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Cost Value Reconciliation 2005
Cost Value Reconciliation 2005
Conference Proceedings
Edited by A. C. Sidwell
45 July 2005, Brisbane, Australia
A COLLABORATION OF:
COBRA
the Construction Research Conference of the RICS
Foundation
AUBEA
the Australasian Universities' Building Educators
Association Conference
3rd CIB Student Chapters International Symposium
CIB W89
Building Education and Research
CIB TG53
Postgraduate Research Training in Building and
Construction
Australasian
Universities
Building
Educators
Association
Conference Proceedings
Editor: A. C. Sidwell
July 2005
Published by:
Queensland University of Technology
Australia
ISBN 1-74107-101-1
ABSTRACT
The application of cost value reconciliation (CVR) in the construction industry is
considered an important part of cost management for the financial control of
construction projects. However, it is often assumed that CVR is not widely utilised
by contracting organisations operating in the UK construction sector. This is
purported to be due to the associated resource requirements and technical skills
necessary to accurately incorporate the technique into an organisations processes.
Clearly, this is especially the case with regard to smaller contractors with less
financial capabilities, and a requirement to keep overhead costs to a minimum. This
assumption has formulated the basis of this research.
The review of literature indicated that the field of CVR is not a widely covered topic.
This paper therefore considers the application of CVR in the UK construction
industry. This includes how CVRs are produced and the information output, in
addition to a measure of its utilisation within industry. Additionally, areas are
identified that may be adapted in order to increase its application. From the research
theoretical CVR models are developed aimed at enhancing CVR as a management
tool. The proposed models are devised to widen the application of CVR amongst
contractors with less financial capabilities or for those that operate mostly on shortterm contracts. Additionally, the proposed models will provide the opportunity to
enhance the benefits to those who regularly apply the technique in practice.
Keywords: budget monitoring, cost and value forecasts, project cost accounts.
INTRODUCTION
There are many aspects of construction work which impinge on the process of
bringing a project to a successful conclusion (Pilcher, 1994). Almost every project
undertaken within the construction industry is to some extent unique and will contain
some elements of uncertainty. Therefore, losses and possible ultimate financial failure
are an ever present problem, and even the most sophisticated contractors may operate
on a very low percentage profit turnover (Upson, 1987). With clients demanding
more complex and sophisticated buildings, to be constructed with increasingly tight
budgets, cost control and financial management is of paramount importance.
Therefore, for all construction projects, costs must be monitored and controlled,
whether from the point of view of the client or owner, or the designer or builder.
It is suggested that many contractors only compare cost and value when the final
account has been agreed. However, it is essential that such reconciliations are
completed during intermediate stages of individual contracts, primarily to establish the
respective profitability but also to identify any financial difficulties.
Financial control through a CVR can provide detailed information to identify the need
for reserves, downturns in cash flow, and information to make decisions to stem future
losses (Perceval, 1997).
APPLICATION OF CVR
A CVR at a specific data is relatively meaningless unless it is accompanied by an
analysis of the final position of the contract (Capon, 1990). Without additional data;
such as a cost to complete analysis, or means of being certain of a profit at the final
position of the contract, there can be no justification of taking profit. However, the
detailed preparation of the reconciliation together with the associated forecasts to
completion, provide management with a very powerful tool for the identification of
potential problems or critical elements of the contract. In this respect, if
reconciliations identify that a project is making a loss, the process has relatively
limited value without being able to identify the reasons for the losses occurring and
thus providing vital information to prevent a repetition of the loss (Harrison, 1993).
An effective CVR form should generally contain: the initial tender figures and
expected profit, forecast figures at completion for value and profit, the current
payment applications by the contractor, the current certified value, an account of any
adjustments or provisions to the certified valuation, the cost to date at the accounting
period in question, and the cash received to date including the retention deducted and
certified sums unpaid (Barrett, 1992).
Such information will facilitate a
comprehensive CVR assessment to be completed, which will allow the current
financial position of the project to be determined. This will also better indicate the
final position of a contract.
The responsibility for cost value reconciliations will vary from company to company.
However, it is essential that those responsible are aware of all of the implications and
requirements of SSAP9 (Upson, 1987). Those performing such financial management
techniques should be prudent to ensure that they are accurate and realistic to prevent a
company claiming that they are more profitable than they actually are.
There is no defined frequency at which CVRs should take place and there is no timing
criteria set in SSAP9. However, good management practice denotes that to effectively
control project finances such reports should be carried out on a reliable and regular
basis, and should ideally coincide with either the availability of cost figures or current
valuations, and preferably both (Upson, 1987).
Awareness of the
information:
Yes
No
100%
Usefulness of the
information:
Very
Not very
100%
97%
3%
100%
94%
6%
94%
6%
78%
22%
91%
9%
56%
44%
84%
16%
53%
47%
75%
25%
Data were also collected in relation to CVR and other cost control techniques. This
provided for identification of where CVR was under performing or where other
techniques were performing better than CVR. From such data, ideas can be generated
relating to standardisation of the application of CVR that could also be validated by
hard evidence. The majority of organisations used a budget monitor system followed
by those using a cost coding system. These were the main two techniques used
though others such as, earned value management, and network analysis methods were
also applied to control project costs. The main features of the cost control systems in
the survey were also reflective of the perceived usefulness of the techniques. Budget
monitoring systems illustrated close assessment of identified budgets with actual
expenditure for monitoring purposes. Cost coding systems identified the features of
identifiable costs which could be coded and related to cost centres and sections of
work, some being integrated into company accounting systems. Earned value
management, while being less popular than the previous two, provides the opportunity
for project assessment in terms of cost and time. Data can be established, and also
presented graphically, for budgeted cost of work performed (BCWP), actual cost of
work performed (ACWP) and budgeted cost of work performed (BCWP) i.e. earned
value. This provides a powerful tool for use in project cost control and is starting to
gain more widespread use within UK construction. Network analysis, however, did
not feature strongly in the survey, although its use in cost control can be directly
related to programmed activities of construction work. The responses from companies
using these techniques are shown in figure 1.
40
Number of respondents
35
34
30
23
25
20
15
10
5
1
0
Budget monitor
system
Network analysis
Cost coding
system
Earned value
management
Furthermore, the reasons for the selection of the cost control techniques utilised,
including CVR, were examined to identify what the determining factors are. The
responses received are demonstrated in figure 2.
It was identified that company polices and best practice procedures were the most
dominant selection factors. With regards to CVR, best practice procedures tend to
relate to SSAP9 and the production of management of company accounts. This also
30
27
25
Number of respondents
25
20
15
15
10
7
6
4
0
Company policy
Best practice
procedures
Legislation/audit
trails
Cost/time
constraints
Contractual
obligations
Contract length
Selection factors
CVR MODEL
From the knowledge gained on the application of CVR and the information extracted
from the research, a theoretical model was developed in order to standardise the
application of CVR and enhance the benefits. This is shown in Figure 3.
External interim
valuation received from
Cut-off cost accounts to establish
cost to date for work performed
Completion by contractor
Amend external valuation
(to incorporate: claims,
variations, overvaluation,
and undervaluation)
Completion by contractor
Information Output:
profit earned to date,
profit expectations of
project, movement in
company provisions,
present cash position
By this method, when the interim external valuation is certified by the clients
architect, the project costing account is cut-off to coincide with the date of the
valuation. Here a total for the cost to date can be established, which will cover the
same quantity of work as that certified in the valuation. However, before these totals
can be reconciled, some preliminary adjustments may be required.
From the external valuation received, adjustments may be necessary to incorporate the
anticipated value of any disputed items or variations involved in the contract, or for
items that have been under/over valued. For such adjustments SSAP9 requires a
conservative estimate to be made. Therefore, the completion of this aspect of the
CVR can be performed by an individual with detailed knowledge of the contract, but
without specialist skills in this field; for example, a site manager. By producing the
totals for the valuation side, a large proportion of the required calculations and
assessments will have been transferred to the clients QS. Thus, the process of
establishing the value earned to date is largely shortened whilst the accuracy is
maintained. However, such a process does denote that the value earned may be
determined by the client rather than the contractor if the external valuations are not
closely examine to ensure they represent the work completed. Furthermore, additional
calculations may be necessary to incorporate any provisions required for future costs
not recoverable under the conditions of the contract.
To maintain the accuracy of the reconciliations, the project cost will need to be closely
monitored to ensure that the costs included have actually been incurred and therefore,
that cost matches revenue. If the contractor can make every endeavour to ensure that
the monthly valuations coincide as nearly as possible with the companys accounting
period, then this will quicken the CVR process as it will substantially reduce the
adjustments to be made. However, this is often unlikely, and therefore to ensure that
they represent the same quantity of work, necessary adjustments may be required to
the established actual cost to date totals. The adjustments will be predominantly made
to material, plant and subcontractor costs.
When the interim valuation is prepared materials incorporated into the works or stored
on site will be included in the detailed make-up of the valuation. However, the
relevant invoices for such materials may not necessarily have been raised by the
supplier or indeed received by the contractor, and consequently they will be excluded
from the cost accounts. In such circumstances a schedule of accruals will need to be
prepared in order that cost may be adjusted to match the valuation.
Where plant is hired externally similar problems to those outlined above will also
apply to plant invoices. In fact, it is probably more common for plant invoices to be
delayed as plant hire companies often delay raising invoices until the plant is taken off
hire. Moreover, delivery and collection charges may also distort the true costs at
various stages of the contract, and the contractor may be contra-charged for any losses
or damage to plant. It is therefore essential that provisions for anticipated losses or
damage are made and any adjustments for distortions or late invoices are made to the
cost accounts.
Payments to subcontractors are likely to be inaccurate during the course of an
accounting period for a number of reasons. Primarily, there is likely to be a difference
in the date of the close down of the cost accounts to the date that the subcontractor
submits their application for payment. Such payment applications will cover a
difference quantity of work to that of the cost accounts, and therefore, adjustment will
be necessary to the cost of the subcontracted work to ensure that it covers the same
volume of work. Such adjustments can easily be made on a pro-rata basis. In this
respect, the valuation of the subcontractors work may also be inaccurate as it may be
considerably under or overvalued. In such circumstances, the contractor will be
required to establish an accurate valuation of the work carried out by the subcontractor
and take the relevant costs of such work into their cost accounts. Additional
difficulties may occur where the subcontractor has claims against the main contractor
which have not been settled. Here, the amount of the claim must be added to the
adjusted cost.
The process of the cost side of the reconciliation, including the adjustments that may
be required, is largely unchanged from that of the traditional CVR process. Though
additional calculations are necessary to primarily establish the cost to date when the
cost account is cut off. However, this does not denote that additionally skills or
resources are required on the individual producing the CVR. Again, any individual
with detailed knowledge of the contract, such as a site manager, can prepare such
calculations, as they are relatively straight forward. This should therefore become
routine practice in a short period of time. Additionally, it is unlikely that any training
would be required to enable such an individual to produce such data.
Once realistic and accurate totals have been calculated for the costs incurred and value
earned, including provisions for future additional costs and foreseeable losses, the
figures can be reconciled. By subtracting the cost from the value, the present
profitability performance of the contract will be determined.
At project level, the information output, accuracy and control received from this CVR
model would be the same as a traditional CVR system; thus enabling management to
make essential decisions regarding the performance of the project. However, the
skills, resources and time required to produce the reconciliation outcomes would be
significantly shorten as a large quantity of the calculations will be produced outside
the organisation. As previously highlighted, this does transfer the establishment of the
contractors value earned to the clients representatives, and therefore, the contractors
must demonstrate caution.
Conversely, at an organisation level, the simplified CVR model is less satisfactory as
accurately transferring the established data to company accounts becomes difficult.
This is because the dates at which the reconciliations will take place will be
determined by the production of the external valuations for each project, rather than a
standard cost cut off date across all projects undertaken by the contractor. Therefore,
annual reporting would require additional reconciliations or the continuation of
techniques already in place. Furthermore, on long-term contracts, the determination
of attributable profits to be taken into a companys accounts would also become
difficult, especially in conformance to the provisions of SSAP9 and general rules of
prudence.
However, it was established that the level of control extracted from CVRs by those
that apply the technique was significantly less than for contracts of a smaller value or
shorter duration. With regards to smaller contractors, it could be assumed that they
would be predominantly involved in such contracts and therefore the level of control
received at project level would be sufficient to justify its application.
undertaken it was noted that some contractors proposed the application of CVR in
conjunction with a budget monitor system. By combining such techniques, it is
possible to enhance management control of project costing accounts in addition to the
variation of standards of prudence. This should inevitably increase the accuracy of the
information produced from the reconciliations completed. If a budget monitor system
is to be used in conjunction with CVR, it should be set up alongside project cost
accounts, to allow relevant costing information to be transferred across. This is
illustrated in figure 4.
Completed by contractor
Completed by contractor
Assessment of provisions
used to aid calculations
Forecasts of financial
performance of future events
used to aid calculations
Information produced:
Profit/loss summaries,
Provisions summary,
Cash position,
Future position of contract,
Progress assessments,
Performance of work executed
Figure 4: Flowchart of CVR and BMS model used to enhance management control
Cost value reconciliations provide a snap shot of the financial status at a particular
time, without necessarily presenting information regarding the final outcome of a
project. Combined with a budget monitory system, data concerning future resource
SUMMARY
From the research and the application of CVR in the UK construction industry it has
been established that, as a whole, the full potential of CVR is being realised by those
that utilise it. It was observed that CVR is mostly applied as a management tool, at
both project level and throughout the financial management of company operations.
The research also identified the essential characteristics of CVR in addition to specific
areas which were comparably underperforming. The theoretical models developed
on the findings of the research demonstrate how CVR could be adapted to increase the
benefits realised by contractors.
Firstly, a model was identified that would increase the application of CVR amongst
contractors with lower financial capabilities, referred to as smaller contractors. Such
companies could not justify the application of a traditional CVR technique as the
value received, with regards to the level of control desired, would be largely
outweighed by the resource input required. Therefore, by simplifying the process of
producing CVRs without reducing the accuracy of the information output at project
level, the introduction of project costing accounts provide a satisfactory alternative.
More conclusively, by utilising CVRs in conjunction with a BMS, the benefits
received are enhanced as a contractor is more able to forecast and control future
activities and is able to base decisions made on reliable information. Additionally, by
combining the techniques the accuracy of the information produced is validated as the
BMS reduces the judgments to be made and restricts variances in standards of
prudence; thus enhancing the benefits received.
REFERENCES
Barrett, F. R. (1992) Cost Value Reconciliation (2nd edition), Berkshire, The Chartered
Institute of Building.
Capon, G. C. C. (1990) Construction Industry: An industry accounting and auditing guide,
London, Chartac Books.
Harrison, R. S. (1993) The transfer of information between estimating and other functions in
a contractors organisation, Construction Papers, Berkshire, The Chartered Institute
of Building.
Perceval, C. S. (1997) Management and Financial Reporting, Construction Papers,
Berkshire, The Chartered Institute of Building.
Pilcher, R. (1994) Project Cost Control in Construction (2nd edition), Oxford, Blackwell
Scientific Publications.
The Institute of Chartered Accountants in England and Wales (ICAEW) (1998) Standard
Statement of Accounting Practice 9 (Revised): Stocks and long-term contracts,
London, The Institute of Chartered Accountants in England and Wales.
Upson, A. (1987) Financial Management for Contractors, Oxford, BSP Profession Books.