Let’s discuss the impact of change orders on revenue. (2.15 AICPA Construction Contractors Audit & Accounting Guide), Accounting for change order depends on the underlying circumstances, which may differ for each change order depending on the customer, the contract, and the nature of the change.
2.18 If the percentage-of-completion method is used and the contractor and the owner agree on both the scope and price of a change order, contract revenues and costs should be adjusted to reflect the change order.
Many change orders are un-priced; this means the work has been defined, but the price will be negotiated later.
FASB ASC 605-35-25-87: includes the following guidelines for accounting for un-priced change orders:
- If it is not probably that costs related to an un-priced change order will be recovered through a change in the contract price……read more(see below)
- If it is probably that the costs of the change order will be recovered by adjusting the contract price….read more (see below)
- If it is probable that the contract price adjustment will exceed the costs attributable to the change order and that the excess can be reliably estimated…..read more (see below)
If the contractor uses the completed contract method, it should defer costs associated with the un-priced change orders together with other costs……
Read More…. for further reading you can purchase at: AICPA Construction Contractors Audit & Accounting Guide May 1, 2016
Keep in mind when you are working on your month end WIP report, you will need to check with your PM’s to verify if there are any change order not yet in your accounting system. And, that all change orders are fully executed, entered and included on your WIP report. If you do not include these change orders your percentage of completion will be incorrect.
What are the calculating factors on the WIP report?
- Current Contract Value (Contract value after adjusting with change orders, claims etc.)
- Current Estimated Cost (this is the revised estimate, Pm’s revise monthly (typically), some are weekly. Depends on your policy and reporting time lines
- contract Value (1) minus Estimated Cost (2) = Estimated Gross Profit
- Billed to Date
- Cost to Date
- Cost to Date (4) divided by Current estimated cost (2) = Percentage of completion
- Contract value (1) times percentage of completion = Revenue to Date
- Billed to date (3) minus Revenue to date = Under/ Over billings
More Fun Stuff to come!!
We will begin to work on these POC’s (percentage of completion WIP reports).
Read up and don’t forget to go through the flashcard and match games!
2 thoughts on “Impact of Change Orders on Revenue”
There are also instances where one of our large customers want us to bill a change order before it has even been done. It is the customers internal control to not release until such time but they do so they look good to their manager. So we have to do what we have to do and accrue based on judgement. I’m sure this happens to allot of contractors. It has everywhere I have worked.
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Hi David, when this is the case we note the financials for transparency. Construction is by far different than most industries I’ve been in. Thanks for sharing!