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Need to Know: Change Order Management and Payment Applications

October 25, 2022

Contract modifications are required whenever a change affects the contract documents, regardless of whether the change will affect time or cost. Regardless of the reason, managing the entire process correctly is essential to keeping projects on time and on budget.  

In this post, we look at  

  • Change order basics as they relate to contract modifications  
  • Best practices for calculating costs related to change orders  
  • Documenting the impact of changes on a time horizon  
  • Incorporating change order requests (and related costs) into payment applications  

Change Order Fundamentals  

The two most common categories of change orders that require a contract modification include:  

  1. Change order: modifications that affect cost or time of the contract.  
  1. Change directive: modifications that ultimately will affect cost or time but agreement between owner and contractor has not yet been obtained and the work needs to be executed right away.  

When a change affects cost or time, a change order is necessary to add or deduct value from the total contract amount.  Some typical reasons for change orders include: 

  • errors and omissions in contract documents 
  • unforeseen conditions 
  • owners’ requirements to add or delete scope of work 
  • changes in regulations 
  • interpretations of the regulations by Agencies Having Jurisdiction (AHJs)  
  • unavailable materials 
  • cost increase 
  • unattainable requirements exist and need to be revised 

The owner, the contractor, or the Architect/ Engineer of Record (EOR) can initiate a request for change order. Requests may be submitted in several ways:  

  • written request for change initiated by owner or Architect/EOR 
  • proposal request initiated by Architect/EOR 
  • change order request initiated by the contractor triggered by a RFI or proposal request 
  • request for substitutions by contractor for various reasons 
  • change directives by owner or Architect to proceed with work without agreeing with a cost.  

While the above provides general guidance on procedures, it is of critical importance that the contract documents be consulted to make sure all required procedures are strictly followed. 

Procedures for Calculating the Costs of Change Orders  

Change orders should be processed promptly to avoid delays. Consider the following when determining the cost of a change: 

  • Value of contractor’s overhead and profit 
  • Method of crediting owner for deductions 
  • Unit prices to be used in determining the cost 
  • Confirmation of costs incurred by contractor 
  • Use (or not) of subcontractors to perform the work 
  • Equipment rental costs for both active and idle equipment 
  • Amount of time extension and general conditions costs if applicable 

The construction contract typically includes specific guidelines to follow when pricing changes. These may include the amount of overhead and profit that the contractor is allowed to add to the cost of labor, equipment, material, and supplies. Additionally, when change orders are priced and prepared by the contractor, the impact on time must also be considered and included, if appropriate. 

After a change order has been issued, the contractor should adjust the schedule of values and the construction progress schedule to reflect the appropriate changes. The contractor typically adjusts the schedule by adding additional, independent lines to the original schedule of values, allowing for the review of the work described in the change. Doing so also keeps the original schedule of values intact with no adjustments in those line item costs necessary. 

Another way, in a typical G703 form, is to adjusts the schedule of value directly by breaking down the change order by trade. In this method is necessary to have two additional columns in the schedule of value form; one column will show “previous change orders” and another column for “current change orders”. The total value of the “current change orders” columns must match with the total value of the change order. See example below.  

When a Change Order Affects the Time Horizon 

Typical contract provisions state that time limits in the contract documents are of the essence. “Time is of the essence” means that performance by the contractor within the period specified in the contract is necessary to provide a completed project to the owner. Failure to act within the time required constitutes a breach of the contract. The time limit is the period allotted in the contract documents to achieve substantial completion of the project. By signing the agreement, the contractor acknowledges that the time limit stated is a reasonable period in which to construct the project. 

Some changes do not have significant monetary impact but do require more time for completion. Time changes should be documented as prescribed in the contract, which may include documentation on how the change affects the schedule’s critical path. Often, a formal record of the day count on the project is kept. In such cases, all parties to the contract need to review the count regularly and immediately notify the others if there is disagreement with the stated day count. 

Payment Applications, Change Orders and Contract Modifications 

Once the change orders have been documented and are reflected in contract modifications, the next step is to incorporate these changes in the payment application. The payment application is a document that must be prepared in the form stipulated within the contract documents.  

Each pay application must include the  

  • contract accounting summary that includes the original contract sum 
  • total of approved change orders to date 
  • total completed and stored to date  
  • total amount to bill the specific period 
  • any stored material and retainage  
  • balance to finish 

This form must be certified by the contractor, signed and notarized. (Refer to Understanding the Schedule of Values (SOV) and Payment Applications from an Entry-level Perspective)  

In order to incorporate the change order in a pay application, the change order must be properly submitted and approved by the owner. Incorporating the change order in the pay application can be done in two different ways: 

  1. Adding an additional line per change order without affecting the original schedule of value.  
  1. Adding two columns showing previous change orders and current change orders amount and split it by trade throughout the schedule of value to adjust the contract amount.  

It can be included individually, but a common method is to create one change order monthly that includes all individual changes approved during that month, differentiating the documents by names or acronyms, such as: 

  1. Change order request (COR) or potential change orders (PCO) that include one change order in a per basis case.  
  1. Prime contracts change order (PCCO) that includes all change orders approved during that month.  

In the construction business, changes are often inevitable. The important thing to remember is that with rigorous upkeep of processes and documentation, events that require a change in plans can be managed smoothly. For more information on best practices in managing change orders and contract modifications, please contact Gisel Hernandez.

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