Computation of Price Adjustment in a Construction

Contract – FIDIC RED BOOK

Contents

Background........................................................................................ 2

Price adjustment in FIDIC conditions of contract FIDIC red book .............. 2

The Table of Adjustment Data .............................................................. 3

Adjustment Formula............................................................................ 4

Application of Price Adjustment on a Virtual Project ................................ 5

BY BARASA ONGETI
Background
This document addresses the application of price adjustment in contracts for goods,
works, and plant that are based on the FIDIC Conditions of Contract for Construction of
Works Designed by the Employer (FIDIC Red Book, 1999).

It highlights the the principles of price adjustment and discusses the procedure to be
followed in computing price adjustment for construction contracts. This document
includes explanations of components in the price adjustment formula. A sample
computation is demonstrated. It may be used as reference during project preparation,
the procurement process, and for contract management.

Often, a significant amount of time passes between bid submission and project execution.
During this period, a substantial cumulative rise (or fall) of commodities may occur and
result in increases (or decreases) in price. Price adjustment clauses in construction
contracts therefore are essential in protecting the project owner and the contractor from
these fluctuations.

Price escalation is likely to arise:

▪ for goods contracts with long delivery periods;
▪ for works contracts with long completion periods;
▪ for major civil works contracts;
▪ for contracts that contain supplies or commodities whose prices
▪ fluctuate significantly over a short period;
▪ for time-based consulting services, such as construction supervision
services; and
▪ due to any unusual circumstances in the market in question.

Price adjustment is a modification made to the overall price of a contract to take account
of legitimate changes in the costs of performing the contract. The intention of including
price adjustment clauses in construction contracts is to protect both the project owner
and the contractor from unforeseeable market fluctuations of input prices such as costs
of labour, materials and equipment. Price adjustment provisions are planned during the
tender stage and bid preparation stages of the construction cycle and are implemented
as necessary during project execution phase.

Price adjustment in FIDIC conditions of contract FIDIC red book

Clause 13.8 in the FIDIC Suite (1999) allows for the amounts payable to the Contractor
to be adjusted for rises or falls in the cost of labour, Goods and other inputs to the Works,
by the
addition or deduction of the amounts determined by the formulae prescribed under that
Sub-Clause.

BY BARASA ONGETI
This sub-clause only applies if the completed table of adjustment data for local and
foreign currencies included in the Schedules is completed at tender. If there is no such
table of adjustment data, this Sub-Clause does not apply.

The Table of Adjustment Data

The bidding documents will specify how information in “Tables of Adjustment Data” is
to be provided. Bidders will provide coefficients for an a fixed and an adjustable portion
for payment in local currency and foreign currency(ies) in their bids.

An example, ordinarily contained in the Bid Submission instructions, is shown in the

figure below.

The Bidder will enter proposed weightings for the indices B, C, D, and E of determined
definitions, sources and corresponding bid amount.

The base date is the date 28 days prior to the closing date of bid submissions. [Sub-
Clause 13.8]

BY BARASA ONGETI
Adjustment Formula
The adjustment for changes in cost (price adjustment) is to be applied to the payment
certificates in the appropriate currency of payment.

The formula is of the following general form:

𝐿𝑛 𝑀𝑛 𝐸𝑛
𝑃𝑓𝑛 = 𝑎 + 𝑏 ( )+𝑐( )+𝑑( )+⋯
𝐿𝑜 𝑀𝑜 𝐸𝑜

Where,

▪ “Pfn” is the adjustment multiplier, applied to the amount due for works carried
out in the period “n”;

▪ “a” is a fixed coefficient, representing the non-adjustable portion in contractual

payments;

▪ “b”, “c”, “d”, … are coefficients representing the portions of cost elements such as
labour, equipment and materials;

▪ “Ln”, “En”, “Mn”, … are the current cost indices for period “n”, on the date 49 days
prior to the end of the period to which the particular Payment Certificate relates;
and

▪ “Lo”, “Eo”, “Mo”, … are the base cost indices applicable to the relevant tabulated
cost element on the Base Date and tabulated in the schedule of adjustment.

Succinctly put, the adjustment multiplier is obtained by the ratio of each cost element at
the time of the statement to the cost at base date, multiplied by the coefficients
determined at tender.
In cases where the “currency of index” is not the relevant currency of payment, each
index shall be converted into the relevant currency of payment. Provisional indices may
be used until the current indices become available. The weightings (coefficients) for each
of the factors of cost stated in the table(s) of adjustment data remain fixed. However,
they may only be adjusted if they have been rendered unreasonable, unbalanced or
inapplicable, as a result of Variations.

BY BARASA ONGETI
Application of Price Adjustment on a Virtual Project

Please note that the indices used for the purpose of this document are only
demonstrative, and are not derived from any real source.

The Contract documents define the Schedule of Adjustment Data as below:

The Schedule will ordinarily identify the index code, its description and the cost it relates
to, the source and the weight as selected by the bidder. The value of the indices will be
the value relevant on the base date as derived from the source.
Notice that the sum of all the weights, is 1. (0.15 + 0.09 + 0.26 + 0.40 + 0.10 = 1.00)

The computation procedure will be in the order of the following steps:

i) Obtain the current value of the indices at the date 49 days prior to the end of
the invoice period. If the statement relates to works completed at the end of
March 2019, then 49 days prior to that would be on or about 11 February 2019.

Values of the Indices 49 Prior to the End of the Period Invoiced:

Ln Labour = 122.5
En Equipment = 132.2
Mn Material = 2120.0
Fn Fuel = 117.1

ii) Obtain the adjustment multiplier, using the formula in Sub-Clause 13.8 of the
Conditions of Contract:

122.5 132.2 2120 117.1

𝑃𝑓𝑛 = 0.15 + 0.09 ( ) + 0.26 ( ) + 0.40 ( ) + 0.10 ( )
120 131 2240 107.0
𝑃𝑓𝑛 = 0.15 + 0.092 + 0.262 + 0.379 + 0.109

BY BARASA ONGETI
 Pfn, Multiplier Coefficient = 0.992

iii) The value of works would be the value contained in the statement that the
Contractor considers due for payment.

Po, Value of works done = KES 1,253,200

Pn, Adjusted Value of works = Pfn x Po
= 0.992 x KES 1,253,200
= KES 1,243,174

iv) Therefore, the adjusted amount can be obtained.

ΔP = Pn – Po, Adjusted amount = 1,243,174 – 1,253,200

= KES (- 9690.54)

This is a negative value. This means that some of the cost elements underwent a decrease
in price during the invoice period, as compared to the reference date at tender. From our
example, we can easily see that the cost of materials went down from 2240 to 2120. This
has a net effect of bringing about a multiplier of less than 1. Subsequently, the adjusted
value becomes less than the actual value.

In most cases however, in practice, it is more likely that cost elements increase in price.

If the contract sum is payable in different currencies, then a similar procedure is followed
for the foreign currency. The results above are best presented in a spreadsheet,
accompanied by notes elaborating the computations:

***

BY BARASA ONGETI