If you've been in construction for more than five minutes, you know that the original contract is really just a starting point. Clients change their minds. Architects discover problems. Underground conditions surprise everyone. And suddenly, you're dealing with change orders.
From a project management standpoint, change orders are just part of the job. But from an accounting standpoint? They can turn a clean set of books into a tangled mess if you don't handle them right. Poor change order accounting is one of the fastest ways to lose track of your true job costs, misrepresent your financial position, and make decisions based on numbers that don't reflect reality.
Let's break down how to account for change orders properly—so your books actually tell you what's happening on your jobs.
What Change Orders Really Are (From an Accounting Perspective)
A change order is any modification to your original contract that affects scope, timeline, or cost. Maybe the owner wants upgraded finishes. Maybe you hit rock where the plans showed dirt. Maybe the engineer redesigned the HVAC system mid-project.
Whatever the cause, each change order represents a mini-contract within your larger contract. And just like your original contract, it needs to be properly documented, priced, approved, and tracked through your accounting system.
The accounting challenge is that change orders affect almost everything: your contract value, your cost estimates, your revenue recognition, your WIP schedule, and your cash flow projections. Miss any of these, and your financial picture gets distorted.
The Right Way to Handle Change Orders in Your Books
Start with proper identification and documentation. Before you touch your accounting system, you need clarity on what's actually changing. What work is being added, deleted, or modified? How does it affect your timeline? What will it cost, and what will you charge?
This isn't just about having a signed piece of paper (though you absolutely need that). It's about having enough detail that anyone looking at the documentation six months from now can understand exactly what changed and why. Include descriptions of the work, the reason for the change, itemized costs, and the agreed-upon price. Get signatures from everyone who needs to approve it—you, the owner, and any affected subcontractors.
Update your contract value. Once a change order is approved, your original contract amount is no longer accurate. Your accounting system needs to reflect the new total contract value. This seems obvious, but it's easy to let approved change orders pile up without formally adjusting the contract in your system. When that happens, your percentage-of-completion calculations, your estimated gross profit, and your WIP schedule all become unreliable.
Track the costs separately. Here's where many contractors get sloppy. Change order costs need to be tracked with the same rigor as your original job costs. That means capturing both direct costs (the labor, materials, and subcontractor expenses specifically tied to the change order work) and indirect costs (the additional overhead, equipment mobilization, supervision, or administrative time the change requires).
If you're lumping change order costs into your general job costs without any way to identify them, you're losing visibility into whether your change orders are actually profitable. Some contractors consistently undercharge for change orders because they don't realize how much indirect cost they're absorbing.
Revise your estimates. A change order doesn't just affect what's happened—it affects what's coming. Your estimated cost to complete and your total estimated profit need to be updated to reflect the new scope. This is critical for percentage-of-completion accounting, where your revenue recognition depends on comparing costs incurred to total estimated costs.
Failing to update estimates is one of the most common WIP schedule errors in construction. You end up with revenue recognition that doesn't match reality, and potentially some ugly surprises when the job closes out.
Recognize revenue appropriately. How you recognize revenue from change orders should be consistent with how you're recognizing revenue on the overall contract. If you're using percentage-of-completion (which most contractors are for longer projects), you'll recognize change order revenue as you incur the related costs, proportional to your progress. If you're using completed contract method, you'll wait until the job is done.
The key is consistency and making sure your revenue recognition reflects the updated contract terms, not the original ones.
Update your financial statements and reports. Change orders need to flow through to your WIP schedule, your job cost reports, and your financial statements. Your WIP schedule in particular needs to show the current contract value (including approved change orders), your current estimated costs, costs incurred to date, and the resulting over/under billing position.
If your WIP doesn't reflect approved change orders, you might look underbilled when you're actually on track, or overbilled when you're really in trouble.
Where Things Typically Go Wrong
The most common problems I see with change order accounting come down to timing and discipline. Change orders get verbally approved but not documented. Costs get incurred before the change order is formally recorded in the system. Estimates don't get updated. The contract value in the accounting system doesn't match the actual approved contract value.
Each of these gaps creates a disconnect between your books and reality. And in construction, where margins are tight and cash flow is everything, you can't afford to make decisions based on bad numbers.
Building Better Habits
Good change order accounting isn't complicated, but it does require discipline. Document everything before work begins. Update your accounting system promptly when change orders are approved. Track costs specifically. Revise your estimates. Reconcile your records regularly to catch discrepancies early.
The contractors who do this well always know where they stand on every job. They know which change orders are making money and which ones are eating into their margins. They can have honest conversations with owners about what changes will really cost. And they're never surprised by their job closeout numbers.
That's the goal: books that tell you the truth, so you can run your business with confidence.