Professional Documents
Culture Documents
Tauqir Haider
Tauqir Haider is a qualified Professional Accountant, Visiting Faculty member in leading Universities
of Pakistan for Finance subjects and having a wide experience on construction contracts
(Various World Bank Projects), Consultant & Visiting faculty Member
(ACMA-PAK & CMA-USA)
E-mail: tauqirhaider890@gmail.com,tauqirhaider890@hotmail.com
Tel: 92-042-5184870; Fax: 92-042-9203515
Abstract
1. Introduction
A Construction Contract is a contract specifically negotiated for the construction of an asset or a
combination of Assets that are closely interrelated or interdependent in terms of their design,
technology and function or their ultimate purpose or use (“Construction Contract: IAS 11” 1995) 1.
Managing the activities of Construction contract in a productive way produces the concept of
Constructability. Constructability has been defined as the optimum use of construction knowledge and
experience in planning, design, procurement, and field operations to achieve overall project objectives
("Constructability: A Primer" 1986). As a result of constructability, the quality of a constructed facility
1
IAS 11 specifically deals with the management, Accounting and recognition of Construction contracts. Construction
contracts are given a specific identification through IAS 11.
International Research Journal of Finance and Economics - Issue 28 (2009) 43
can be improved by better communication among major project participants such as design engineers
and construction professionals. Communication among these participants reduces the chance of project
failure and other related performance problems.
Cost shifting 2 is an accidental or deliberate misstatement in a contractor’s job cost system that
can have a substantial impact on the contractor’s balance sheet and income statement. Both contractors
and their auditors should be aware of the potential impact of shifts in job costs from one contract to
another. The contractor should have a reliable job cost system in place to record contract costs
accurately. The auditor should always test contract costs and look for unusual contract costing trends.
There is considerable discussion among industry professionals as to how constructability is
related to Total Quality Management (TQM) and value engineering. This paper attempts to
conceptually describe these interrelations. It also presents a framework to measure costs and benefits
related to constructability.
Significant attention has been given to the topic of Construction Contract (IAS-11), The Construction
Management 1991, "Constructability: A Primer" 1986, “ Audit of Contract”: A Practical Guide 2005,
Constructability: An Article of Tauqir Haider in The NEWS”, “Total Quality Management in
Construction Contracts”: By James. Santee 2006, “Value Engineering and Cost Benefit: Costing
Techniques” By Houston & jordeen 2003.
2
Cost shifting is an illegal practice that can change results and outcomes seriously.
3
A fixed price contract is a construction contract in which the contractor agrees to a fixed contract price, or fixed rate per
unit of output, which in some cases is subject to cost escalation clauses.
4
A cost plus contract is a construction contract in which the contractor is reimbursed for allowable or otherwise defined
costs, plus a percentage of these costs or a fixed fee.
44 International Research Journal of Finance and Economics - Issue 28 (2009)
A contract may provide for the construction of an additional asset at the option of the customer
or may be amended to include the construction of an additional asset. The construction of the
additional asset shall be treated as a separate construction contract when:
a. The asset differs significantly in design, technology or function from the asset or assets
covered by the original contract.
b. The price of the asset is negotiated without regard to the original contract price.
5
Contract revenue is the initial amount of revenue agreed or variation in contract and claim or reliable measurement.
6
Contract cost directly relates to the specific contract, costs are attributable to the contract activity in general and other
costs specifically chargeable to the customer under the terms of the contract.
7
A format used to describe the cost and structure of a project. This PC-1 is required to be approved by the Planning
Commission before execution.
8
Mobilization advance is normally a certain percentage (usually 10%) of the total contract that is paid as advance to start
work on it against bank guarantee.
9
Running Bill is a periodic basis Bill which is submitted along with stage of completion for payment.
International Research Journal of Finance and Economics - Issue 28 (2009) 45
and the payment is made on the work which is certified by the concerned professionals. Some advance
payment cans also be availed on the availability of material stock which is again adjusted in future. In
the Final Bill all adjustments are done to close the matter however Bank guarantee remains in custody
up till the end of the specified period of satisfactory work.
5. Cost Shifting
It is now a day in routine to find out many corporations improperly booking assets related to
uncompleted construction contracts. To the public, it seems improbable that a qualified auditor could
simply overlook the improper capitalization of significant assets. However, traditional audit procedures
designed without construction accounting in mind can fail to detect the improper booking of assets
related to uncompleted construction contracts. Significant cost shifting can quickly cause a material
misstatement to a contractor’s financial statement and leave the contractor and the auditor open to
serious charges.
Cost shifting is an accidental or deliberate misstatement in a contractor’s job cost system that
can have a substantial impact on the contractor’s balance sheet and income statement. The most
dangerous type of cost shifting involves moving or misdirecting job costs from an unprofitable job to a
profitable job. Cash and accounts payable balances are unaffected. Accounts receivable and expense
account balances are also unaffected. In many cases, however, cost shifting can have a balance sheet
and income statement impact larger than the amount of the costs that have been shifted.
Contract A Contract B
Completed Uncompleted
Contract Contract
Before Cost Shifting
Contract Amount $1,200,000 $1,500,000
Estimated Job Costs (1,300,000) (1,200,000)
Estimated Profit ($ 100,000) $ 300,000
Billings to date $1,200,000 $ 600,000
Overbilling (Liability) - (100,000)
Revenue to date 1,200,000 500,000
Costs to date (1,300,000) (400,000)
Gross Profit to date ($ 100,000) $ 100,000
Job percentage complete 100% 33%
46 International Research Journal of Finance and Economics - Issue 28 (2009)
In this example, Completed Contract A improves by $200,000 due to the costs shifted off the
job. However, Uncompleted Contract B also improves because the contract is now 50% complete
rather than 33% complete. Because Contract B is incomplete, gross profit is recognized on the
percentage of completion basis. Therefore, Contract B recognizes 50% of the estimated gross profit for
the entire job ($150,000) rather than 33% of the gross profit for the entire job ($100,000). The
$200,000 cost shifting entry improved the books of the contractor by a total of $250,000.
In this example, Uncompleted Contract B received $200,000 of costs which did not belong to
that job. When Contract B is completed, it will either finish $200,000 over budget or another cost
shifting entry will occur.
6. Constructability
Since the formalization of constructability, constructability has been an evolving work process. Years
ago, construction and design activities were integrated within the master builder's organization. Master
builders were responsible for all project activities required to plan, design, and construct a facility.
During the planning and design phases, the master builder focused on the entire project and considered
the impact early decisions had on the construction process. In a sense, the level of design and
construction integration achieved within these organizations serves today as the model for modern
constructability programs.
10
Total Quality Management (TQM) is a comprehensive and structured approach to organizational management that seeks
to improve the quality of products and services through ongoing refinements in response to continuous feedback
International Research Journal of Finance and Economics - Issue 28 (2009) 49
doing, it provides more resources, including construction knowledge and experience, for planning and
designing a quality project that maximizes construction productivity.
Constructability is a means of continuous improvement in several respects. Maintaining a
lessons-learned database allows communication of positive and negative activities and experiences
from one project to future projects. Thus, improvements and innovations can be implemented in future
designs. Also, construction personnel may be more aware of innovations in equipment or construction
techniques that may play a key role in improving designs.
Measurement of program effectiveness is also a key aspect of both a TQM and constructability
program. This includes tabulating quantitative costs and benefits stemming from constructability and
TQM such as dollar and schedule savings, as well as recognizing qualitative effects such as higher
quality and increased customer satisfaction.
TQM and constructability both stress commitment from all personnel. This commitment must
be established from the executive level to the construction craftsmen on the site. This is a proactive
process requiring teamwork, recognition of the need for education regarding the program, and a self-
assessment regarding capabilities and resources available to achieve the desired goals.
8. Value Engineering
Implementation of value engineering 11 involves six steps:
a. information,
b. functional analysis,
c. creative,
d. evaluation,
e. planning/proposal, and
f. implementation/follow-up
The creative step involves a brainstorming session where life-cycle cost alternatives for design
components are considered.
Value engineering may be performed in two ways:
(1) proactively or
(2) reactively.
A proactive approach uses value engineering to collect ideas starting at the beginning of design.
Thus, multiple design alternatives are considered and the most cost effective selected on a continual
basis throughout the design phase. A reactive approach gathers cost effective alternatives through
design reviews by other project personnel such as constructors and other designer engineers. This is
performed after the entire design or specific component of design is complete. Thus, suggestions for
improvement require design rework.
In the building sector, often the term V.E. is synonymous with "The project is over budget and
we need to cut X Rupees from the project's scope." Some designers view V.E. as an attack on their
design.
The primary objective of value engineering is to reduce the total life-cycle cost of a facility,
whereas constructability focuses upon optimization of the entire construction process. In most cases of
industry implementation, value engineering is normally performed during the design phase of the
facility delivery process. An effective formal constructability program ideally begins during the
conceptual planning phase and continues through construction.
Constructability and value engineering differ in terms of the criteria discussed above. However,
this does not mean that they are mutually exclusive. Rather, activities within the two work processes
may complement each other in achieving their goals. This may result in construction optimization
11
Value Engineering (VE) has been defined as "the systematic effort directed at analyzing the functional requirements of
systems, equipment, facilities, procedures, and supplies for the purpose of achieving the essential function at the lowest
total (life-cycle) cost, consistent with meeting needed performance, reliability, quality, maintainability, aesthetics, safety,
and fire resistance" ( Kavanagh)
50 International Research Journal of Finance and Economics - Issue 28 (2009)
while, at the same time, achieving lowest life-cycle cost. Constructability implementation can act as a
precursor to value engineering, providing information through constructor input and lessons learned
from past projects such that value engineering may be more effective.
9. Cost Effectiveness
As with TQM, improvements of a constructability program depend upon accurate and consistent
measurements of its effectiveness. Inconsistent means of cost/benefit measurement may incorrectly
reflect the effectiveness of constructability on a project in comparison to other projects or programs in
industry. Thus, a need exists for standardized cost effective parameters so that constructability
performance may be documented and compared among projects and organizations. This section
describes a simplified framework for identifying and quantifying the costs and benefits stemming from
implementing constructability at the project-level.
11. Conclusion
In Developing Countries there is an immense need of actual application of COST & MANAGEMENT
Accountants to find out the ways to improve the construction quality and its financial impacts so that
we can handle the natural disasters and other problems leading to causalities and loss of precious lives.
Summing up Total Quality Management, value engineering, and constructability are not mutually
exclusive. Instead, value engineering and constructability are complementary work processes that may
be used as key elements in achieving total quality. A coordinated effort with the application of
available standards the Financial Management Aspect as well as cost shifting can be evaluated. A
practical approach towards implementation of standards can yield desired results
References
[1] International Accounting Standard –IAS(11) Published in 2005
[2] "Manual for special project management." (2006).
[3] Value Analysis in Design and Construction, J.J e- Brown (2007)
[4] "Benefits and Costs of Constructability: Four Case Studies," J.S & J.G
[5] "A Comparison of Two Corporate Constructability Programs," J.S & J.G
[6] Snodgrass, T.J. and Kasi, M. (1986). Function Analysis: The Stepping Stones to Good Value,
The Department of Engineering Professional Development, University of Wisconsin, Madison,
WI, pp. 1-3.
[7] "Total Quality Management: The Competitive Edge." (1990).
[8] “Cost Shifting Analysis by Norton Cannons” (2007)
International Research Journal of Finance and Economics - Issue 28 (2009) 51