No matter how thoughtfully it may be planned, critical changes can arise and can complicate a project. As a result, contractors frequently encounter change orders almost daily.

A change order can be initiated by either the contractor or the owner, and may encompass changes in specification or design, manner or method of performance, or other modifications. On more complex projects, change orders can significantly add to the final contract price.

While contractors are no strangers to project changes, it’s imperative that they properly account for these changes in order to ensure the company’s financial health.

Accounting for Change Orders

While accounting for approved change orders on the financial statement is fairly simple, accounting for unapproved change orders and claims can be challenging.

Unapproved change orders are heavily scrutinized by banks and bonding companies, which often take a conservative view on adjusting contract price until such changes are agreed to in writing.

If a contractor’s bank and bonding company do not fully understand the specific facts and circumstances that resulted in changes to a contractor’s estimated gross profit on a job, then unapproved change orders will be removed from contract price, causing assets to be removed from working capital and a decreased equity position. This can impact banking financial ratios and bonding program capacity, and lead to credibility and potentially lethal credit underwriting issues down the road.