How to Manage Unexpected Costs from Change Orders in Cost-Plus Construction Contracts
- Cost Construction Accounting
- Sep 10
- 6 min read
Updated: Sep 10
Cost-plus contracts are widely used in the construction industry, especially for projects with complex or uncertain scopes. Unlike fixed-price contracts, cost-plus agreements reimburse contractors for allowable project costs plus a pre-determined fee or profit percentage. While this approach provides flexibility, one of the biggest challenges for contractors and project owners is managing unexpected costs from change orders.
Change orders—requests to modify the original scope of work—are common in construction projects. They can arise from unforeseen site conditions, design adjustments, regulatory requirements, or client-requested changes. While change orders are sometimes necessary, they can quickly escalate project costs, impact timelines, and strain relationships if not managed properly. For contractors, accurate cost tracking and construction bookkeeping practices are essential to maintain profitability under cost-plus contracts.
In this article, we will explore strategies for managing unexpected costs from change orders, highlight common mistakes to avoid, and provide practical tips to ensure financial transparency and success.
TABLE OF CONTENT:
Understanding Change Orders in Cost-Plus Contracts
In a cost-plus contract, the contractor is reimbursed for actual project costs plus a fee for profit and overhead. Change orders, which alter the original scope, affect both cost and schedule. Unlike fixed-price contracts, cost-plus agreements require detailed tracking of additional costs from changes.
Change orders can be initiated by the owner, contractor, or third parties like architects. They may involve adding new features, correcting design errors, or addressing unforeseen site conditions. Since cost-plus contracts reimburse actual expenses, accurate documentation and verification of these costs are crucial to avoid disputes.
It's important to distinguish between direct costs (materials, labor) and indirect costs (overhead, administration). Change orders often increase both, so contractors must categorize and justify these expenses.
Additionally, change orders can impact project timelines. They may require extra planning, material procurement, or labor reallocation, leading to delays. Effective communication among all parties is key to managing changes, avoiding misunderstandings, and ensuring smooth project execution.
Identifying and Documenting Change Orders Early
Importance of Early Detection
Timely identification of potential change orders is crucial. Early detection allows all parties to assess impacts, negotiate terms, and adjust project plans before costs escalate. Delays in recognizing changes often result in rushed decisions and inadequate documentation, which complicates cost control and dispute resolution. Moreover, early detection fosters a collaborative environment where stakeholders can openly discuss potential issues, leading to innovative solutions that may not have been considered otherwise. This proactive stance not only mitigates risks but also enhances the overall quality of the project, ensuring that the final outcome aligns closely with the original vision.
Best Practices for Documentation
Accurate and thorough documentation is the foundation for managing change orders effectively. Each change should be recorded with:
A detailed description of the change
Reasons for the change
Estimated cost implications
Impact on schedule
Signatures from authorized parties
Using construction management software can streamline this process, providing real-time updates and centralized records accessible to all stakeholders. Additionally, incorporating visual aids such as diagrams or photographs can enhance understanding and clarity. This multi-faceted approach to documentation not only helps in keeping everyone on the same page but also serves as a valuable reference throughout the project's lifecycle, making it easier to track changes and their effects on the overall project scope.
Negotiating Change Orders to Control Costs
Establish Clear Change Order Procedures
Having a predefined process for submitting, reviewing, and approving change orders helps control costs and maintain transparency. This process should outline who can initiate changes, how cost estimates are prepared, and the timeline for approvals. Additionally, it is beneficial to establish a standardized template for change orders that includes all necessary information, such as project details, reasons for the change, and the potential impact on the overall project timeline. This not only streamlines the process but also ensures that all parties are on the same page, reducing the likelihood of misunderstandings and disputes.
Collaborative Approach to Negotiation
Adopting a collaborative mindset between owners and contractors fosters trust and facilitates fair negotiations. Open communication about the necessity and impact of changes helps avoid adversarial situations and supports mutually beneficial solutions. Regular meetings to discuss ongoing project developments can also be instrumental in this regard. By creating a culture of collaboration, both parties can proactively address potential issues before they escalate, leading to more efficient project execution and a stronger working relationship.
Leveraging Cost Estimates and Market Data
Accurate cost estimation is vital during negotiations. Contractors should provide detailed breakdowns of labor, materials, equipment, and overhead costs associated with the change order. Owners can cross-reference these with current market rates to ensure reasonableness. Furthermore, it is advisable for both parties to stay informed about industry trends and fluctuations in material costs, as these can significantly impact the overall budget. Engaging a third-party cost estimator or consultant can also provide an objective perspective, ensuring that both sides feel confident in the financial aspects of the negotiations.
For example, if a change order involves upgrading to more expensive materials, comparing supplier quotes can help validate costs and identify savings opportunities. Additionally, exploring alternative materials that meet project specifications but come at a lower price point can lead to significant cost savings without compromising quality. This proactive approach not only helps in managing the budget but also encourages innovation and creativity in problem-solving, ultimately benefiting the project's outcome.
Implementing Rigorous Cost Tracking and Reporting
Why Cost Tracking Matters
In cost-plus contracts, where costs directly affect the final price, real-time cost tracking is essential to avoid surprises. Detailed tracking enables project teams to monitor expenditures against budgets and identify cost overruns early.
Tools and Technologies for Cost Management
Modern construction management platforms offer integrated cost tracking, linking purchase orders, invoices, and labor hours to specific change orders. These tools provide dashboards and alerts, helping project managers stay informed and make data-driven decisions.
Regular Reporting to Stakeholders
Consistent and transparent reporting keeps all parties aligned. Weekly or biweekly cost reports detailing current expenditures, forecasted costs, and variances help owners understand the financial status and prepare for upcoming payments.
Transparent reporting also reduces disputes by providing an audit trail that supports the legitimacy of costs incurred.
Mitigating Risks Associated with Change Orders
Risk Allocation in Contracts
While cost-plus contracts inherently transfer some risk to the owner, clear contractual terms can define responsibilities related to change orders. For example, clauses specifying how unforeseen conditions are handled or caps on certain types of costs can limit financial exposure.
Contingency Planning
Including contingency allowances in the project budget provides a financial buffer for unexpected changes. Industry standards recommend setting contingencies between 5% and 15% of the total project cost, depending on project complexity and risk factors.
Training and Education
Ensuring that project teams understand the implications of change orders and cost-plus contract dynamics improves decision-making. Regular training on contract administration, cost control, and negotiation techniques empowers teams to manage changes proactively.
Case Studies: Successful Management of Change Orders
Infrastructure Project in California
A large infrastructure project in California faced multiple change orders due to unexpected soil conditions and regulatory updates. The project team implemented a rigorous change order management system, including early detection protocols, detailed documentation, and collaborative negotiations.
As a result, the project completed within 8% of the original budget despite a 20% increase in scope, demonstrating how structured management can mitigate cost impacts.
Residential Development in New York
During a residential development in New York, the contractor and owner agreed on a transparent cost-plus contract with strict change order procedures. The use of real-time cost tracking software allowed the team to identify cost overruns early and adjust plans accordingly.
This approach led to a 15% reduction in change order costs compared to similar projects, highlighting the value of technology and communication.
Conclusion
Managing unexpected costs from change orders in cost-plus construction contracts requires discipline, transparency, and proactive cost tracking. By implementing robust documentation, real-time bookkeeping, clear client communication, and regular audits, contractors can maintain profitability, reduce disputes, and deliver projects successfully.
Construction Cost Accounting specializes in providing construction bookkeeping, cost tracking, and accounting services for contractors navigating cost-plus contracts. Our expertise helps contractors stay on budget, manage change orders effectively, and ensure compliance with tax and payroll regulations. Partnering with experienced construction accountants allows contractors to focus on project delivery while maintaining financial clarity and control.
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