3.20 A project's total approved budget can be disaggregated into two elements:
● the programmed budget, which covers the project's approved activities, including approved actions to treat risks that were identified prior to the budget's approval; and
● the contingency budget, which is provided to cover the costs of any approved actions for new technical, financial and schedule risks or emerging issues that arise within the approved project scope.
3.21 As a result of the JCPAA's interest in the DMO providing a higher level disclosure of projects' contingency budgets in the MPR,59 the ANAO examined the contingency log for each project reviewed in 2009-10.60 The observations made by the ANAO included the following:
● where projects had used contingency funds, the purpose appeared to be within the approved scope of the project, with appropriate formal sign-off required before the contingency funds could be spent;
● the method for managing and recording a project's contingency budget varied, with some projects demonstrating a direct link between the contingency log and the approved risks identified in the risk log, while for other projects there was a less direct relationship;
● while the recording of contingency budget allocations within the contingency log is not required by DMO Finance Instructions, DMO does consider the practice to represent good management practice;61
● where projects allocated contingency funds to mitigate or address an actual risk, the method for assigning costs also varied. Some projects attributed contingency budget on the actual expected costs of the risk treatment, while other projects used a proportionate allocation based on the likelihood of the risk eventuating; and
● the ANAO observed that some project contingency budgets have made provision for an anticipated price indexation gap between price indexation obligations built into current supplier contracts with industry62, and the fixed 2.5 per cent per annum price indexation the DMO now receives through the budget and appropriation process. Prior to 1 July 2010, the DMO was supplemented for price indexation based on the non-farm Gross Domestic Product deflator.
3.22 The appropriate management of contingency to deal with any indexation gap is also highlighted in the Defence Procurement Policy Manual, which states, "Procurement Officers should ensure that where indices for variation in the cost of labour and/or materials are proposed to be included in their contracts, the project has sufficient contingency in their budget to cover future increases in their agreed labour and materials indices."63
3.23 The ANAO notes that the emergence of any indexation gap would to some extent change the nature and use of the contingency budget, from dealing with project risk management to broader price management, and will require project staff to have a greater understanding of the factors that influence indices and their likely movement over the life of the project.
3.24 Further information on contingency management has been provided by the DMO at Part 2, paragraphs 2.37 to 2.40 of this report.
___________________________________________________________
59 Joint Committee of Public Accounts and Audit, Report 416, Review of the Major Projects Report 2007-2008, November 2009, pp.13-14.
60 A contingency log is used to record the use of contingency budget.
61 Defence Materiel Instruction (DMI), Management of Contingency Budget in DMO Acquisition Projects; and DMO Project Risk Management Manual (PRMM) 2010, Chapter 9 - Contingency Budgets, p.111.
62 Contract escalations are usually based on indices linked to the price of labour and materials.
63 Defence Materiel Organisation, Defence Procurement Policy Manual (April 2010), Section 3, Chapter 3.3 Financial Policy and Advice in the Procurement Process, paragraph 15.