Cost Management PMBOK® Guide 5th Edition
In the PMBOK® Guide 5th Edition, PMI made a great leap forward in explaining reserve analysis. The new explanation is greatly improved, although there are areas that can still use further delineation. In the text that follows, I will attempt to bring clarity to this subject, including these shortcomings.
Contingency and Management Reserves
The definitions of contingency reserve and management reserves have been completely overhauled in the 5th Edition. The effect is that they are now much more clearly defined, especially when compared to the Guide's 4th Edition. In addition, PMI has added a definition for contingency that is distinct and separate from the definition for reserve. In the 4th Edition, contingency and reserve were treated as synonymous terms. Now, contingency is:
"An event or occurrence that could affect the execution of the project…",
Whereas reserve remains:
"A provision in the project management plan to mitigate cost and/or schedule risk."
In the Guide's 5th Edition, it is obvious that considerable effort went into reworking the definitions of contingency reserves, management reserves and related terms to ensure clarity. In addition, it is clear that contingency reserves are part of the Earned Value Baseline, and that management reserves are not. It is also clear that contingency reserves are factored into determining the project's Budget at Completion (BAC), but management reserves are not. Management reserves are, however, factored into the overall project budget. Except for the one exception noted below, the approach taken in the 5th Edition is shown in Figure 2.
Figure 2 - Reserve analysis as presented in the PMBOK® Guide, 5th Edition
The one exception mentioned above is the disparity between the text in the Guide's 5th Edition and its Figure 7-8, Project Budget Components, and is worthy of some attention. In paragraph 220.127.116.11, the Guide says, "Contingency reserves can provide for a specific activity, for the whole project, or both." (Emphasis added.) One will note that while Figure 2, above, corresponds with Figure 7-8 in the Guide, the written description in paragraph 18.104.22.168 of the Guide overlooks adding a contingency reserve at the work package level, but allows the addition of a contingency reserve at the whole project level, which is not reflected in the Guide's Figure 7-8 or in Figure 3 above. This needs clarification.
Also worth noting is the idea that contingency reserves can be added in twice, as noted by the words within the textual reference "or both." Another way of reading the referenced sentence is that contingency reserves, once factored into the project's cost baseline, can be bound to the activity for which they were computed, or be amassed in a single, large contingency amount that can be distributed across the project where needed. For me, the intent of the Guide's authors is unclear.
Another issue that is not clear comes from the same figure. This pertains to how contingency reserves are incorporated, which show up as both additions to Activity Cost Estimates and to Work Package Cost Estimates. This is not discussed in the text, but rather only shows up in the figure. The impression the figure leaves is that contingency reserves are added at both the activity level and the work package level, meaning that one is incorporating a contingency amount in the estimates twice, or double counting. In my opinion, the contingency reserve should only be added at one level, and neither of these levels is what I would recommend.
A third issue is that activities are part of the project schedule, and not necessarily a part of the work breakdown structure. Figure 7-5, Estimate Costs Data Flow Diagram, indicates that process 6.6, Develop Schedule, must be done before one can do process 7.2, Estimate Costs. Depending upon the type of estimating technique used and degree of accuracy desired, the project schedule may not have to be done in order to prepare a cost estimate. Only if one is doing a detailed, bottom-up estimate would it be necessary to first work out the schedule. When doing rough order of magnitude estimates using a bottom-up approach, one may only have the WBS to work with, meaning that one might not yet have activity information to work with.
In response to all of the issues cited above, I refer the reader to my recommendations in Part 2 of this paper: A Recommended Solution.
8. PMBOK® Guide 5th Edition, p533
9. Ibid, p558
10. PMBOK® Guide 5th Edition, p213, Figure 7-8
11. Ibid, p206, para 22.214.171.124
12. Ibid, p213, Figure 7-8
13. I prefer the approach found in the Guide's 3rd Edition,
which is reflected in Figure 1
of this article. The rationale for this is articulated further down
in this article.
14. PMBOK® Guide 5th Edition, p201, Figure 7-5