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Change Order Accounting: Best Practices to Avoid Disputes

  • Writer: Cost Construction Accounting
    Cost Construction Accounting
  • Dec 25, 2025
  • 6 min read

Change orders are inevitable in construction, but disputes over them don’t have to be. Every year, construction disputes cost the industry billions in legal fees, project delays, and damaged relationships. The primary culprit is rarely the work itself; it is poor change order accounting practices that leave room for misunderstandings, miscalculations, and mistrust.

If you are a construction owner, general contractor (GC), or subcontractor, you know the stakes. A single disputed change order can escalate from a simple field disagreement to a multi-year battle in arbitration or litigation, draining your resources and stalling project momentum.

Most disputes are entirely preventable with the right accounting framework and documentation practices. This guide delivers battle-tested strategies to help you document, track, and account for change orders in ways that minimize risk, ensure compliance with revenue recognition standards, and keep your projects profitable.

Understanding Change Orders: The Foundation

Before diving into accounting best practices, we must establish a clear taxonomy of what constitutes a change.

What Is a Change Order?

A change order is a written modification to the original construction contract that alters the scope of work, project schedule, or contract price. To be legally enforceable and "accountable" on your books, these modifications must be documented and approved by the authorized parties.

Types of Change Orders You Need to Know

  • Directed Change Orders: These occur when the owner explicitly requests a modification through proper channels. They are straightforward: the owner wants a change, you price it, they approve it.

  • Constructive Change Orders: These are the leading cause of disputes. They occur when contractor actions are required due to owner conduct or faulty contract interpretation, even without a formal written order. For example, if an owner delays providing critical submittal approvals and you incur acceleration costs to meet the original deadline.

  • Additive vs. Deductive Changes: These refer to whether the change increases or decreases the total contract value. Deductive changes often require careful accounting to ensure overhead and profit (O&P) aren't unfairly stripped from the contractor.

The Legal and Contractual Framework

Most U.S. construction contracts reference standards like AIA (American Institute of Architects). These documents are not just suggestions; they establish the "rules of engagement" for your accounting department:

  1. Notification Timeframes: Often 7–14 days. Missing a deadline can forfeit your right to payment entirely.

  2. Documentation Requirements: Specific formats for Labor/Material/Equipment (LME) breakdowns.

  3. Approval Hierarchies: Who has the financial authority to sign off on a change?

Best Practices for Change Order Documentation

Documentation is your insurance policy. In the world of construction accounting, the party with the most detailed, contemporaneous records almost always wins the dispute.

1. Identify and Notify Immediately

The moment a field supervisor recognizes a potential change, the clock starts. Create a Preliminary Change Order Notice (PCN) that includes:

  • Precise timestamp and location of the discovery.

  • Description of the changed condition (with photos).

  • Potential impact on the critical path of the schedule.

  • Reference to the specific contract provision that justifies the change.

2. Maintain "Bulletproof" Records

Your accounting system is only as good as the data fed into it from the field. To survive an audit or a dispute, you need:

  • Daily Reports: Note exactly which workers and equipment were diverted to the change order work.

  • Photo Evidence: High-resolution photos with GPS metadata and timestamps.

  • The Paper Trail: Every RFI, email, and meeting minute related to the modification.

3. Leverage Construction-Specific Digital Tools

Manual spreadsheets are a recipe for disaster in SME construction. Integration between project management and accounting is vital.

  • Sage 100 Construction / QuickBooks Enterprise: These should be your "source of truth," where change orders are tied directly to job costing.

  • Procore or Autodesk Build: Use these to route approvals and ensure that field directives are captured before the concrete is poured.

Technical Accounting Principles for Change Orders

This is where many contractors lose money. If your Change Order (CO) isn't accounted for correctly, your Work in Progress (WIP) reports will be skewed, leading to "overbillings" or "underbillings" that can scare off sureties and lenders.

Revenue Recognition under ASC 606

Under the Financial Accounting Standards Board (FASB) ASC 606, revenue is recognized when you satisfy performance obligations. For change orders, this is categorized by the "probability of collection."

  • Approved Change Orders: Recognize revenue and profit when both scope and price are agreed upon.

  • Unapproved (Unpriced) Change Orders: You may be able to recognize revenue for the scope if it is probable the customer will pay. However, standard practice suggests recognizing revenue only to the extent of costs incurred (zero-margin) until the price is finalized.

  • Claims: If a change order is disputed, it becomes a "claim." Revenue should generally not be recognized on claims until legal certainty is high.

Percentage-of-Completion (PoC) Adjustments

Change orders change the denominator of your profit equation. If you have a $1M contract and add a $100k change order, your Percentage Complete must be recalculated immediately.

Formula: 

Percent Complete = Actual Costs Incurred / Total Estimated Costs (including COs)

Failure to update the "Total Estimated Costs" monthly leads to "Profit Fade" at the end of the project a massive red flag for construction CPAs and bond agents.

Job Costing and Code Segregation

Never "bury" change order costs in the original budget line items. Create unique Cost Codes for each major change order. This allows you to prove exactly how much labor and material went into the extra work, making it nearly impossible for an owner to argue the price during a back-charge dispute.

Advanced WIP Analytics: The Contractor's Secret Weapon

For Small to Mid-Sized Contractors, WIP (Work in Progress) Analytics is the heartbeat of the business. When change orders are pending, your WIP report tells the real story:

  • Under-billings on COs: If your WIP shows significant under-billings, it often means you are performing change order work but haven't successfully billed for it. This is a "silent killer" of cash flow.

  • Over-billings on COs: Conversely, if you've billed for a change order but haven't incurred the costs yet, you are essentially borrowing money from the owner. You must track this to ensure you have the cash to finish the work later.

Strategies to Proactively Avoid Disputes

Establish a "No Verbal Directives" Policy

Field staff often want to "keep the project moving" by accepting verbal orders. This is a $100,000 mistake waiting to happen. Implement a policy where every verbal directive is followed by a Confirmatory Email within 4 hours:

"Per our conversation at 10:00 AM, we are proceeding with the additional footing reinforcement. We estimate this will cost $X and take Y days. Please reply to confirm."

Weekly "Change Order Alignment" Meetings

Don't wait for the monthly pay app to discuss changes. Hold a 30-minute weekly sync with the Owner or GC specifically to:

  • Review pending PCNs.

  • Review the status of unpriced change orders.

  • Identify upcoming "design gaps" that might trigger future changes.

Implement Internal Approval Tiers

To prevent errors, set internal limits. For example:

  • Project Manager: Can approve COs up to $10,000.

  • VP of Operations: Can approve COs up to $50,000.

  • Owner/CFO: Must approve anything over $50,000.

Common Pitfalls That Create Disputes

  1. The "Lump Sum" Trap: Presenting a $20,000 change order without a breakdown. Owners hate feeling "nickel and dimed" or cheated. Always provide a transparent LME (Labor, Material, Equipment) breakdown.

  2. Ignoring Cumulative Impact: Often, ten small changes individually don't delay a project, but together they cause "trade stacking" and inefficiency. Use a Cumulative Impact Analysis to account for these hidden costs.

  3. Late Submission: Many contracts state that if you don't submit the price within 30 days of the notice, you waive the right to the money. Construction accounting is a race against the clock.

Conclusion: Your Action Plan

Change order disputes are not an "unavoidable cost of doing business." They are a symptom of a breakdown in communication and accounting discipline. By implementing rigorous documentation and aligning your job costing with your WIP reports, you protect your margins and your professional reputation.

Implement These Five Actions This Week:

  1. Audit your current CO log: Are there items older than 30 days that haven't been priced or signed?

  2. Standardize your forms: Ensure every PCN and COR looks identical and professional.

  3. Review your WIP: Identify any "hidden" costs associated with unapproved change orders.

  4. Clean up your Cost Codes: Start segregating CO costs from the base contract immediately.

Does your current accounting system give you the visibility you need to manage change orders effectively? At Construction Cost Accounting (CCA), we specialize in helping SMEs navigate the complexities of job costing, WIP analytics, and tax services specifically for the construction industry. Whether you use Sage, QuickBooks, or specialized project management software, we can help you build a "dispute-proof" accounting engine.


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