Handling Project Contract
Modifications
During times when project
starts are slowing and profit margins appear to be shrinking, contractors
have to examine every aspect of their operations to maximize their bottom
line. Project modifications deserve close scrutiny since they can
potentially reduce a contractor's profit margin and adversely affect cash
flow. Contractors can be proactive by developing procedures to minimize both
the frequency of project modifications and their impact. These suggestions
may help.
Know Exactly What the Project’s Requirements Are
A good first step is to obtain clarification on any aspect of the project
that may give rise to misunderstandings later on. Contractors should sort
out to their satisfaction any concerns they have over language or unclear
instructions in the project’s specifications before they sign a contract.
Familiarize Staff with Contract Provisions
Familiarizing field personnel with the extent of the project as detailed in
the contract is another effective step that contractors can take.
Supervisors should be able to identify what is and what is not included in
the contract and, when necessary, know what to do to obtain approval and
payment for any changes. Supervisors who do not grasp the scope and the
specifics of a project can end up failing to properly process and bill for
changes.
Communicate Proposed Changes to the Customer
Once changes have been requested or identified, contractors should
immediately contact the customer to confirm them. If the project contract
specifies notification procedures, it’s important that supervisors follow
those procedures to the letter.
Ensure Fair Payment for Changes
Some contracts specify the method for pricing changes. In cases when the
contract does not offer pricing guidance, contractors have to be sure to
include both direct and indirect costs, such as additional project
management and staff time to compile and bill the change. Most important,
contractors should leave room for a profit when they are pricing changes.
Contractors who develop and implement procedures for handling project
contract changes are more likely to get paid for their work. For help with
developing systems and procedures to strengthen your company’s financial
position, please contact us.
Types of Contract Changes
Change Orders. Typically originated by the customer, change orders
modify an original contract by increasing or decreasing the project’s
original scope. They commonly involve changes in design or specifications
and may affect both pricing and a project’s scheduled completion date.
Extras. Additional work that is not included in the original contract
can range from the simple to the complex. Extras are usually billed
separately and rarely affect the original contract amount.
Back Charges. These are charges for completed work or costs incurred
by one party that, under the original contract, should have been performed
or incurred by the party being billed.
Disputes/Claims. Contractors sometimes claim that a customer owes an
additional amount for costs associated with delays caused by the customer,
errors in the original specifications, unapproved change orders or
additional work that was not anticipated or agreed to. Typically, disputes
and claims take some time to settle (or litigate) and are not always
resolved in the contractor’s favor.
Incentives/Penalties. Incentive clauses allow for payments to the
contractor that are greater than the contract price if the contractor meets
or exceeds certain specified goals. And some owners insert penalty clauses,
such as a liquidated damage provision, that penalize the contractor for not
meeting a completion date specified in the contract.
Work-In-Process is provided by
Somerset for our clients and other interested persons upon request.
Since technical information is presented in generalized fashion, no
final conclusion on these topics should be made without further review.
For additional information on the issues discussed,
please contact
Ken
Hedlund,
Jay Feller,
Steve George,
Chris
Mayfield or
Rebecca Ogle
of our
Construction & A/E Team.
This document is not intended or written to be used, and cannot be used,
for the purpose of avoiding tax penalties that may be imposed on the
taxpayer.
Somerset CPAs,
P.C.
3925 River Crossing Parkway, Third Floor
Indianapolis, Indiana 46240
317.472.2200 • 800.469.7206 • FAX 317.208.1200
www.somersetcpas.com
