COST VALUE RECONCILIATION AND EARNED VALUE

INTRODUCTION A Projects success or failure is basically hinged on three constraints of Cost, Time and Quality and their interrelation. McGowan, (2006, p.2). states that all construction projects contain elements of uncertainty and financial risk and therefore the possibility of financial loss. It is no wonder that business analysts, accountants and the like find the industry perplexing. After so much effort, sheer manpower, uncertainty and risk aversion, construction projects will typically make a single digit net profit percentage after deducting a contribution to the fixed overhead costs of the business. Therefore, for all construction projects it is essential to have efficient cost controls and financial management. The use of cost control in Construction projects cannot be over emphasized since the primary aim of organizations is profit maximization. The focal point of this paper is going to be on cost management of which Earned value and Cost value reconciliation would be reviewed showing their effectiveness in providing information about cost and in monitoring progress of the works, which party benefits most from their use, ease of use in practice, and their advantages and disadvantages.

COST VALUE RECONCILIATION (CVR) CVR is the act of determining and reporting profitability on a construction project on a regular basis. It is the comparison of cost with value (revenue) per time, the difference being the cumulative loss or profit on the project. The information from CVR is very effective provided the cost information is accurately collected and interpreted, this is because it takes into account SSAP9 which has a dual function of forming the basis for statutory accounts, which is a legal requirement being the guidelines for standard statement of Accounting practice number 9 (SSAP9 ICAEW) which sets out accounting requirements and recommendations for the construction industry. This requirement promotes prudent financial statements highlighting losses or potential losses immediately so the business does not claim to be more profitable than it is. Secondly, and perhaps more importantly, it provides management information to assist in the identification of problems, the need for reserves, the reasons for loss and information to prevent repetition of such losses( Potts, 2008, p.199). It also has a high degree of progress monitoring of works as this responsibility is bestowed on the clients QS or representative whose primary concern is to undertake external valuation at a mutually agreed cut off date, for the benefit of the contractors CVR process; to ensure the

level of work achieved meets the agreed milestone before activating the process of payment for contractor, and the QS or site manager on the contractors side who makes a case for necessary conservative adjustments, disputes and variations to be included as stipulated by SSAP9.

CVR is a management tool used for Budget monitoring, cost & value forecasting and project cost account. This goes to underscores the reliability of its output on cost information as it can be used to This tool is adequately suited to measure not only the current financial positions of a project, but the current financial position of a contracting company with its implications on the management of its operations. The traditional CVR process placed emphasis on cost and value to the detriment of time which is a very important factor in measuring project performance. Stephenson & Hill (2005, p.12) 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 levels, methods of sequence of work, and programme progress, would also be provided. This would facilitate cost/time assessment and provide a direct relationship between cost and progress/performance on construction projects.

Advantages 1. Gives accurate statement of the present profit/loss on Individual projects, financial year for company. (Sidwell, 2005). 2. It provides management information that assists in identification of Problems, the need for reserves, the reasons for loss and information to Prevent repetition of such losses (Potts, 2008, p.199). 3. It provides greater control outside the boundaries of the project; this is as a result of the cost control measures being applied at the organizational level to enhance the project performance to meet the financial objectives of the company. 4. In order to adequately control project finances CVR process encourages reconciliations at frequent intervals not only to establish profitability but also to point out any financial difficulties. 5. Traditional CVR used with BMS gave the adv of monitoring cost in relation to time thereby enabling progress/performance on projects. It is also worthy to note that this combination of techniques reduces the possibility information that can be subjective to judgement. 6. Time frame for the reconciliations is reduced at project level as the bulk of the calculation is produced outside the organization by client.

Disadvantages 1. Stephenson & Hill, (2005, p. 8) state that traditional CVR focus on the skill requirement of the individuals producing the CVR even though this information is subjective to judgment.

2. The traditional CVR tends to give the responsibility to determine value earned more to the client; this might have adverse effect on contractors account if not properly monitored to ensure it represents work completed. 1. Traditional CVR is not suitable for use on the operations of small value and short term contracts or for contractors with less financial capabilities as the value may no longer be commensurate with the cost incurred for this level of financial control. 2. CVR is unable to categorize the event that triggers a loss even though it identifies that the project is running at a loss. 3. 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). 3. For an effective CVR assessment to be carried out more information would be required to determine the current financial position of a project. 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).

4. At organizational level, it is tedious to transfer information from various projects to company accounts due to different cut off dates to determine cost to date. 5. This approach suffers from the disadvantage that there is no breakdown of the cost/profit figures between the types of work or different locations within the project; it therefore only provides guidance on which project requires senior management attention. Potts (2008, p.199)

EARNED VALUE: can be defined as the performance measurement to report the status of a project in terms of both cost and time at a given data date (Popescu & Charoenngam, 1995). This concept has been a part of cost/schedule control systems criteria (C/SCSC) developed by the US department of defense. (Fleming & Koppelman, 1994), it is used for projects where the big-picture needs to be reviewed monthly (Potts, 2008, p.198) If a company employs the earned value concept, the cost status at a given progress can be identified. This gives an insight on whether and how much, at a given progress, the total expenditure of each item has been over or under the established budget and this can be done before the finishing of any work item so that timely proper corrective actions can be taken before being too late. There are three major element of Earned value. At any point in time we have planned work, actual work and cost of the actual work, allowing for full analysis of project progress and performance. By comparing these elements, we can be sure of the true state of a project. This is because the project manager will be able to know really why the actual cost is less than the budgeted cost. If the activity is going on as planned, it means the project is doing well as it is costing less than planned which is a sign of profit, but if there is a delay, it means that what was planned is more than what has been achieved for the particular time. That therefore is not a good sign as it clearly tells you that in terms of time the project is not doing well and in the financial aspect profit is not certain as the work is less than the intended work with a reason for the difference being cost.

Using the three elements of earned value, other terms as shown can be calculated. These are Budget at Completion (BAC), Estimate at Completion (EAC) Schedules Variation (SV) and Cost Variation (CV). Earned Value is practically applied to any project in nine steps. The first five (5) steps is the setting up while the remaining four (4) steps is its use. The following are the steps:

1. Establish the Work Breakdown Structure (WBS). WBS provides a multi-level structure for analyzing a project at varying degree. It provides that each element is the responsibility of an individual who has managerial authority over those

elements. This is organised along the component line of a project with each lower elements rolling into one and only one element at the next level above it .The bottom level should be the activity of the project.

2. Identify the Activity. The WBS provides the frame work for identifying the project activity components. The completion of this step produces the project schedule activity.

3. Allocate the Cost. This step involves identification and allocation of cost to be expected on each activity. This is because resources are expended in the duration of time towards each activity.

4.

Schedule for Activity. This provides the spread of resources over the entire duration of the project. This generates the BCWS curve.

5. Tabulate, Plot and Analyze. This involves tabulating and plotting of the information that was loaded and finally analysing it. This ensures that the allocation of resources is properly planned. It is three folds- analysis of individual resources to see if the maximum requirement during any time period is available. Also provides review of cash flow to see if financing plans for the project supports the schedule and provide review to see that all project resources and costs that are budgeted are in the programme.

6. Update of the Schedule. This is the first in the periodic process involving the update of the schedule with the periodic progress. The project schedules are reported as started, complete or with a remaining duration as appropriate. The percent complete of unfinished activity should be reported. The practitioner should avoid subjectivity.

7. Enter the Actual Costs. The second is to enter the actual cost into the schedule from the time sheets and invoice to the project

8.

Calculate Print and Plot. Earned value is calculated and reports printed, and charts plotted for analysis. The earned value is simply the percent complete of an activity times its budget. Other values like the schedule and cost variances, performance indices, estimate at completion and percent complete of the upper elements of the WBS can be calculated.

9. Analyze and Report. The final step is to analyze and report the result of the analysis Earned value therefore provides a uniform methodology of assessing elements that make up a project activity even though they are very different in nature. It also enhances the cost performance analysis of a project, and the percent complete of a project.

Advantages 1. The technique can be applied to the management of all capital projects in any industry, while employing any contracting approach.(Potts, 2008, p.201) 2. An open and verifiable view of progress improves sponsor confidence (Webb, 2003). 3. When used to forecast, output is easily understood. 4. EV provides a consistent method of analysis for project cost and schedule. Disadvantages 1. Emphasizes time instead of the actual progress of activity on the project. 2. It is not suitable for small projects of time and resources it uses. 3. It is deterministic as it does not address critical path. 4. EV does not address variations nor does it handle management reserve.

The afore mentioned has looked at the advantages and disadvantages and can reasonably conclude that CVR method of cost control benefits the contractor more since it helps both at project and organizational level to meet the statutory requirement of providing periodic statement of accounts and at providing data for management operational decisions. It is a tedious and complex process which would prove hard for a client to grapple with except he employs the services of a technical consultant to undertake the external valuations on his behalf; its benefit to the client is providing a basis for the client to verify status of work before making financial commitment. This method of cost control gives value to both the client and the contractor, its more detailed analysis of the sections within the project in order to identify those sections of the works which are underperforming. (Potts, 2008, p. 198) It was not suitable for small contractors with lower financial capabilities as the value they would receive, with regards to the level of control desired would be largely outweighed by the resource input required, this was until research identified a model that would simplify the process of producing CVR, using in conjunction with the Budget Monitoring System BMS without reducing the accuracy of the information output at project level.

EV focuses on cost and value without being able to show exact reasons for cost or time over runs, as stated by (Harrison, 1993) that, 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. It is suitable for very large and complex projects and benefits the clients more as its easily read and does not go into the minute details but shows a general view of the whole project showing the relationship between cost and time highlighting the shortfall. It may be used for some small to medium contracts.

REFERENCE
Barrett, F. R. (1992) Cost Value Reconciliation (2nd edition), Berkshire, The Chartered Institute of Building.

Charoenngam, C. & Sriprasert, E. (2002) Assessment of cost control systems: a case study of Thai construction organizations . Engineering Construction and Architectural Management. Volume 8, Issue 5-6, pages 368380, October/December 2001

Fleming, Q.W. & Koppelman, J.M. (1994) The essence of evolution of earned value. Cost Engineering, 36, 2127. Harris,F. & McCaffer,R. with Francis Edum-Fotwo (2006) Modern Construction Management. 6th edn. Blackwell publishing. Mcgowan, P. (2006) Improving the cost/value reconciliation (CVR) process in the construction industry. Easybuild White paper. Popescu, C.M. & Charoenngam, C. (1995) Project Planning, Scheduling, and Control in Construction . An Encyclopedia of Terms and Applications. John Wiley & Sons Inc., New York. Potts,K. (2008) Construction Cost Management. First published 2008 by Tayrol & Francis. Stephenson, P. &. Hill, M.S. ( 2005) Cost Value Reconciliation (CVR) in the UK Construction Industry. In: Sidwell, A.C. (ed.), Conference proceedings: The Queensland University of Technology Research Week International Conference. 4-8 July 2005. Brisbane, Australia Webb,A. (2003) Using Earned Value, A Project Managers Guide, published byGower Publishing Limits