W2- Cost Index

COST INDICESBy Puan Sarah Mazhar Iqbal Khan

QSM 556 Construction Economics II 1

QSM556

Introduction Sources of Cost data are usually from completed

projects thus make it a historical data.

When these data are used to prepare cost plans or estimates, this information has to be adjusted using indices.

The index numbers are used to update the information of historical cost to the current value or to forecast price trend and future cost.

Thus, Cost Data & Cost Indices are interconnected!

Historical Cost Data

Cost Indices

Current value/updated

cost data

a) Cost Planning

Forms of cost planning: approximate estimate, cost plan, cost of element, total project cost.

Requires wide range of historical cost data.

By using indices, updated cost data can be apply toproduce an accurate cost planning.

Quick Ex 1: An office was constructed in 2007 at RM 2,200.00/m2

GFA. Another new office will be constructed in the middle of 2010. Calculate the new rate and the percentage in the change of rate if the current index given is 224 and the base index is 194. Other factors remain unchanged.

Formula:

New Price/rate (current)= Base Price X Current IndexBase Index

Answer:

New Rate (current) : RM 2, 200.00 /m2 GFA X 224

194

: RM 2, 540. 21/m2 GFA

% Index Change: 224- 194 X 100 : 15.46%

194

% Change in Price : 2, 540.21 – 2, 200 X 100 : 15.46 %

2, 200

Quick Ex 2: A school was constructed in 2006 at RM 1,600.00/m2

GFA. Another new school will be constructed in the early of 2010. Calculate the new rate and the percentage in the change of rate if the current index given is 215 and the base index is 180. Other factors remain unchanged.

What is the formula??

Answer:

New Rate (current) : RM 1, 600.00 /m2 GFA X 214

180

: RM 1, 902.22/m2 GFA

% Index Change: 214- 180 X 100 : 18.89%

180

% Change in Price : 1,902.22 – 1, 600 X 100 : 18.89 %

1,600

b) Prediction The pattern or trend of the

current index may be extended to a certain date in near future. i.e. for projects 1 or 2 years ahead

HOWEVER, the prediction has to be done cautiously.

Prediction can be accurate when market condition and price are stable.

Less reliable when prediction are made for a longer period due to inflation of rate.

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2005 2006 2007 2008 2009 2010 2011

Index

c) Adjustments to price fluctuation

Is used to calculate the increase in the construction cost for contracts that consist FLUCTUATION CLAUSE.

Contract that provides for the increase in the cost of the contractor’s resources like materials, labour wages, etc.

I.e.:-

(find standard form that allow this)

i.e. evaluate the increase or reduction in cost of 15 materials to the contractor since the tender date to avoid loss to the contractor

d) Price comparison The cost of different materials

and processes does notchange at the same fixed rate.

To identify when acomponent appears to be abetter proposition thananother

Therefore, indices can beused to measure suchchanges and observe changesin cost between componentsat a stipulated duration.

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2007 2008 2009 2010

Ready Mix Concrete

Cement

e) Evaluation of market trend/condition To forecast the tender price

Market condition will affect the price charged to the client

Trend of indices might not be the same as cost index, e.g.cost of material increases but due to lack of jobs, pricemay be competitive

c) Cost Index Is an input index that measures changes over time

in resource costs such as labour, plant, material

Cost for CONTRACTORS i.e.: Measures the changesin cost which is spent by the contractor.

The cost index can be prepared for the total cost ofbuilding or type of building to reflect generalincrease in cost.

Location is also a factor that effect cost index

COST TO CONTRACTOR!

c) Cost Index HOWEVER it is difficult to apply cost index to reflect total

cost of building due to numerous methods ofconstruction, variety of materials used and types ofbuilding. (except for some of government project-e.g:Schools)

Application is easier when cost index is in the forms ofelement: i.e.: concrete work, substructure, or specificmaterials i.e.: cement, sand, aggregate, etc.

Sources? : Department of Statistics, Malaysia- producedmonthly:

a) Special Release 1 for Civil Engineering Work

b) Special Release 2 for Building and Structural Works

http://www.statistics.gov.my

Cost Index ------------- Price Index

Cost incurred during construction

Price for the completed building

a) Price Index Also known as Tender Price Index!

The most common form of index used by the quantitysurveyor. (that works with QS firms)

The best index which should be used by QS because the clientis most interested in how much he has to pay to thecontractor .

The main uses of this index are to update historical cost datafor estimating purposes.

Factors like building cost, market condition, profit and pricefluctuations is included in the preparation of price index. (dodiagram)

Amount to be paid by CLEINT!

b) Price Index Manage & produce by PWD- produced for standard

government buildings once every six months.

Year Tender Price Index

1/ 2003 249.97

2/ 2003 246.81

1/ 2004 243.69

2/ 2004 288.59

1/ 2005 312.09

2/ 2005 312.56

1/ 2006 393.64

2/ 2006 412.62

1/ 2007 415.44

Cost /m2 for Building Construction, 2004 & 2007, PWD

b)Location Index Used to adjust the building cost according to its

location:

[A=Perak,Kedah,Perlis], [B=Perak], [C= KL,Selangor, N.S, Melaka],[D=Johor],[E=Pahang], [F=Kelantan,T’ganu]

This index is gathered from the tender price index.

E.g.: The total cost for a 2 storey office building in Kuala Lumpur will be different from a similar building in Pahang.

Region A B C D E F

LocalityFactor

1.1134 1.0652 1.000 1.0811 1.0582 1.0580

d) Maintenance Index Is an output index that measures changes in the cost

for maintenance works only. No such index is

prepared in Malaysia

a) Cost Index Index for resources like plant, material, and labour.

The average index can only be prepared if cost of each resource of a ‘typical building’ is monitored over time

Construction of a simple index for cost of a brick wall-

Cost per square meter of wall:

Base Year Current Index

£ £

Bricks 20 28 140

Mortar 2 3 150

Labour 8 10 125

Average Index 138.34 /3 415

Index on individual element

However- no account has been taken of the fact that bricks have more effect on the cost of a brick wall.

All the three sources was given an equal status.

Thus if very rapid rise in cost of one of the resources, the index will be uneven.

To overcome this- resources need to be ‘weighted’ accordance to their importance:

a) Cost Index

Index Base Year Weighting

Extension

Bricks 140 20 2,800

Mortar 150 2 300

Labour 125 8 1,000

Average Index: 136.67 /30 4,100

Construction of Cost Index

Total

MaterialsPublished Source the

most reliable

LabourTypes of labour?

Working Hours? Paid Holidays? Insurances,

Plant Hiring rates?

Weighting Average?

Weighting Average?

Weighting Average?

Index per element

Weighted Again (for total building cost)

Final Index-change in cost in time for the typical

building chosen

Importance points about cost index: What is the cost index is actually measuring? It measures

the change in the cost of resources to a contractor for a ‘typical building’.

It does not directly measures the change in in the pricethe client must pay

It does not measure the change in cost of specific building

Although resources for even ‘typical building’ will not have the exactly same resources, but the main resources are usually very similar.

Suitable for identifying trends in resource costs.

b) Tender Price IndexIntroduction:

Indicates tender price of building works.

Compiled by comparing tender rates from acceptable tenderswith Base Schedule Rates

Measures changes in materials, labour and plant, and theinfluence of economic conditions operating at the time of thetender

More useful in updating prices compared to cost indices because:

a) TPI considers price to client actual amount he should payfor the building not building construction cost only

b) TPI measures economic market trend/market conditionse.g. cost increases but price may remains the same orreduces due to competition

b) Tender Price Index Directly relevant to Quantity surveyor that provides service

for client. (not for QS that will works with contractors)

Why TPI and not CI? Because cost index takes no account of the tendering market. (tendering market: how many projects that are available to enter for tender?- will influence the competitiveness and the pricing of profits)

The source? The tender documents itself (priced tenders by contractors)

By monitoring the tendering markets, more useful to client in updating prices that suite his budget.

Construction of TPI• Based on priced BQ of successful tenderer :i.e. contract document.

• Not final account figure because

• Has to wait 2/3 years for completion therefore

• Limited application

• Unreliable result

• Does not reflect the price level at the completed date

• Tender price = price at the time of the tender close

• Purpose is to predict tender figure

• When to construct TPI

• Preferable immediately after the contract is signed

• JKR – within 1 month after the contract is signed

• JKR/ISM – 80 price indices are considered reliable samples to compileaverage index (TPI)

• To prepare quarterly i.e. every 3 months or half yearly

Preparation of TPI

• Projects of new building works tendered for competitively in the

form of Bills of Quantities under conventional contractual

arrangement are used as samples.

• Housing projects, Civil Engineering Works, Mechanical and

Electrical Works are not included in the samples.

• Random samples from around peninsular Malaysia, includes

samples from both private and public sectors.

• Bills of Quantities of selected new building projects are re-

priced at a Base Level (Base Schedule – JKR Schedule Of Rates

For Lump Sum Tenders) and the re-priced amount compared to

the actual tender amount to produce a Project Index.

Sampling procedure for TPI Measured works = Contract Sum Less Non-measured

works(prelim, PC Sum, Prov Sum, Profit and Attendance, Contingencies).

BQ consists of thousands of measured works – consider only a small number of items, only those financially significant items.

Items should be taken or selected in descending order of value for every section or element.

Priority given to most expensive items, the followed by less expensive items.

Priced BQ using Base schedule of

prices

QS for Client

Cost

Increase / decrease in cost to the client within the current

tendering market

Contractor 1 Contractor 2

Priced BQ

Cost and Current Index

Obtain index for every element

Each section-take the largestvalue itemsuntil a total of25%

Index for a particular project

Average Index for publication

Increase / decrease in cost to the client within the current

tendering market

Current Index

Index by average

Up to 80 priced tender

The formula

(M)(A)

The TPI for a period is the geometric mean of the project

indices of all samples for that period

where

(A) is number of samples

(M) is product value of all indices of the samples

Uses of TPI

1. Cost planning may be improved by bringing the cost of

known projects and historical data to a common level

for comparison purposes using the index.

2. It can be used to set realistic target cost and cost limits.

3. The individual TPI for the project can be used to

evaluate specific price determinants such as location,

building type, method of construction, size of contract

or length of contract.

4. The index of individual project will indicate the

price level against the norm and therefore the

keenness.

5. It indicates the effectiveness of cost planning, e.g.

if the project has a low key index compared to the

norm, and its price level is well above the cost

limit, then it has either been badly cost planned or

the cost limit was inadequate or both.

Uses of TPI

Advantages of TPI

1. It measures the changes of project over time, takinginto account market conditions in addition to thechange in cost to the contractor.

2. Simple to operate once a base schedule of prices hasbeen obtained.

3. It allows comparison for a specific project withnational or regional building price trend.

4. It allows relationship between the market forbuildings of different function and locality to beplotted.

Problems associated with TPI1. A large number of projects are required for each index. It is

suggested at least 80 are required for a suitable sample. Very

few organizations have access to this number of projects and

therefore cannot prepare their own index by this method.

2. The index relies heavily on the base year schedule which will

be regularly revised to take into account new products, new

measurement. This is time consuming and costly task.

3. Lack of projects at any one time results the average index rely

on unbalanced sample containing more jobs of one particular

functions and location. This may lead to error in the trend

plotted.

Items included in the indexItems that are selected must be readily achieve thepurpose of the index, adequately representing the typeof work they are trying to describe. It is necessary toselect items that adequately measure the changes thatare likely to occur, and items with long utilization lifespan.

Weighting of itemsItems in the index must be weighted in accordance with their proportional importance.

Factors to be considered include in the construction of an index

Factors to be considered include in the construction of an index

Which Index?Identify the purpose of the index e.g. building cost index measures costs to contractor whereas tender price index measures cost to client, thus includes the contractor’s profit while building cost index does not include such allowances.

Any index based upon a particular form of construction using a dominant form of material, or combination of components cannot be relied upon to form any realistic assessment other than for that category of work.

Factors to be considered include in the construction of an index• Base year

A typical year with no unusual fluctuations and events shouldbe chosen as the base year. The selection of a sound base year isimportant so that allowance for the increases or decreases maybe soundly based for the subsequent years.

• Method of construction

One common method relies on pricing the same items from atypical bill of quantities. These same items are then re-priced atsome future date. An index is produced that expresses how thesame items have changed in price during the period underexamination. The more complex indices can be based oncomplex mathematical formulae and require computers toprocess the data.

a) Based on past data Indices are constructed based on past data. They are

projected in the future with the assumption that the past trends will largely continue in the future. The projection can be wrong if the trends of price movement changes drastically.

b) Composition The composition of the index is based upon a

representative samples or combination of components. If the composition do not reflect the location, or becomes outdated, or very unique project, then it will not reflect the price movement accurately.

c) Components outside the index Where certain importance materials and components which are

not included in the index, but used in the project with give significant impact in price and this will affect the overall accuracy of using the index. In this situations

d) Substitutes and obsolescence Ideally, to make accurate and realistic assessments for the

various components in the index the same item, the samequantity and common source should be used. However,problem can arise where an original significant componentceases to be used or cannot be used any longer (e.g.asbestos) there will be a need to substitute an alternative inits place, but this may give rise to inaccuracies as we are nolonger comparing the same components.

e)Taste and fashionIndices that remain unchanged in content over a long period oftime are likely to be subject to inaccuracy due to changes intaste and fashion that alter the mix and extent of items in theindex. The content of the index should be reviewed atreasonable intervals to judge whether the balance of items asoriginally established remains valid at a later date.

f) Human error

Where information is collected from a variety of sources using

several people there is always the possibility of errors in

calculations and false submissions, produced either innocently or

consciously.