.

Contractor selection is relatively easy.

Lump Sum

Disadvantages: Changes difficult and costly. Early project start not possible due to need to

complete design prior to bidding. Contractor free to choose lowest cost means, methods,

and materials consistent with the specifications. Only minimum specifications will be provided.

Hard to build relationship. Each project is unique. Bidding expensive and lengthy. Contractor may include high contingency within each

Schedule of Value item.

Unit Price

Unit Price In a unit price contract, the work to be performed is

broken into various parts, usually by construction trade, and a fixed price is established for each unit of work. For example, painting is typically done on a square metre basis. Unit price contracts are seldom used for an entire major construction project, but they are frequently used for agreements with sub-contractors. They are used for maintenance and repair work. In a unit price contract, like a lump sum contract, the contractor is paid the agreed upon price, regardless of the actual cost to do the work

Unit Price

Requires: Adequate breakdown and definition of work units Good quantity surveying and reporting system Sufficient design definition to estimate quantities of units Experience in developing bills of quantities Payment terms properly tied to measured work completion Owner-furnished drawings and materials must arrive on

time Quantity sensitive analysis of unit prices to evaluate total

bid price for potential quantity variations

Unit Price

Time and Cost Risk are Shared: Owner at risk for total quantities Contractor at risk for fixed unit price Large quantity changes (>15-25%) can lead

to increase or decrease in unit prices.

Unit Price

Advantages: Complete design definition not required “Typical” drawings can be used for bidding Suitable for competitive bidding Easy for contractor selection Early project start possible Flexibility: Scope and quantities easily

adjustable

Unit Price

Disadvantages: Final cost not known at outset since bills of

quantities at bit time are only estimates Additional site staff needed to measure,

control, and report on units completed Unit price contracts tend to draw unbalanced

bidding

Construction Management

In this delivery method a Construction Manager (CM) is selected to construct

the project based on fully completed drawings and specifications prepared by an architect . The CM provides advice during design. The CM approach differs from the other methods in the following ways:

The project manager approves the CM’s construction management staff and their required time on the project.

The CM provides pre-construction services, including construction cost estimating and constructability review, throughout programming and design.

The project manager approves the subcontractor bidders list and the selected subcontractors.

All of the costs of the CM and subcontractors are “open book” to the project manager and subject to the project manager’s approval. There is no profit mark-up by the CM on the subcontracts.

Construction Management

Types of CM construction contracts commonly used: Cost-Plus-Fee: In a cost-plus-fee contract the owner pays the

CM the actual cost of the construction (based on competitive bids for each trade subcontract) plus certain reimbursable expenses without any profit mark-up, and is charged a fixed fee by the CM for the services provided.

Guaranteed Maximum Price (GMP): In this contract, the CM agrees before hand that the cost of the work will not exceed a specified figure, known as the GMP. The GMP is based on competitive bids for each trade subcontract, but the CM charges an additional fee for taking on the risk of the guarantee. The CM is also allocated some contingency to pay for construction changes that are within the design intent of the project. Changes beyond the design intent require approval by all stakeholders.

Design-Build

Design-Build is very old method that fell out of use until recent years. In this process the owner selects one contractor to both design and build the project. typically means that the owner selects a builder who then hires the design team as required. Design-Build is primarily intended to save time. Like Construction Management with pre-construction services, the designers and builders work together from the beginning, the design effort can be substantially reduced. It is not necessary to prepare drawings in great detail if the builder already understands what needs to be done.

Design-Build

Like Construction Management, time may be saved by using a fast track schedule where the builder begins working on each phase of the construction as soon as the design for that phase is complete.

There may be some slight savings in design costs, but those have no impact on the costs of labor and materials for the actual construction, which is where the greatest part of the total cost is to be found.

Fast track schedules eliminate the possibility of integrated design. They also often mean that very little time is spent with the occupants to ascertain their needs in a new facility.

Design-Build

When the designers work for the builder, rather than the owner, the checks and balances that exist in other methods are lost.

People in a hurry make mistakes. Fast track schedules can lead to serious problems which are difficult and expensive to resolve.

Saving time is the main advantage of design-build, but that should not be as critical an issue for a project as cost and construction quality.

Changes are difficult to implement once construction starts in a Design-Build project because everything moves too fast and the budget is often inflexible. When a costly unforeseen situation arises, the only alternative is often a reduction in the scope of work. This will lead to a final product that is something less than what was envisioned at the beginning of construction.

Unforeseen circumstances are the bane of any construction project, but they are particularly difficult to handle in Design-Build. For this reason Design-Build is ill suited for renovation projects.

Price Negotiation in Commercial Contracts - Considerations

In competitive sealed bidding, there is no flexibility to negotiate prices with the successful bidder and in a sole-source situation, of course, negotiation of the price or cost will be a significant part of the contract negotiation. So remember to:

Challenge assumptions in the pricing proposal because most prices are subject to adjustment, based on principled negotiations;

Ask for "cost and pricing data" when required by the Procurement Rules or as necessary to perform adequate price/cost analysis;

Press for a comprehensive understanding about what is "driving" the contractor's price proposal;


Press for information on direct rates for labor, e.g. what labor rates were used and how they were priced;

Evaluate whether the experience/education for the labor categories are appropriate for the work being performed;

Determine what the "direct costs" are (which must be recovered) and the indirect costs, which may be subject to negotiation;

Find someone familiar with the contractor's indirect cost/pricing practice, or with customary ranges of indirect cost rates in the industry;


Press for information on and critically evaluate "markup" on supplies and other subcontractor work/services

Evaluate the sources, costs, and quantities of key supply/material elements of a contractor's proposal;

Determine what profit margin is being proposed by the contractor, and formulate arguments for a lower profit margin if appropriate;

Understand and evaluate the contractor's labour hour estimates for key aspects of the work, and have your own estimates prepared by people who understand the project requirement;


Ask the contractor to demonstrate how its pricing proposal integrates "efficiencies“ (e.g. learning curve analysis) where appropriate;

Consider the availability of State-supplied equipment/service to lower costs;

Determine how much is being paid for unspecified "mobilization" costs;

Evaluate how much "contingency" is being proposed; Determine availability of "quantity discounts", (those

discounts commonly offered to the contractor's customers who order large quantities of supplies or services), "seasonal discounts", or "cash discounts" paid to customers who pay "in full";


Make sure you understand all of the contractor's cost categories in cost reimbursement-type contracts;

Formulate pricing objectives after price/cost analysis to integrate into the contract negotiation;

Consider options available from trading price or cost for delivery times, quality, and warranty coverage; and

Insure that the contract terms reflect the agreement on the price, the type of contract, and the payment provisions

Component of contract price

Cost AnalysisPrice analysis focuses on a comparison of the total price against objective indicators ofreasonableness, such as competitors' prices, catalog or market prices, prices of similar work, etc.Sometimes, market conditions are not suitable for price analysis, e.g. "sole source" situations,pricing of modifications to contracts, "cost reimbursement type" contracts, etc. In those cases,"cost analysis" is used to determine whether the price to the Client will be "fair and reasonable."The purpose of cost analysis is likewise to arrive at a price that is "fair and reasonable." But coststend to vary among companies, based on the capabilities of management, the efficiency of labor,and the quality and amount of subcontracting.

"Cost Analysis" Defined

Cost analysis is an evaluation of actual or anticipated costs. Successful cost analysis requiresapplication of experience, knowledge, and judgment to cost data. The purpose is to forecastexpected contract costs and assess an appropriate profit. Cost analysis is useful for establishingnegotiation objectives for cost/price negotiation.


Direct cost: direct cost comprises cost of materials, plant, wages and all direct expenses. this cost varies in proportion to activity and therefore it is also known as a variable cost.


site overhead: these is composed of over heads incurred in production (i.e. salaries and expenses on site staff) as far as a construction project is concerned, a site overhead is also known as a fixed cost because it remains unchanged despite changes in activity over a fixed time span.


Head office overheads: this consists of overheads incurred in managing a contractor’s business. It includes top management costs, directors fees, rents and the like. As this cost remains unchanged in the short run, despite changes in the contractor’s business activity, it is also known as period fixed cost.


Profit: this is the difference between the total value and the total cost of production.

As a general rule, though, a contractor is entitled to receive a "fair and reasonable" profit. In general, profit should be a reward for efficiency and the risk assumed by a company. 10% profit is a common profit baseline for commercial, fixed price contracts having moderate risk and only incidental amounts of subcontracting.

Profit

Here are some general considerations in evaluating and negotiating profit:

A contractor assuming higher technical and/or cost risks should be entitled to more profit. Similarly, a contractor merely passing through someone else's productive effort should receive less (or no) profit.

Generally, higher profit is justified per unit on low volume sales than larger orders, particularly where there is risk from mobilization or setup.

Companies in high tech, rapidly developing and changing technologies are entitled to greater profit, because they have higher training and development costs to stay competitive.

Companies who make substantial capital investments during performance are entitled to a higher profit.

Consistently higher quality justifies higher profit

Reasons for price changes

defective or incomplete design information. Owners dissatisfied with product of their engineering department or the performance of their design consultant would probably vote for this as a major cause. Symptoms of this are numerous or massive revisions to design drawing and specification.


late or defective owner furnished material and equipment. Many owner purchase equipment or material and furnish it to the construction contractor(s) for erection or installation. Owner who decide to save money or exercise direct control on buying this item themselves must consider the additional responsibility and liability they assume by doing so


changes in requirement. Changes in operating, safety, environmental, market, feasibility, funding, or regulatory requirement, particularly for project that span several years or concern highly complex or sensitive effort represent major causes of change, both formal and informal. There is little and owner or contractor can do about this type of changes. At best every effort should be made to anticipate changes of this nature and provide for their impact in project budget and contractual terms and conditions.


changed or unknown site conditions. Subsurface conditions represent a classic example of site conditions that may not be known or may change during the cause of construction. The occurrence of subsurface water, rock, or other material often directly affects contractor’s performance. Other site changes, though as common also occur. These include weather, access, congestion in the work place, warehouse storage, and security restrictions.


ambiguous contract language and contract interpretations (claims). Extensive contract formation control, consistent and clear documents, and contract administration training and procedure help prevent changes due to this cause.


restriction in work method. There are countless example of owner restricting or changing contractor work methods. Unless it is specified otherwise in the contract document, contractors are generally free to construct in the manner they deem suitable.


Late or inadequate contractual compliance on the part of the owner (Claims).

Construction contracts are a one way street, requiring compliance by both parties. Virtually every contract require (expressly or implicitly) action on the part of the owner in addition to payment of the bill. Most of this deals with a prompt and timely owner inspection and acceptance of the work product as it progresses. Owner are often required to review design or shop drawing produced by the contractor in a timely manner. This is usually a duty that must be performed within so many days. it is not uncommon for owner in their zeal to manage or monitor contractor performance, to overlook commensurate performance required on their part. The capability of the owner to meet this contractual commitments should be analyzed before they are inserted into contract document. If you cannot meet this obligations, do not take them on.


Delay or acceleration. When a contractor work is delayed, by the owner, other contractors, or third parties, it incurs additional cost and it might be unable to meet contractual time commitment. The same is true when work is accelerated, or compressed.

Procedure of incorporating price changes into the contract

Price Adjustment Clauses:What are price adjustment clauses? Price adjustment clauses are often inserted into long

term supply agreements. They permit an adjustment to the agreed price of goods

with the aim of ensuring that prices remain in line with current market pricing and general inflationary levels throughout the contract term.

How do price adjustment clauses operate?

Price adjustment clauses usually operate with reference to a stated pricing index. This aims to ensure that price adjustments reflect relevant prevailing market forces (usually

inflation but, in the current economic climate, also deflation) and are, to an extent, limited so as to provide a degree of cost certainty to customers.

For example, a clause may permit a pricing adjustment to reflect a supplier's increase (or decrease) in costs, provided that such an adjustment is limited to the variation in a

specified index over a particular period (typically, the preceding 12 months of the contract term).

What are the most commonly used pricing indices?

Retail Prices Index (RPI): measures inflation by recording the average monthly change in the prices of specified goods and services purchased by the average household (inclusive of mortgage and interest payments).

RPIX: the RPI, but excluding mortgage and interest payments. Consumer Prices Index (CPI): measures inflation using

similar data to the RPI, but excludes council tax and various housing costs, covers a broader population sector than the RPI and adopts a different mathematical formula for calculating the index.

Sample price adjustment clause

An example of a price adjustment clause follows: "Supplier shall be entitled, once during each year of the term, to

increase the Prices to take account of any material increase in the cost incurred by Supplier in producing the Products, provided that Supplier demonstrates to Customer's reasonable satisfaction that it has incurred such an increase in costs. In any event such increases in the Price shall be limited to the increase, if any, in the RPI during the 12 month period immediately preceding the relevant Price increase."

Effect of price changes to budget and arrangements to contend by developers/employers?

What could a supplier do to protect their position Permit regular price adjustments so that ongoing

price fluctuations in the relevant market are taken into account in the contract pricing; and

• Restrict adjustments to increases in prices only, so that decreases in price are not passed on (in other words, inflationary adjustments only).

What could a Developers/employers do to protect their position?

Limit the number of price increases a supplier is entitled to make over a specified period;

• Limit any price increase to a specified index;

• Require suppliers to evidence any increase in costs; and

• Ensure that the price adjustment provisions take account of both increases and decreases in the relevant index.

Documents for final account

The final account represents the final gross amount obtained after financial adjustment of variations, prime cost and provisional quantities, day works, fluctuations and contractual claims at the end of a construction contract.

The production and agreement to a final account usually lead to the following; The client’s ascertainment of the total financial commitments (i.e the total

amount payable to the contractor) The contractor’s awareness of the total entitlement under the terms of the

contract The issue of the final certificate by the architect for payment which, if not

challenged becomes the final account. The agreement of both the client and the contractor to adjust the contract sum Awareness that the effects of extension of time granted under the contract have

been considered and settled.

Documents for final account

Prior to commencement of the preparation of the final account, the client’s quantity surveyor needs to cross-reference all sources of information, including the following;

Architects’ instructions (including site verbal/written instructions and clerk of works’ instruction)

Copies of minutes of project team meetings. Day work sheets. Wages sheets and material invoices (for traditional fluctuations). Contract bills of quantities and the correspondence file. Original drawings used in preparation of bills of quantities. Revised architects and engineers drawings. The original take –off dimensions for the bills of quantities. Records of nominated sub –contractors’/suppliers’ work. Clerk of works’ site diary.

Components for final account

Variations account; consist of measured items grouped as omissions and additions under architect’s instruction.

Omissions are a group of items contained in the contract documentation which are no longer needed and, hence require a total deletion or substitution.

Additions are either substituted items (quantity and/or specification) or simply extra items required for the project. Items of additions be measured from revised drawings or additional works measured on site


Adjustment of prime cost sums Prime cost sum (PC) is a sum of money written into the contract bills

of quantities for either works which required to be carried out by a nominated sub-contractor or goods and materials required from a nominated supplier. In the final account, the adjustment of prime cost sum involves omitting the sums contained in the contract bills of quantities and setting against the agreed invoices or accounts for work executed and/or materials/components supplied. In the process, the client’s quantity surveyor takes into account the main contractor’s profits (where applicable), cash discounts, general and special attendance


Adjustment of provisional sums A provisional sum is a sum of money written into contract bills

of quantities for work or for costs which cannot be defined or detailed due to uncompleted design. therefore, financial adjustment of provisional sums covers a multitude of items which, owing to lack of adequate information, could not be measured in detail at contract bills of quantities stage. Like the variations account adjustment of provisional sum involves omitting sums contained in the contract bills of quantities and adding back the detailed designed work.


Adjustment of provisional quantities The adjustment of provisional quantities

comprises the omissions of items in the contract bills of quantities qualified as provisional and adding back of the actual remeasured items.


Day works account All day work sheets submitted by the contractor are examined to

determine whether the items of work they contain can be properly measured and priced. If not, they are valued as day work. In the day work valuation, the client’s quantity surveyor should be satisfied that the labour, materials and plant recorded on day work sheets are reasonable for the items of work involved. In addition, he or she will also check the arithmetic and ensure that the day work valuation neither overlaps with the measured work valuation nor does the reverse by leaving a gap in the final account. The total of the day work sheets is transferred to the final account summary and the prime cost sum for day work is omitted from the contract bills of quantities


Fluctuations As a continuous process from the interim

valuations, the client’s quantity surveyor will check the details of contractor’s claims for increases in cost of labour and materials and statutory contribution before inclusion in the final account


Contractual claims Where contractual claims for additional

payments under the contract conditions have been accepted, evaluated and /or agreed, they are included in the final account

Example of final account summary

Omissions (kshs) Additions (kshs)

PROJECT NAME

FINAL ACCOUNT

Summary

Contingencies

Variations account

Adjustment of prime cost sums

Adjustment of provisional sums

Adjustment of provisional quantities

Dayworks account

Fluctuations

Total

Project close out procedure implications, consequences, and residual responsibilities in common law

Project and Closeout Procedures Construction Projects - When all work

items in the contract description have been completed in accordance with the approved (certified) plans and specifications, a final inspection conducted, all punch list items have been completed and certification of construction work has been submitted by the sponsor.


Construction Projects Submit: - As-Built or Record Drawings - Audit of Engineer (unless lump sum contract). - A revised drawings "As Built" construction for the

work performed.A Sponsor's Final Closeout Report detailing the cost breakdown for each

of the following items: Design and Inspection Engineering Services Construction Contracts Change Orders Miscellaneous costs (legal fees, advertising and administrative

costs,etc.)


The Core Issues for close-out of projects to check in construction contracts.

Indemnification—including casualty provisions. Insurance—including waiver of subrogation, casualty

provisions and insurance certificate issues. Hazardous Material—including hazardous material found at

the site and brought to the site. Changes in the Work—including equipment rental, claims

process, "reasonably inferable"/precedence clauses. Site Conditions—including existing and unforeseen

conditions and site inspection.


Safety—including code compliance. Delay/Acceleration—including project coordination/third

parties. Final Acceptance/Final Payment—including payment

process, especially with regard to retainage and substantial completion, impact of pay-when-paid developments.

Defective Work—including: punch lists, latent defects, warranty provisions and process.

Limits of Liability—including contractor requirements to provide professional services

price changes, final accounts & project close out procedure presenter vincent juma wesonga...

Documents

unit price unit price

contracta contract price

price changes

fixed price

specific price

unit price contracts

lump sum contract

contract law