As you know, change orders are an inherent part of the construction industry. Alterations to the original design, specifications, execution methods or scope of a job can impact the budget and timeline. And when not discussed and documented properly, they can lead to nonpayment for additional work and legal disputes.
That's why establishing a standard, comprehensive change order management process is critical to the financial well-being and operational stability of every construction business.
Approved change orders, whereby the contractor and project owner formally agree on the additional work and price — and put that agreement in writing — are relatively straightforward to account for in billing and financial reporting.
On the other hand, unapproved change orders call for careful evaluation and documentation until formal approval is obtained. As you may have learned the hard way, a verbal agreement and handshake don't always guarantee payment.
What's more, waiting for approval documents before entering change orders into your accounting system could prevent your company from accurately tracking project costs. This may compromise financial reporting, which can in turn negatively impact creditworthiness and internal financial management.
Fortunately, there are a variety of measures that can help you more effectively manage and account for change orders — both approved and unapproved. Here are some to consider:
However, as you may have experienced, real-world circumstances sometimes force you to move forward on an unapproved change order. If such a change order will likely be approved, you could add the costs to a special asset account until approval is obtained. Another option is to conditionally add the cost to the total project costs and increase the anticipated job revenue by the same amount.
If you believe a change order is unlikely to be approved, you may choose to add the associated costs to the job's direct costs. Again, careful documentation of the work performed and costs incurred will be imperative, as you may need to undertake legal action down the line.
To be clear, the optimal accounting treatment for each change order will depend on the facts and circumstances involved. We'd be happy to help you properly account for your construction company's change orders, as well as assist you in improving your change order management procedures.
Get in touch today and find out how we can help you meet your objectives.