Accounting for Contract Change Orders & Their Costs

Almost inevitably in any contract, change orders often present a unique accounting issue for construction contractors from both a contract valuation and cost standpoint. Contractors frequently contact us with questions relating to change orders and whether their accounting treatment is appropriate. Generally, accounting software systems, especially those software packages tailored specifically for contractors, have controls in place to help guide users in the appropriate treatment. The following are some of the common issues we encounter:

– Change orders generally result in the incurrence of additional materials and labor over the life of the project; therefore, the total budget for the project needs to be updated accordingly. In reality, the change order work generally occurs before final approval of the change order; therefore, the budgeted costs and actual costs incurred should reflect the change order work, while the contract value is not allowed to increase until the change order is actually approved by the customer.

– Billings on change orders cannot occur until an approved change order is received from the customer. Billings on unapproved change orders will result in unearned revenue and not improve the bottom line of the business. In fact, certain accounting software packages will not permit billings on the change order portion of a contract if the change order is marked as pending.

– Remember to update a project’s total budgeted costs for the additional overhead expected to be consumed on the expanded work for a project. Change orders might result in additional fabrication time in the shop department or new plans being drawn up by the drafting department, all of which impact project profitability.