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Suitable Cost Escalation Indices for Volatile Economic Conditions

Raieszadeh, Abbas | 2014

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  1. Type of Document: M.Sc. Thesis
  2. Language: Farsi
  3. Document No: 45646 (09)
  4. University: Sharif University of Technology
  5. Department: Civil Engineering
  6. Advisor(s): Mortaheb, Mohammad Mehdi
  7. Abstract:
  8. Under volatile economic conditions, where inflation is high and market prices of materials, labor, and equipment change unexpectedly, construction cost rise. To avoid the disruption of work, the owner may be required to compensate the contractors in a way that the excess construction cost is partially or completely covered. This compensation should be provided to the contractors in a way that is authorized by the laws and regulations under which the contract is stipulated. Hence it is essential to have the proper mechanism, for sharing the burden of cost overruns caused by unforeseen economic conditions.
    In Iran, the payment scheme for the majority of the medium-and large-scale contracts is based on unit cost indices. In many cases, the unit cost indices are calculated based on outdated market data. As a result, the indices do not reflect the actual costs of performing construction activities. In addition, irregularities in publishing adjustment (escalation) indices along with high inflation, makes these adjustments useless. The objective of this study is to demonstrate the gap between the actual construction costs and the construction costs calculated based on unit cost indices as well as an appropriate approach to closing this gap to the extent possible. The itemized analyses performed, as part of this study, show that the difference between actual construction costs and the costs calculated using unit cost indices has been widening over time. For instance, the ratio of actual construction costs to the cost calculated based on indices for steel forming (Chapter VI buildings) has grown from 1.41 in 1389 to 2.7 in 1391. Similarly, for concrete works (Chapter VIII buildings) the same ratio has grown from 1.23 in 1389 to 2.12 in 1391. In order to narrow down the gap between the contractors' actual construction costs and clients' payments in such circumstances, it is suggested that the parties to the contract agree upon using adjustment indices that reflect the real market prices. These indices are commonly developed based on known indicators such as Passche, Laspeyer and Fisher. By utilizing these mechanisms, contractors can ensure that they are compensated for the economic risks such as high inflation on which they have no control. Ultimately, it is expected that adopting these mechanisms can lead to the reduction of claims and time extensions as well as the overall project construction costs for the clients.
  9. Keywords:
  10. Inflation ; Unit Cost Indices ; Actual Construction Cost ; Construction Cost Indices

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