Construction Law/PRICE ADJUSTMENT
AOA. SIR I HOPE U LL BE FINE BY THE GRACE OF ALLAH.if any other adjustable item(s) is not used in a particular billing period then the ratio of current date price and base date price for that particular adjustable item(s) shall be considered as one.I VE QUOTED IT FROM PEC DOCUMENTS. IS IT MATHEMATICALLY CORRECT ? IS THIS PRACTICE BEING ADOPTED INTERNATIONALLY ?
Dear Muhammad Iqbal
Thank you for your question.First of all I will reproduce my answer to a similar question a few month ago:
"There is a lot of confusion regarding this issue. Please note that the formula used is to compute the factor Pn which is then multiplied with the work done during the period n. The elements selected for this formula are such that a certain percentage of the contract value is considered variable (around 60 to 65%) while the remaining portion remains fixed. This means that to satisfy this requirement, all elements must be considered and therefore entered in the formula even if these are not covered in that IPC otherwise the percentage for variable component will not be achieved.
It will become clear from an example where only excavation is covered in an IPC. Now this does not cover any cost element and therefore if we use the ratio of current prices and base prices as unity then no compensation will be paid for that IPC. This means that the amount of this IPC will not be included in the amount of variable portion which will ultimately result in reducing the percentage of variable portion and therefore such an approach is not justifiable. This will ultimately lead to a scenario where in case of increase in prices of the cost elements, the contractor will suffer a loss while in case of a decrease in prices, the Employer will be at loss.
I understand that from the above example it is clear that all the cost factors are to be used in the formula whether the IPC include a cost element or not and that these are to be valued at the current (prevailing) prices."
I will add to my previous answer as under:
As per Sub Clause 70.1, Increase or Decrease of Cost, the adjustment to the monthly statements in respect of changes in cost shall be determined from the following formula:-
Pn = A + b * Ln /Lo + c* Mn /Mo+ d*En / Eo+………………
Pn is a price adjustment factor to be applied to the amount for the payment of the work carried out in the subject month,
A is a constant, specified in Appendix-C to Bid, representing the nonadjustable portion in contractual payments;
b, c, d, etc., are weightages or coefficients representing the estimated proportion of each cost element (labour, cement and reinforcing steel etc.) in the Works or Sections thereof, net of Provisional Sums and Prime Cost; the sum of A, b, c, d, etc., shall be one;
Ln, Mn, En, etc., are the current cost indices or reference prices of the cost elements for month “n”, determined pursuant to Sub-Clause 70.1(d), applicable to each cost element; and
Lo, Mo, Eo, etc., are the base cost indices or reference prices corresponding to the above cost elements at the base date.
In fact this formula is used to compute the Multiplier (Pn), to be applied to the cost of work done during a specific period, and is completely independent of the fact whether a cost element is used or not, during that particular period.
I shall to explain this with the following example:
Suppose the Contract Price of a project is Rs. 100 Million in which the cost of reinforcing steel is Rs.20 Million, making its weightage as 0.2. The weightage so determined means that any price adjustment will be complete when difference in cost,in proportion of 0.2,is applied to the whole of the Contract Price.
If the completion period is 10 months and for simplicity the progress is taken as linear, then each monthly work done payment will amount to Rs. 10 million. Now suppose the first month covers only excavation items and the next five months completes the whole quantity of reinforcing steel. This is because in building projects most of the reinforcing steel is consumed in foundations and slabs.The last four payment will not contain any reinforcing steel in it.
In this example, according your question, the price adjustment factor Pn will be computed using the current prices of steel for only the Invoices No. 2 to 6 and for all other invoices the current price will be taken same as base price to make it unity. Such a presumption allows adjustment for increase in the prices of reinforcing steel for only 50% (only five invoices amounting to Rs. 50 Million) of the total contract price and that also at weightage of 0.2 while the steel consumed is at much higher proportion. This makes the overall weightage of reinforcing steel as 0.1 if we spread it on the total contract price which is not correct. In this case the contractor is always at loss if there is a continued price increase its prices and if the prices of reinforcing steel starts decreasing after the sixth month then accordingly the Employer will be deprived of any benefit of decreased prices.
The correct way is to compute the Pn factor using all the weightages and the current prices without giving any consideration to the fact that any material is used in that month or not, and then multiply it with the amount of work done in that month. You can make an exercise using data from any of your project and will reach the same conclusions,
Please note that multiplying the Pn factor with the amount of work done actually means that we adjust the price of all the items mentioned in the BOQ whether used in a month or not. Therefore I am of the strong opinion that suggestion mentioned in your is not correct and the current prices of all the cost elements.
Hope the question is answered. If you need any further explanation, please do not hesitate to write.
Abdul Majid Khan