Cost-plus Contracts & Tracking Change Orders | Avoid Cost Overruns in Construction Projects
- Cost Construction Accounting
- 4 days ago
- 5 min read
Updated: 1 day ago
In the world of construction, engineering, and large-scale projects, cost overruns remain one of the most common and frustrating challenges. A 2022 report by the Project Management Institute reveals that nearly 70% of projects globally suffer from budget overruns, often due to unforeseen changes and inadequate contract management.
Among the various contract types, cost-plus contracts are widely used because they offer flexibility and transparency. However, without diligent tracking of change orders, even cost-plus contracts can spiral into costly mismanagement.
In this article, we explore the intricacies of cost-plus contracts, the critical role of change order tracking, and practical strategies to avoid cost overruns. Whether you are a project manager, contractor, or client, understanding these concepts can save millions and ensure smoother project delivery.
TABLE OF CONTENT:
Cost-plus Contracts: Flexibility with Risks
What Is a Cost-plus Contract?
A cost-plus contract is an agreement where the contractor is reimbursed for all legitimate project costs, plus an additional fee or percentage for profit. Unlike fixed-price contracts, which set a predetermined budget, cost-plus contracts provide flexibility to accommodate changes and unforeseen expenses.
A cost-plus contract (sometimes called a “cost reimbursement contract”) is an agreement where a contractor is paid for:
Direct costs – labor, materials, equipment, subcontractors
Indirect costs – overhead, insurance, administrative expenses
Profit margin – usually a fixed fee or percentage of costs
Types of Cost-plus Contracts
There are several variations of cost-plus contracts, each with different implications for risk and control:
Cost-Plus Fixed Fee (CPFF): The contractor receives a fixed fee regardless of the final cost, incentivizing cost control but allowing flexibility.
Cost-Plus Percentage of Cost (CPPC): The contractor’s fee is a percentage of the total costs, which can sometimes lead to less incentive to minimize expenses.
Cost-Plus Incentive Fee (CPIF): The contractor earns additional fees if costs are kept below a target, encouraging efficiency.
Choosing the right type depends on the project's complexity, risk tolerance, and the relationship between client and contractor. For instance, in a project where the client is particularly risk-averse, a CPIF contract might be more appealing as it aligns the contractor's incentives with cost savings. Conversely, for projects where the scope is highly uncertain, a CPPC might be more suitable, as it allows for greater flexibility in managing costs as they arise.
The Challenge of Change Orders in Cost-plus Contracts
What Are Change Orders?
Change orders are formal modifications to the original scope of work, schedule, or costs agreed upon in a contract. They can arise from design changes, unforeseen site conditions, regulatory updates, or client requests. While change orders are a normal part of construction projects, they can significantly impact budgets and timelines if not managed properly.
In cost-plus contracts, change orders can be particularly tricky because the flexible nature of the contract may lead to scope creep—where small changes accumulate into large, unplanned expenses.
Why Tracking Change Orders Matters
Effective change order tracking is essential for several reasons:
Cost Control: Without detailed tracking, costs can escalate unnoticed, leading to overruns that strain budgets.
Transparency: Clear documentation ensures all parties understand the reasons for changes and their financial impact.
Dispute Prevention: Accurate records reduce conflicts between clients and contractors by providing evidence of agreed changes.
Project Scheduling: Change orders often affect timelines; tracking helps adjust schedules realistically.
According to a 2023 survey by the Construction Management Association of America, projects with rigorous change order management experienced 30% fewer budget overruns than those without.
Common Pitfalls in Managing Change Orders
Some of the most frequent mistakes include:
Failing to document verbal agreements or informal changes.
Delaying approval of change orders, causing work stoppages or rushed decisions.
Underestimating the cost or time impact of changes.
Lack of a centralized system for tracking changes, leading to miscommunication.
Strategies to Track Change Orders and Avoid Cost Overruns
Establish Clear Contract Terms and Expectations
Clarity at the outset is critical. The contract should specify how costs will be documented, what constitutes allowable expenses, and the process for submitting and approving change orders. Defining roles and responsibilities for all stakeholders helps prevent misunderstandings.
For example, including detailed definitions of indirect costs, overhead, and profit margins can prevent disputes about what expenses are reimbursable. Additionally, setting a cap or target budget—even in a cost-plus contract—can motivate cost discipline.
Implement Robust Change Order Management Processes
A formalized process for handling change orders can dramatically reduce risks:
Standardized Forms: Use consistent templates for submitting change requests with detailed descriptions, cost estimates, and schedule impacts.
Timely Review and Approval: Establish deadlines for reviewing change orders to avoid delays.
Documentation: Keep all correspondence and approvals in a centralized, accessible system.
Regular Reporting: Provide stakeholders with frequent updates on change order status and cumulative costs.
Many companies now leverage project management software tailored for construction, which integrates change order tracking with budgeting and scheduling tools, enhancing visibility and control.
Enhance Communication and Collaboration
Clients are less likely to dispute costs if they’re updated regularly. Provide:
Weekly project financial summaries
Real-time change order updates
Transparent cost reports
Use Technology to Monitor Costs in Real Time
Technological advancements have transformed how projects are managed. Real-time cost tracking tools allow project managers to monitor expenditures as they occur, compare them against budgets, and flag variances immediately. Modern tools like QuickBooks for Contractors, Sage 100 Contractor, or Procore integrate with job costing systems.
Case Studies: Lessons from Real Projects
Case Study 1: Municipal Bridge Construction
A city government contracted a firm to build a new bridge using a cost-plus fixed fee contract. Early in the project, unexpected soil conditions required redesign and additional foundation work. Because the contract allowed flexibility, the contractor submitted change orders promptly, supported by detailed cost breakdowns and geotechnical reports.
The project team used a centralized change order tracking system, which provided transparency and facilitated timely approvals. Despite the additional costs, the project avoided disputes and was completed within 5% of the revised budget. The key takeaway was the importance of documentation and communication in managing unforeseen changes.
Case Study 2: Custom Residential Development
A luxury home builder entered a cost-plus percentage of cost contract with a client. The homeowner frequently requested design changes without formal change orders, leading to confusion and escalating costs. The contractor struggled to track expenses, and the project ended 40% over the initial budget.
This example highlights the risks of inadequate change order management and the potential pitfalls of percentage-based fees, which may reduce incentives to control costs. Implementing a more structured change order process early on could have mitigated these issues.
Best Practices for Clients and Contractors
For Clients:
Define Clear Project Goals: The clearer the initial scope, the fewer surprises later.
Request Regular Updates: Insist on frequent cost and progress reports.
Engage in Change Order Reviews: Don’t approve changes without understanding their impact.
Choose Contract Types Wisely: Consider whether cost-plus contracts fit your project’s risk profile.
For Contractors:
Maintain Detailed Records: Track labor, materials, and overhead meticulously.
Communicate Proactively: Alert clients early about potential changes and costs.
Use Technology: Leverage software to streamline change order management.
Train Teams: Ensure all staff understand contract terms and change order procedures.
Conclusion: Balancing Flexibility and Control
Cost-plus contracts give contractors flexibility and ensure fair compensation, but without a strong change order tracking system, projects can quickly spiral into cost overruns. By standardizing processes, leveraging construction accounting software, and reconciling costs regularly, contractors can protect profitability and maintain client trust.
At Construction Cost Accounting, we specialize in helping contractors manage cost-plus contracts, track change orders, and maintain accurate job costing. With our expertise in construction bookkeeping and project accounting, you’ll gain the financial clarity needed to avoid cost overruns and keep your projects profitable.
Comments