Project Owner’s Guide to Analyzing Change OrdersBy Georgia Stamelos | February 15, 2019
A thoughtful and well-executed contract is the best start to any construction project, but equally important is making sure the terms of the contract are being adhered to at every turn. Typically, there are contracts set up between the owner of the real property and the general contractor, between the owner and the architect/engineer, and between the general contractor and the subcontractors, so there are plenty of instances for unexpected issues and required changes to arise. Contracts for construction projects are created with an agreed-upon price for the total project, but rarely does the total contract price initially agreed upon end up being the final cost of the project, and the difference stems from a very common occurrence – change orders.
UNDERSTANDING CHANGE ORDERS
Change orders are changes to the original contract for scope of work, price, and schedule that were agreed upon by the parties in the original contract. Change orders are issued as the need arises and are a means to track the changes and costs. They occur for various reasons the owner may decide on changes in the project, unforeseen circumstances may arise as the contractor is working on the project, or there may be changes in other specifications on the project. A change order may contain a lump sum cost adjustment to the project or a credit to the cost. The contractor will add their direct costs, material and markup to equal the additional cost for the change order. The amount can also go the other way, resulting in a reduction in the cost. For example, this could happen if there is a change in the quality or quantity of materials as per the owner’s request from the initial contract.
Change orders can have a zero-cost adjustment, which might be done to document a change in the scope of the work without changing the cost of the project. There are also times when the contractor may not be able to quantify the costs related to the change order because of unforeseen circumstances and, in this case, a time and material change order can be provided. The contractor will track the actual time and materials used and will provide the final value to the owner.
In order to track the cost budgets and manage contingency funds, and most importantly, minimize the overall increase in the contract price, owners must manage change orders appropriately. This starts with ensuring that the contract states exactly how change orders will be administered and processed.
ANALYZING CHANGE ORDERS
Analyzing change orders throughout a project is an important step to avoid unnecessary delays and maximize the profitability of the work. Here are a few tips and why they’re important to follow:
1. Stick to the contract
The starting point in analyzing change orders is reviewing the contract and its provisions regarding change orders. It is key to know what is allowed under the base contract to be able to review and verify the scope of the change order. There should be adequate documentation, and change orders should be reviewed on a timely basis to avoid delays in the project.
2. Stay in control
On larger projects, there are usually many change orders coming through. It is important to be able to track them and understand what the changes are for. A control log can be set up to track the change orders by date, number and change in scope and pricing. This will assist in reviewing for duplicate change orders, or previously rejected change orders being resubmitted.
3. Put it in writing
After reviewing the contract provisions and determining that the contractor has followed the proper procedures in submitting the change order proposal, the project owner needs to confirm the detail of the work. There should be an inspection of the job with proper documentation of the inspection.
The contract should also address the documentation that is required to be submitted for the change order proposal. Some contracts may have general requirements, such as sufficient documentation to substantiate the proposal. Whatever the contract provisions are for the documentation, the contractor needs to meet them.
Labor rates should be verified to the base contract. Quantities and hours in the change order should be verified if appropriate for the scope of the work. If there is an owner-controlled insurance program (OCIP) or “wrap up program” for the project, verify the labor rates used are being adjusted for this. And any markups should be agreed back to the contractually allowed markups.
After review, if the owner has agreed to the changes and price, the change order is approved and the owner will prepare and sign off on the final change order. The contractor is then obligated to perform the work. If the owner rejects the change order, the owner will provide a written response as to the reason for the rejection and provisions of the contract should be cited or quoted.
5. Be prepared
When entering into a construction contract, it is important to anticipate the potential costs that can be requested in change order proposals, such as: labor costs; material costs, equipment costs, subcontractor costs, contractually specified markups and other supplemental costs. Labor costs include the wages of the trade workers including labor burden, which includes the cost of employee benefits, payroll taxes as well as insurance costs such as workers’ compensation. Contractual specified markups are for such items as overhead and profit, costs of insurance premiums and costs of bond premiums if applicable.
If the contract addresses how change orders will be documented and dealt, the owner and contractor can easily refer back to the contract to ensure they are following the provisions, which will minimize the disputes, delays and cost increases incurred by the project.
About Georgia Stamelos
Georgia Stamelos, CPA, is a Director in the Commercial Business group at Marks Paneth LLP. She has over 20 years of experience in public accounting. Ms. Stamelos manages engagements for privately owned, closely held businesses in industries such as wholesale distributors, construction and professional services such as law, graphic design, architecture, and advertising. She advises her clients on all facets of accounting and tax matters. She is a member of the American Institute of Certified... READ MORE +