An Unusual Look at Change Orders
The Big Picture
You get it. You know that change orders are woven into the fabric of construction contracting. Even if they aren’t inevitable, they’re at least always a possibility.
It’s in the contract.
And you understand the three broad categories under which they may fall:
Approved Change Orders = adjustments made concerning time and money issues.
Approved and Unpriced Change Orders = define the work to be performed, but the price is negotiated later.
Unapproved and Unpriced Change Orders = may not be recovered even to the extent of adding unrecoverable cost to the subcontractor.
Further, you understand a few common problems that lead to change orders. They might include:
Conflicting or inaccurate specifications
Damage from inclement weather
Design changes, including the addition or subtraction of items or features
Differences between the contract and project documents
Errors and omissions in plans and drawings
Financial problems on the part of the owner or the contractor
Lack of workers or materials
Poorly defined scope
Quality issues and construction defects
Substitutions of materials due to shortages or upgrades
Unanticipated site conditions
Unrealistic budgets and schedules
But there are other things to take into account when dealing with change orders.
Three Considerations Regarding Change Orders
Construction change orders can be initiated by the general contractor, a subcontractor, the project owner, or a code inspector. They can significantly change the financial results of the parties involved (except for the code inspector.) So, it is vital to consider three aspects concerning change orders. They are:
The Legal Side
The Accounting Side
The Human Side
The Legal Side
“Contract” is the name of the game when it comes to dealing with the legal side of change orders. Modifying the original contract is what change orders are all about. Finding a construction-centric attorney who can guide you through all the facets of the original contract and subsequent change orders is essential.
Remember, timing is essential. Bringing an attorney into play only when it gets to the point of litigation is like bringing out the referee only when both teams are brawling on the playing field.
The Accounting Side
In an approved change order, all involved parties support the scope and price of the work. The work-in-progress (WIP) schedule will be impacted by adjusting the contract price and total estimated costs to reflect the amounts approved.
With a written approved yet unpriced change order, there is a need for separate documentation for identifiable and reasonable costs. Then the contractor may recognize revenue for the change in the contract price.
In an unapproved change order, costs roll on with work that has not been approved in either scope or price. Depending on the circumstances, an unapproved change order that adjusts contract price and gross profit requires a detailed examination to determine if the amount is recoverable. This, too, will most likely result in an underbilling on the WIP schedule. Still, by examining all the circumstances and further negotiation, it is possible to recover some or all of the costs incurred.
Remember, even though change orders can be a hassle involving a project’s budget and schedule, properly accounting for them can mean the difference between a profit and a loss.
The Human Side
One aspect to consider when determining how to proceed with change orders is providing goodwill for the owner or another party involved. For example, staying in the good graces of a trusted GC may mean completing a change order without hassle, negotiation, or expectation of immediate financial gain.
Another condition that might come into play is that of changed circumstances (usually financial) of one of the parties in the contractual relationship. Suppose an owner is caught in a seemingly never-ending run of dire circumstances, and their funds are greatly affected, for instance. In that case, the other parties may wish to help by including a deductive change order to reduce the amount of work and cost.
The third facet that may come into play is philanthropy. Charity can play a part in deciding how to deal with change orders. For example, suppose the contractor believes in the cause of his or her client and feels that contributing better quality materials or providing labor at no charge will benefit them. In that case, they may produce a change order to that effect.
To the Point
Contractual obligations (the external factor) are vital when determining the use of change orders. And construction contractors have a legitimate right to charge a reasonable fee for changes requested by the owner, subcontractor, or GC. Within that right is the ability to reset the completion date based on the extent of the changes.
Another critical aspect of dealing with change orders is implementing systems and processes (the internal factor) that inform your employees and subcontractors how to deal with each change order. Everyone must know the proper procedure for authorizing, organizing, and handling each change order, from those in the field to the back office.
Change orders are common but can have uncommon results depending on how they are approached. Remember the legal, accounting, and human sides of change orders and make strategic decisions based on that input.
Reflection: Do you know how change orders are affecting your bottom line? Do you need to make changes to your practices concerning change orders?
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