What is the change order revenue for a construction company?

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How is change order revenue defined in a construction company's accounting structure?

Change order revenue is the additional income your construction company recognizes when a project's scope, contract value, or timeline is formally modified through documented agreements between you and your client.

This revenue is tracked separately from your base contract value in your project accounting systems. The separation allows you to monitor how modifications impact individual project profitability and overall company financial performance. Your accounting team records these changes only after both parties—your company and the client—have mutually approved the modifications through signed documentation.

The accounting structure for change orders in construction companies follows specific project accounting principles that differ from standard revenue recognition. Each change order is assigned a unique identifier linked to the original contract, creating a clear audit trail. This structure enables you to analyze which projects generate the most change order revenue and whether these modifications are improving or eroding your profit margins.

Your chart of accounts should include dedicated revenue codes for change orders, allowing you to generate reports that show base contract revenue versus change order revenue. This visibility is essential for construction companies because it reveals patterns—such as whether certain project types or clients consistently require more modifications—that inform your bidding strategy and risk assessment for future projects.

What percentage of total project revenue typically comes from change orders in construction?

Change orders typically account for 5-10% of total project revenue in construction companies, though this percentage varies significantly based on project complexity and industry segment.

Projects with higher uncertainty—such as renovation work, infrastructure projects with extensive underground components, or design-build contracts—can experience change order revenues reaching 25% or more of the original contract value. Commercial construction projects with well-defined scopes tend to fall on the lower end of the range, while residential remodeling and civil engineering projects often see higher percentages due to unforeseen site conditions.

The percentage also depends on how thoroughly your construction company defines the initial scope and manages client expectations. Companies that invest in detailed pre-construction planning, comprehensive site surveys, and clear contract language typically experience lower change order rates. Conversely, projects with aggressive timelines that skip thorough planning phases often generate more change orders as hidden conditions emerge during construction.

For your construction business, tracking this percentage across projects reveals important insights. If your change order revenue consistently exceeds 15% of base contract value, it may indicate scope definition problems, pricing strategies that rely too heavily on change orders, or client relationships that need better expectation management. Industry benchmarks suggest that well-managed construction companies maintain change order revenue between 5-12% while preserving healthy profit margins on both base and change order work.

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How are change orders initiated, documented, and approved before revenue is recognized?

Change orders in construction companies follow a structured process that begins with identification of the needed modification and ends with formal approval by all stakeholders before any revenue can be recognized.

The initiation phase starts when your project team, the client, or design professionals identify a required change to the original scope. This could result from design clarifications, unforeseen site conditions discovered during excavation, client-requested upgrades, or regulatory changes. Your project manager documents the proposed change in a change order request form that describes the modification, explains why it's necessary, and provides preliminary cost and schedule implications.

During the evaluation phase, your estimating team performs a detailed impact assessment that calculates the exact cost of labor, materials, equipment, and subcontractor work required. Your project manager assesses schedule impacts, determining whether the change will extend the completion date or require acceleration to maintain the original timeline. This analysis also includes markup for overhead and profit, which typically ranges from 10-30% depending on your company's pricing policy and the change order's complexity.

The documentation phase requires your construction company to prepare a formal change order document that includes the change description, detailed cost breakdown, schedule impact, updated contract value, and any modifications to project specifications or drawings. Best practices dictate that all change orders are numbered sequentially and reference the original contract to maintain a clear connection between base work and modifications.

The approval process involves circulation of the change order document to all required stakeholders—typically your project manager, your company's contract administrator, the client's representative, and sometimes the architect or engineer. Each party reviews the documentation, and formal approval requires signatures from authorized representatives. Only after all parties sign does your accounting team recognize the revenue in your financial statements, ensuring that unapproved or disputed amounts don't inflate your reported income.

What criteria determine when a change order is billable versus absorbed as a project cost?

A change order is billable to your client when it introduces additional scope, effort, or materials beyond the original contract and the client explicitly agrees to pay for it through formal approval.

The first criterion is whether the change represents work outside the original contract scope. If your construction company encounters conditions or requirements that were not reasonably foreseeable when you bid the project—such as contaminated soil requiring special disposal or structural issues in an existing building—these changes are typically billable. The key test is whether a reasonable contractor would have anticipated the condition based on the information available during bidding.

Client-initiated changes are almost always billable, including upgrades to finishes, modifications to layouts, additions to the project scope, or changes in specifications. When your client requests these modifications, your construction company documents them as billable change orders with full cost recovery plus markup. However, you must secure written approval before proceeding, as verbal agreements can lead to disputes during billing.

Changes absorbed as project costs typically result from errors, omissions, or deficiencies in your company's performance. If your subcontractor installs materials incorrectly and rework is required, this cost is absorbed internally rather than billed to the client. Similarly, if your estimating team made calculation errors or overlooked items clearly shown in the contract documents, your construction company bears these costs. Changes required to correct work that doesn't meet code requirements—when compliance was your responsibility—are also absorbed costs.

The contract language plays a critical role in determining billability. Your construction agreements should clearly define what constitutes a change, specify the change order process, and outline cost responsibility for various scenarios. Contracts with broad "all-inclusive" language may require your company to absorb costs that would otherwise be billable, while contracts with detailed exclusions protect your ability to bill for unforeseen conditions. Reviewing these provisions during contract negotiation is essential for protecting your construction company's profitability on change order work.

How does the timing of change order approval affect revenue recognition in financial statements?

Your construction company can only recognize change order revenue in financial statements after formal approval is obtained from all required parties, which directly impacts the timing of reported income.

Under current accounting standards (GAAP and IFRS), revenue recognition for construction companies follows the completion of performance obligations. For change orders, the performance obligation is updated when the change is approved, and revenue is recognized as the modified work is performed. If your company completes change order work in March but doesn't receive formal approval until May, the revenue cannot appear in your March financial statements—it's recognized in May when approval occurs.

This timing requirement creates cash flow and financial reporting challenges for construction companies. If you perform significant change order work without timely approvals, your financial statements will underreport revenue relative to costs incurred, temporarily depressing your reported profitability. Your balance sheet will show these costs as work-in-progress (WIP) inventory until approval allows revenue recognition, potentially affecting your working capital ratios and credit facility covenants.

For unapproved change orders, conservative accounting practices require your construction company to treat them as claims. You can only recognize revenue from unapproved changes if recovery is highly probable and you can reliably estimate the amount. This high threshold means most unapproved change orders remain unrecognized in revenue until formal approval occurs, even if you believe the client will ultimately pay. Documenting the status of pending change orders in financial statement footnotes provides transparency to investors, lenders, and other stakeholders about potential future revenue.

The percentage-of-completion method commonly used by construction companies compounds these timing effects. Under this method, revenue is recognized proportionally as work progresses, so delays in change order approval create a mismatch between costs incurred and revenue recognized. Your project accounting team must carefully track approved versus unapproved change orders to ensure your financial statements accurately reflect your construction company's performance and comply with accounting standards.

This is one of the strategies explained in our construction company business plan.

What accounting method is used to record change order revenue in construction companies?

What are the main causes driving change orders across construction projects?

Design revisions, unforeseen site conditions, regulatory changes, client preferences, and coordination issues among project stakeholders drive the majority of change orders in construction projects.

Design-related changes represent one of the largest categories, including incomplete drawings, design errors, conflicts between architectural and engineering plans, and changes made by designers during construction. When your construction company encounters drawings that don't match field conditions or specifications that contradict the plans, these design deficiencies generate change orders. Projects with aggressive design schedules or design-build delivery methods where design and construction overlap particularly experience high rates of design-driven changes.

Unforeseen site conditions account for substantial change order volume, especially in renovation and infrastructure projects. Your company may encounter contaminated soil requiring remediation, unexpected underground utilities, poor soil bearing capacity, groundwater levels different from those indicated in geotechnical reports, or hidden structural conditions in existing buildings. Despite thorough pre-construction investigation, complete knowledge of subsurface and concealed conditions is rarely possible, making these changes common even on well-planned projects.

Client-initiated modifications occur when project owners request changes to finishes, layouts, equipment specifications, or scope additions after contract execution. These changes often result from evolving business needs, market feedback, budget reallocations, or simply changing preferences as clients see their project taking physical form. While these changes can be profitable for your construction company, managing client expectations and securing timely approvals is critical to preventing disputes.

Regulatory and permitting changes force modifications when building codes are updated, permitting authorities impose new requirements, environmental regulations change, or utility companies revise connection standards during construction. Your construction company must track regulatory changes and document when external agencies mandate modifications beyond your control, as these typically constitute billable change orders.

Coordination issues among trades and stakeholders generate changes when subcontractor scopes conflict, material delivery sequences don't align with construction logic, or means and methods selected by one trade impact others. Construction companies with strong project management and coordination processes minimize these changes, while projects with multiple prime contractors or fast-track schedules experience higher rates of coordination-driven modifications.

How is the profitability of change orders tracked compared to base contract work?

Construction companies track change order profitability by comparing actual costs and revenues for each modification against base contract work margins using dedicated project accounting systems and financial dashboards.

Your accounting system should assign unique cost codes to change orders, allowing separate tracking of labor hours, material costs, equipment expenses, and subcontractor fees associated with each modification. This coding structure enables your project management team to calculate the gross profit margin for individual change orders by subtracting direct costs from change order revenue. Many construction companies find that change order margins differ significantly from base contract margins—sometimes higher due to markup on emergency or time-sensitive work, sometimes lower due to inefficiencies caused by disruption of planned work sequences.

Comparing change order profitability to base contract work requires your construction company to analyze several key metrics. The gross profit percentage on change orders should be calculated and compared to your base contract gross profit percentage. If base contract work generates 18% gross profit while change orders only generate 12%, this indicates that change orders are dragging down overall project profitability despite adding revenue. Your financial team should investigate whether lower change order margins result from insufficient markup, higher execution costs, or underestimation of the work required.

Project accounting dashboards display change order performance through visual reports showing revenue, costs, and margins for base versus change order work. These dashboards should update in real-time as costs are incurred, providing your project managers with early warning when change order work is trending over budget. Advanced construction companies segment change order profitability by cause (client-initiated versus unforeseen conditions), project phase (early versus late in construction), and size (small field changes versus major scope modifications) to identify patterns that inform future pricing and project management strategies.

Detailed tracking also reveals the fully loaded cost of change orders, including not just direct execution costs but indirect impacts such as schedule delays, loss of productivity on base scope work, and administrative overhead for managing the change order process. Construction companies that only track direct costs often underestimate the true profitability impact of high change order volumes, leading to pricing strategies that don't adequately compensate for the disruption and management burden that changes impose on project teams.

What internal controls prevent unapproved or disputed change orders from inflating revenue?

Construction companies implement mandatory stakeholder approval workflows, standardized documentation requirements, workflow management software, and periodic audits to prevent recognition of unapproved or disputed change orders that would artificially inflate revenue.

The first control is a formal approval authority matrix that defines who can approve change orders at various dollar thresholds. Your construction company should require dual authorization—one from the project manager who verifies technical aspects and one from contract administration who confirms contractual and financial accuracy. Change orders above specified amounts (commonly $10,000-$50,000 depending on project size) should require senior management or executive approval, ensuring that significant modifications receive appropriate scrutiny before revenue recognition.

Standardized change order templates enforce documentation completeness by requiring specific fields—change description, cost breakdown, schedule impact, contract reference, client approval signature, and company approval signature—before the change can be processed. Your accounting system should reject change orders that lack any required field, preventing incomplete or unapproved modifications from entering your financial records. These templates create consistency across all projects and establish a clear paper trail for auditors and financial reviewers.

Workflow management software provides digital approval routing that tracks each change order through its lifecycle from initiation to final approval. The system automatically routes change orders to appropriate approvers based on the authority matrix, maintains a complete audit trail of who reviewed and approved each change, and flags change orders that remain unapproved beyond specified timeframes. Your construction company's accounting integration should only allow revenue recognition for change orders that have completed the entire approval workflow, creating a system-enforced control that prevents manual override of approval requirements.

Periodic internal audits conducted by your finance team or external auditors sample change orders to verify that revenue recognition aligns with approval documentation. These audits check that signed change orders exist for all recognized revenue, approval dates precede revenue recognition dates, and the approved amounts match recorded revenue. Discrepancies trigger corrective actions and financial statement adjustments, while patterns of control failures prompt strengthening of approval processes or additional training for project staff.

Segregation of duties ensures that the individuals who initiate change orders, approve them, and record revenue are different people within your construction company. Project managers should initiate but not approve their own change orders; accounting staff should record revenue based on approved documentation but not authorize the changes themselves. This separation prevents any single individual from creating fictitious change orders or recognizing revenue from disputed modifications without proper oversight.

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How is change order revenue forecasted and reported in project and company-level dashboards?

Change order revenue is forecasted by updating project budgets as each approved change order is added, with robust project management and ERP systems reporting impacts at both individual project and company-wide levels through real-time performance indicators.

At the project level, your construction company's project managers maintain a change order log that tracks all proposed, pending, approved, and rejected modifications. This log feeds into project financial forecasts by adding approved change order values to the remaining revenue forecast while flagging pending changes as potential upside. Your forecasting model should categorize change orders by approval status—"approved and in progress," "approved but not started," "pending client approval," and "proposed but not submitted"—to provide realistic revenue timing predictions. Only fully approved change orders are included in committed revenue forecasts, while pending changes are shown separately as opportunities or risks.

Monthly project financial reports display change order performance through variance analysis comparing budgeted versus actual change order revenue and costs. Your dashboard should show cumulative change orders as a percentage of original contract value, current month change order activity, change order margin compared to base contract margin, and aging of pending approvals. Visual indicators flag projects with unusually high change order percentages or low margins, prompting management review of pricing strategies or project execution issues.

Company-level dashboards aggregate change order data across all active projects to provide executive visibility into overall change order performance. Key metrics include total change order revenue as a percentage of total company revenue, average change order margin across all projects, backlog of pending change orders (representing potential future revenue), and trend analysis showing whether change order volumes are increasing or decreasing over time. Your CFO and executive team use these dashboards to assess whether change orders are enhancing or undermining overall company profitability.

ERP systems integrate change order data with other financial metrics, allowing your construction company to analyze relationships between change orders and other performance indicators. For example, correlating high change order volumes with project delays reveals whether modifications are causing schedule impacts, while comparing change order margins to customer satisfaction scores shows whether aggressive change order pricing is damaging client relationships. Advanced analytics identify which project types, clients, or market segments generate the most profitable change order revenue, informing strategic decisions about market focus and pricing approaches.

Rolling forecasts update monthly to reflect new change order approvals and revised estimates for pending changes, providing your construction company with current visibility into expected cash flows and revenue timing. These forecasts are critical for resource planning, as high volumes of approved change orders may require additional labor, equipment, or subcontractor capacity that must be secured in advance to maintain project schedules and profitability.

How does a construction company handle change orders that remain pending or disputed at project closeout?

Pending or disputed change orders at project closeout are recorded as claims, contingent assets, or unapproved work and are excluded from recognized revenue until resolved, with appropriate disclosure in financial statement footnotes or project summaries.

When your construction company reaches substantial completion or final closeout with change orders still pending approval, your accounting team reclassifies these items from "pending change orders" to "claims" on your balance sheet. Claims represent work performed or costs incurred for which your company believes it is entitled to payment but for which formal client approval has not been obtained. Under conservative accounting principles, your construction company should not recognize revenue from claims unless recovery is highly probable and the amount can be reliably estimated—a threshold that is rarely met for disputed items.

The dispute resolution process depends on the mechanisms specified in your construction contract. Most contracts include a tiered approach starting with direct negotiation between project managers, escalating to senior management discussions, then potentially involving mediation or arbitration before litigation. During this process, your construction company continues to document all costs associated with the disputed work and maintains detailed records of communications and negotiations. These records are essential both for supporting your position in dispute resolution and for demonstrating to auditors that your revenue recognition decisions are appropriate.

For financial reporting purposes, your construction company must disclose material pending or disputed change orders in the footnotes to your financial statements. This disclosure typically includes the aggregate dollar amount of claims, a description of the nature of the disputes, management's assessment of the likelihood of recovery, and any provisions or reserves established for potential unfavorable outcomes. Public construction companies or those with bank financing often face additional scrutiny regarding these disclosures, as lenders and investors view high levels of disputed change orders as risk factors affecting future cash flows.

Project closeout procedures should include a final change order reconciliation where your project team and the client review all pending items and attempt to reach agreement before final payment is processed. Many construction companies offer discounts or negotiate compromise positions to avoid protracted disputes over relatively small change orders, weighing the cost of pursuing claims against the administrative burden and relationship impact. For larger disputed amounts, your company may agree to final payment on all undisputed work while formally preserving rights to pursue claims for disputed items through the contract's dispute resolution process.

Cash flow management becomes critical when significant change order revenue remains unpaid at closeout. Your construction company should establish reserves or contingency funds to cover costs incurred on disputed work, ensuring that disputes don't create liquidity problems. Regular aging reports track how long change orders have been pending, with management review of items outstanding more than 60-90 days to determine appropriate escalation or resolution strategies.

What systems or KPIs are used to monitor trends and improve change order management efficiency?

• Change Order Approval Cycle Time: This KPI measures the average number of days from change order submission to final approval. Your construction company should track this metric by client, project type, and change order size to identify bottlenecks in the approval process. Industry benchmarks suggest approval cycle times should range from 5-15 days for routine changes and 15-30 days for complex modifications. Longer cycle times indicate inefficient processes, unclear approval authorities, or difficult client relationships that require attention. Reducing approval cycle time directly improves cash flow by accelerating billing and payment for change order work.
• Change Order Volume as Percentage of Contract Value: Calculate total change order revenue divided by original contract value for each project and as a company-wide average. This percentage reveals whether your construction company is experiencing normal change order levels (5-10%) or excessive modifications indicating scope definition problems, inadequate preconstruction planning, or clients who consistently change requirements. Tracking this metric over time shows whether project management improvements are reducing unnecessary change orders while still capturing legitimate additional scope.
• Change Order Profitability Rate: Measure gross profit margin on change orders compared to base contract margin across all projects. Your construction company should track profitability by change order cause (client-initiated, unforeseen conditions, design errors) to identify which types of changes generate the best returns. If change order margins are consistently below base contract margins, your pricing strategy needs adjustment or your execution efficiency on change work needs improvement. Elite construction companies often achieve higher margins on change orders (20-30%) compared to base work due to premium pricing for disruption and schedule impact.
• Change Order Incidence Rate per Million Dollars of Revenue: This normalized metric allows your construction company to compare change order frequency across projects of different sizes. Calculate the number of change orders divided by project revenue in millions. High incidence rates suggest your company is creating numerous small changes rather than consolidating modifications into fewer, larger change orders—a practice that increases administrative burden without adding value. Best practice is to minimize change order count by batching related modifications when possible.
• Dispute Resolution Success Rate: Track the percentage of disputed change orders that are resolved in your construction company's favor and the average settlement percentage (actual recovery divided by claimed amount). High success rates indicate strong documentation practices and reasonable pricing, while low success rates suggest your company may be overreaching on claims or lacking adequate documentation. This metric also measures the average time to resolve disputes, with shorter resolution periods indicating effective negotiation skills and maintaining good client relationships despite disagreements.
• Unapproved Change Order Aging: Monitor the dollar value and number of change orders pending approval segmented by aging buckets (0-30 days, 31-60 days, 61-90 days, over 90 days). This KPI highlights potential collection problems and helps your construction company prioritize follow-up efforts on overdue approvals. Change orders pending more than 60 days should trigger escalation to senior management, while items over 90 days may require formal dispute resolution processes. Effective construction companies maintain less than 5% of their change order value in the over-60-day aging category.
• First-Time Approval Rate: Measure the percentage of submitted change orders that are approved without requiring revision or resubmittal. Low first-time approval rates indicate quality problems with your change order proposals—inadequate cost justification, insufficient documentation, or unclear scope descriptions. Your construction company should target a first-time approval rate above 80%, with rates below 70% suggesting the need for improved proposal preparation training or better communication with clients before formal submission.
• Change Order Impact on Project Schedule: Track how many change orders cause schedule delays and the cumulative days of delay attributable to changes versus the original project duration. This metric reveals whether your construction company is effectively managing the schedule impacts of modifications or whether changes are becoming a primary driver of project delays. Sophisticated construction companies correlate schedule delay with change order profitability to determine whether their pricing adequately compensates for disruption costs.

Conclusion

This article is for informational purposes only and should not be considered financial advice. Readers are encouraged to consult with a qualified professional before making any investment decisions. We accept no liability for any actions taken based on the information provided.

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