Deductive Change Orders: What Contractors Need to Know

The project owner typically proposes these types of changes when unforeseen issues have impacted the project. They should have a valid reason to remove a portion of the project, but also should consider if the project can be completed without that section of work. If their contractor agrees to the change, he or she will issue a deductive change order that acts as the official agreement on the change in work and in costs.

As you can imagine, reducing prices based on reducing work can in turn reduce your profits. Deductive change orders can have a significant impact on your business, so it’s important you understand common causes, how they work and how it can affect your bottom line.

Common Causes of Change Orders

Although deductive change orders are less common than standard change order requests, they do still happen from time to time. There are three common reasons that a client or you would want to issue a deductive change order.

Changed Their Mind

Perhaps the most common reason project owners request deductive changes is because they’ve changed their mind about what they want. This occurs most often in design build projects, where clients approve a conceptual scope that might not look the same once it’s built.

*Note: Changes are a natural part of the design build process. As contractors, architects and designers all work together to bring a thought to life, necessary changes are made along the way that can make the final product much different from the original idea.

This type of deductive change usually happens at the project owner and general contractor level, before subcontractors are involved. For example, if you’re the general contractor on a design build project, you might receive a deductive change order upon design completion when the owner realizes part of their idea isn’t necessary.

Subcontractors might still be indirectly affected by these changes. If they were hired before the changes were made, the value they provide will likely decrease when certain elements are removed. However, most general contractors don’t hire their subs until the original contract is finalized and signed.

Unexpected Problems During the Project

You might also receive a deductive change order if there’s a problem during the project. This often happens when a project is under construction and there’s a need for significant rework. For example, if material prices spiked unexpectedly on one of your main materials, the project owner might have to reduce the scope to accommodate their budget.

This often has different effects on different types of contractors and which material is being reduced. Subcontractors working with that material will likely see a reduction in the scope of their work, while a general contractor might not feel the reduction in scope as directly.

Problems at Inspection

The third way deductive change orders most often occur is when there’s a problem with an inspection. Typically in this situation, a change order is geared toward fixing the problem at a lower cost.

For example, imagine that you were planning to install metal piping on a commercial building, but an inspector said the piping had to be PVC to meet a new coding requirement. You would have to issue a deductive change order to account for the price difference between metal and PVC pipes in order to fulfill the inspector’s request.

How Deductive Change Orders Work

The deductive change order process is very similar to a regular change order process. There are four basic steps:

1. When the work needs to be reduced, the client or the contractor will request the necessary adjustments.
2. Both parties must agree to the proposed changes.
3. The contractor writes the deductive change order and sends it for the client’s review and approval.
4. Once signed and approved by both parties, the change order becomes part of the contractual agreement for the project.

Remember that a deductive change order is essential for project completion in many situations. It’s much easier to continue making progress on the work when all parties can work together for the benefit of the final product. Once both parties can come to an amicable agreement regarding necessary changes, it should help everyone feel confident in the success of a project.

How Deductive Changes Affect Your Business

When you take away part of a job, it will inevitably impact your costs and profits. The first step when dealing with a deductive change order is to determine if it’s a true deduction or a partial termination.

• Deduction: reducing the scope of the project in some minor way, but keeping the overall job the same.
• Partial termination: removing significant elements of a job that cause notable changes to or completely alter the project.

With a true deduction, you’re still performing the work just with a change to the costs. The previous example of switching out metal pipes for PVC pipes would be a true deductive change. The work will stay the same but the cost of materials will decrease.

In a partial termination, you could lose an entire portion of the job. Imagine a project where you were hired to build an entire house and a gazebo in the backyard. If the owner decides halfway through that they don’t want the gazebo, that would be a partial termination.

Both of these changes can eat into your profits if you’re not careful. You have to change your estimates for planned labor and materials costs differences, without letting it affect your bottom line. You’ll have to thoroughly review your contract and negotiate with the owner to determine how the cost reduction will be applied so you can protect your profits. Depending on how your business operates, this could be an in-depth process.

Use Software to Manage Changes

As the contractor, you need to record every change order you receive or submit in your accounting system. This ensures that you’re always looking at the most recent, updated budget for a project.

In addition to tracking your change orders, you need to calculate all the costs that could be affected by it. A few common costs include:

• Labor
• Materials
• Subcontractors
• Equipment

Once those are inputted in your accounting system, the program can help you track changes over time and estimate total project costs. Your operations and administrative teams should all have access to this information so they can help you plan profitable projects.

The key to quality reporting and tracking is quality accounting software. Crewcost is a purpose-built accounting system specifically designed to help contractors manage their business finances. Try Crewcost FREE for 14 days to see how it can help you protect your profits.