During one of the recent PMP® exam preparation sessions, I came across a very unique but an interesting query on, ‘What is the Point of total assumption (PTA).’ Though not a crucial question from PMP® exam point of view, it still needs a detailed discussion. By and by I noticed that there are lots of misunderstandings and confusions that need to be cleared about PTA.

This concept is only related with fixed price incentive fee contracts and refers to the amount above which the seller bears all the losses of an additional cost overrun. The concept work when buyer and seller has agreed criteria for fixing the price, and buyer is willing to repay part of cost overrun till it reaches a ceiling price.

Let’s look at a few terms before we get into the PTA.

Target Cost: This is the estimated budget, which the seller has planned for delivering the given project; it can be looked as a project budget,in this type of contracts this is shared with the buyer and the process of estimating project budget is also kept transparent.

Target Fee: This is the fee which the seller wants to charge for the work he is doing, this is the planned fee, and the actual fee will depend upon how well the seller manages the project (cost overruns)

Target Price: This is the price the buyer is looking towards, this is a sum total of Target Cost + Target Fee, both seller and buyer use this as a benchmark, if the final project cost less than this price, buyer and seller will share the profit as per profit sharing agreement, if the price goes beyond the target price, buyer and seller share the cost as per cost sharing agreement (subject to maximum ceiling of selling price)

Share ratio:In this type of contract we will have two types of ratio, one for sharing profit, which is used when the project cost less than the target cost and another is cost sharing ratio which is used when the project cost more than the target cost.

Ceiling Price: this price is put by the buyer to limit the cost liabilities, buyer will not pay anything beyond this price, even if the actual project cost more than the ceiling price buyer will not pay anything extra than the ceiling price.

Let’s look at the formula of PTA

PTA =  (Ceiling Price – Target Price) / Buyer’s Share Ration + Target Cost

Lets take an example, I am taking the example from Rita Mulcahy’s PMP Exam Prep Eighth Edition page no 480.

Target Cost150,000
Target Fee30,000
Target Price180,000
Sharing Ratio (Cost Overrun Sharing Ratio)60/40
Ceiling Price200,000

 

Let’s calculate PTA for this

PTA =  (Ceiling Price – Target Price) / Buyer’s Share Ration + Target Cost

PTA = (200,000 – 180,000) /. 60 + 150,000

PTA = 183,333

What does it mean?

The seller should target that the cost of development should not touch Point of Total assumption (PTA) (183,333), if it touched PTA all further cost overrun has to be paid by the seller. Looks theoretical? Lets see what number speaks, here I have created seven scenarios of actual cost, it is starting from target cost equal to actual cost, we are only discussing the case which is associated with cost over run we are not discussing profit sharing here.

S.NoActual CostActual Price (Actual Cost + Target Fee)Price Overrun (Actual Price – Target Price)Buyer’s Share (60% of Price Overrun till PTA)Buyer’s  Payout (Target Cost + Buyer Cost Overrun Share,not more than Ceiling Price)Seller’s Profit (Buyer Payout – Actual Cost)
1150,000180,00000180,00030,000
2160,000190,00010,0006,000186,00026,000
3170,000200,00020,00012,000192,00022,000
4183,333213,33333,33320,000200,00016,667
5190,000220,00040,00020,000200,00010,000
6200,000230,00050,00020,000200,000(0)
7210,000240,00060,00020,000200,000(10,000)

 

Here are some of the things which you might have observed

  1. The seller makes a target profit only when he meets target price, scenario no 1
  2. When the project cost more than the target price, seller profit starts reducing, though the buyer also shares the cost of over run as per agreement ratio scenario 2 and 3
  3. When the cost goes beyond Point of Total Assumption (PTA), buyer cost overrun sharing get frozen, any further increase in cost does not affect buyer payout. Since the total payout touches the ceiling price. The seller may still make profit scenario 4 and 5
  4. The seller will lose money when the cost goes beyond ceiling price, scenario no 7

 
PTA- Actual Cost vs Buyer payout

This graph shows how profit margin starts shrinking once seller miss the target price and margin shrink further when PTA point is reached and seller start making a loss when the actual cost goes more than the ceiling price.

Now I guess it should be easier to understand that if actual cost touches PTA all further cost overruns has to be paid by the seller.

Check out the important PMP® FAQs on Point of Total Assumption (PTA)

What all constitutes the buyer payout, will the seller always get cost and fee from the buyer?
The buyer payout is driven by target price and overrun, now initially when we calculated the target price we used target cost and target fee in driving it, as seller breach the target price, seller profit (fee) starts reducing, its not a cost reimbursable contract where you get all your cost + fixed fee, it’s  a fixed price incentive fee contract, so your profit goes down as you breach the target price.

Does this mean after PTA the cost over run sharing ratio changes to 0:100 (Buyer: Seller)
This sometime looks confusing since we calculate the cost over run based on target price, it’s better to understand that after PTA the cost of buyer reaches the ceiling price, so he does not pay share cost of additional overrun, he is still paying the ceiling price (not target price). If I plot a bar chart of the scenarios discussed in this blog it shows that after PTA point, scenario no 4 buyers share, for cost overrun is frizzed to 20,000, all extra money has to be paid by seller.

PTA - Point of total assumption

To get the maximum profit what a seller should do in this type of contracts?
Manage the project in less than the target price, once a seller breaches the target price his profit starts shrinking.

Once the process crosses the target cost, does the seller still get the target fee (profit)?
No, the profit will be less than the target fee when project costs, raise beyond the target price. Until the buyer is sharing is 100% of the cost overrun.

How many questions do we get on PTA during PMP® exam?
We do not see PTA questions coming in PMP® exam very frequently. I hope now you will not just memorize the formula of point of total assumption with lots of assumptions. Drop us a comment or feedback on the blog. You may also share your further queries on the same topic. We would be glad to answer them.

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