PROVISIONAL SUM

A provisional sum is an allowance included in a fixed price construction contract for an item of
work that cannot be priced by the contractor at the time of entering the contract.

What’s the difference between a provisional sum and a prime cost?

Traditionally, a prime cost is limited to the cost of supplying the relevant item and does not
include the cost of any work that relates to it (such as its installation).
In contrast, provisional sums include allowances for both the supply item and all related work to be
performed by the contractor.
In practice, the distinction is often more academic.
For example, under both AS 2124 and AS 4000, the definition of ‘provisional sum’ includes prime
cost items. The result is that provisional sums and prime costs are treated exactly the same way
under these contracts.

Confusion can arise regarding two items that may appear in standard forms of building
contract – prime cost sums (PC or PC sums) and provisional sums (PS). They both relate
to estimates made for certain costs in the absence of exact figures.

A prime cost sum is an allowance, usually calculated by the cost consultant, for

the supply of work or materials to be provided by a sub-contractor or supplier that will
be nominated by the client - that is, a supplier that is selected by the client to carry out
an element of the works and imposed on the main contractor after the main contractor has
been appointed.

The main contractor is entitled to add mark up and attendance costs to the allowance. If the main

contractor's actual costs then turn out to be higher, the contract sum is increased, and if the main
contractor's actual cost is lower, the contract sum is reduced.

For more information see: Prime cost sum.

A provisional sum is an allowance, usually estimated by a cost consultant, for a specific element of

the works that is not yet defined in enough detail for tenderers to accurately price.

Depending on the degree to which the works that the provisional sum relates to can be described

at the tender stage, provisional sums may be referred to as 'defined' or 'undefined'.

The 5 Main Types of Contracts in Construction

1. Lump Sum Contracts
Lump sum contracts, also known as fixed price contracts, are the most basic type of construction
contracts. That’s because they outline one fixed price for all the work done under them. For this
reason, lump sum contracts are extremely common in construction. Odds are most contractors
have entered into multiple lump sum contracts in the past.
However, as simple as the one price formula seems, lump sum contracts aren’t so cut-and-dry.
Here are a few key benefits and drawbacks of lump sum contracts:
Pros of Lump Sum

 Lump sum contracts simplify bidding. Naming a total price rather than submitting
multiple bids simplifies the selection process for owners and GCs.

 Finishing under-budget means high profit margins. Because the price for the project is
set in stone, finishing under-budget means you pocket the savings.
Cons of Lump Sum

 Miscalculations destroy margins. When drafting a lump sum contract, you need to
account for every variable. Since there’s one set price, unexpected setbacks or changes
during a project cut directly into your profit margin.

 The bigger the project, the more room for loss. If you’re working with subs and suppliers,
there is no room for error. The cost of those inevitable missteps and setbacks from sub-tiers
comes right out of the lump sum price.
As you can see, lump sum contracts involve a fair amount of risk for contractors because they
don’t account for unexpected costs or delays after the project is started. Missteps mean you make
less money, or, even worse, lose money on a project.
That’s why lump sum contracts are best suited for smaller projects with predictable scopes of
work.
2. Time and Materials Contracts
As opposed to lump sum contracts, time and materials (T&M) contracts work best for projects
in which the scope of work is not well-defined. Time and materials contracts reimburse contractors
for the cost of materials and establish an hourly or daily pay rate.
Here’s an overview of the pros and cons of time and materials contracts:
Pros of T&M

 Time and materials contracts are agile. Since the customer reimburses the contractor for
the cost of materials and pays an hourly wage, unexpected delays, roadblocks, and other
changes to the scope of work are covered.

 Time and materials contracts allow for simple negotiations. Setting rules for what
materials will be covered and what the hourly wage will be is simple with time and materials
contracts.
Cons of T&M

 Tracking time and materials is time consuming. Logging each and every material cost on
a project is no small task, and failure to provide an accurate number upon completion
means lower profit margins. Doing a thorough job here means you spend more time
crunching numbers and less time doing the work.

 Efficiency isn’t rewarded. Since time and materials contracts pay by the hour or day,
there’s no real incentive to finish a project early. However, it’s common practice to stipulate
a bonus for finishing ahead of schedule.
When you consider the unpredictable nature of any given construction project, the owner bears a
considerable amount of risk with time and materials contracts. That’s because they’re required to
pay the contractor for any unexpected costs, changes, or time overruns that take place over the
course of the project, costing them more than they initially planned for.
3. Cost-Plus Contracts
Cost-plus contracts, otherwise known as cost-reimbursement contracts, involve the owner paying
the contractor for the costs incurred during the project plus a set amount of money for profit,
which can be determined by a percentage of the total price of the project.
The costs covered by cost-plus contracts can involve direct costs (i.e. direct labor and
materials), indirect costs (i.e. office space, travel, and communication expenses), and profit (i.e. the
agreed upon fee or markup).
Pros of Cost-Plus

 Cost-plus contracts are flexible. Cost-plus contracts allow owners to make design changes
along the way, and contractors know they’ll be paid for the extra time or materials those
changes incur.

 Miscalculations aren’t devastating. Since cost-plus contracts are flexible by nature,

inaccuracies in the initial bid aren’t as detrimental as they are with lump sum contracts.
Cons of Cost-Plus

 Justifying some costs can be difficult. Cost-plus contracts require contractors to justify
the costs on a given project. Sometimes those costs can be hard to account for, and owners
can be resistant to reimbursing indirect costs like administrative expenses and mileage.

 Fronting the cost of materials can put contractors in a bind. Since cost-plus contracts
operate through reimbursement, paying more than you expected for materials could mean
you’re spread thin for the remainder of the project.
When it comes to cost-plus contracts, the majority of the risk is placed on the owner. That’s
because the contractor is paid for all costs incurred during the project, and any unforeseen
expenses come out of the owner’s pocket. For that reason, cost-plus contracts are best suited for
projects in which a lot of creative flexibility is needed.
4. Unit Price Contracts
Unit price contracts divide the total work required to complete a project into separate units. They
are also known as measurement contracts, measure and pay contracts, or remeasurement contracts.
The contractor provides the owner with price estimates for each unit of work, rather than an
estimate for the project as a whole.
Unit price contracts are useful for projects in which the work is repetitive, heavily dependent on
material costs, and the amount of work needed isn’t clear before the project is started.
Pros of Unit Price

 Unit price contracts simplify invoicing. Unit price contracts allow for increased
transparency. Owners can easily understand each cost that goes into the final price of the
contract because the price of each unit is predetermined. This helps avoid disputes and
arguments when it’s time to pay up.
  If more work is required, the profit margin stays the same. Any extra work that’s needed
is simply added on as another pre-priced unit, making it easier to manage change
orders and other alterations to the scope of work.
Cons of Unit Price

 Predicting the final value of the contract can be difficult. Usually, the amount of units
needed to complete a project isn’t known immediately. This means owners may pay more
than they expected.

 Remeasurement can delay payment. Remeasurement, or the owner’s ability to compare

the price of each unit with the total cost of the project, can slow down payment. Although
transparency is something we should all strive towards, this may be something you want to
consider.
When it comes to unit price contracts, the majority of the risk lies with the owner because they
must reimburse the cost of unexpected units that are added. However, the transparency they
afford is a massive benefit to all parties involved.
5. GMP Contracts
Guaranteed maximum price (GMP) contracts establish a cap on the contract price. With this
type of construction contract, the property owner won’t exceed the contract price. Any material or
labor costs above that price should be covered by the contractor.
Sometimes, another type of construction contract may also include a GMP provision. For example,
a cost-plus contract could include a clause that limits total costs to a guaranteed maximum price.
Guaranteed maximum prices are a common feature in construction contracts, and they’re best
suited to projects with few unknowns. For example, the construction of a retail chain with plans
that have been used over and over.
Pros of GMP

 GMP contracts make for quicker projects. Having a final contract price accelerates the
bidding process, and it makes financing projects easier because lenders know the maximum
amount a given project will cost early on.

 GMP contracts incentivize savings. Having a fixed price overhead incentivizes contractors
to reduce costs and finish ahead of schedule. Owners usually agree to share cost savings
with their contractors.
Cons of GMP

 GMP contracts place risk on contractors. Unfortunately, GMP contracts force the party
doing the work to absorb cost overages in the event the contract price maximum is
exceeded.

 GMP contracts can take longer to review and negotiate. In order to protect themselves
from exceeding the price cap, contractors may try to increase the maximum price of the
contract. When this happens, the negotiation process is elongated and the project takes
longer to start.
Since the owner won’t pay for any cost overruns, guaranteed price contracts shift a lot of risk onto
contractors. Considering that risk, one thing contractors can do is use a good cost estimating
software. Job costing is an important accounting process on any construction project, and having a
solid estimate will minimize risk by helping contractors avoid overcharging or undercharging the
owner.