The Accounting Treatment of Change Orders

by Tim Ayler, CPA | Partner, Director Construction Services Group

Change orders are a common occurrence for most contractors. Although it is common, the treatment of change orders in the accounting system is something that is not always done correctly. Sometimes change orders go without pricing even though the work is defined and costs are incurred. Once the price is negotiated it could result in the change order being treated differently for accounting purposes, so it is best to record it conservatively and correctly the first time.

Change orders can be treated several different ways for accounting purposes based on various factors. Below you will find an explanation for the common ways of recording change orders:

Unapproved change orders – and not probable to be approved – when costs are being incurred without approval and there is no basis to determine if the change order will be approved, the costs incurred should be expensed and added to the direct costs incurred on the job. In addition, the total estimated costs for that job should increase by the entire amount of costs that is estimated to be incurred to complete the change order.

Unapproved change orders – probable to be approved – when costs are being incurred without a signed change order, but past experience with the owner or contractor gives you some comfort that the approval will likely happen, then there are two options to consider:

1. It is acceptable to not record the costs incurred as expenses, but rather add the costs to an asset account until a determination of approval is gained
2. It is also acceptable to expense the costs incurred and record revenue for the same amount as the expense recorded, and therefore not increasing the gross profit. The contract amount, the total estimated costs for the job, and the costs incurred to date for the job should all be increased on the uncompleted job schedule to reflect the change order.

Approved change orders – record as an expense all of the costs incurred associated with the change order and record the full profit expected from the change order by increasing the contract amount and the total estimated costs on the contract based on expectations for the total amount of the change order. This will result in the proper underbilling or overbilling being recorded on the contract, including the change order.

The accounting treatment of recording change orders is meant to be conservative in order to not overstate revenues. If you have any specific questions or comments about the recording of change orders please do not hesitate to contact me.