Keeping a close eye on contract allowances

by David M. Wolfenden, CPA, CVA, MS, Managing Director

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In construction, and life, uncertainty leads to conflict. When two separate parties are unsure about something, they could very well reach two different conclusions and end up at odds.

So it goes on many construction projects — especially homebuilding jobs — when contract allowances are involved. So if your business deals with contract allowances regularly, you’ve got to keep a close eye on these often contentious items.

Reviewing the concept
To review, a contract allowance is an estimated dollar amount that allocates funds to a particular job task for which a specific dollar amount couldn’t be arrived at during bidding. Generally, there are two main types of allowances:

  1. Material allowances. This is an amount associated with the cost of a specific construction material, such as carpeting.
  2. Installed allowances. These amounts estimate the price of both the material in question and the cost of its installation. For example, different types of cabinetry may take longer to install than others, so the estimated price would be higher.

When it comes to either kind of allowance, the contract language used must be as clear as possible. It should unambiguously state the amount in question and explain how overages or underages will be handled.

Knowing the limits
A “fewer is better” approach to contract allowance is usually advisable. The more allowances in a contract, the greater the chances of a dispute or misunderstanding.

Make sure allowance amounts are well suited to the job in question. It can be tempting to stick to “rule of thumb” or boilerplate figures. But these can lead to problems — particularly for projects with higher materials and installation costs. It’s generally advisable to include a schedule of allowances under product specifications in the general conditions of an AIA-form contract.

Contract allowances also may trigger suspicions in some owners. Unfortunately, unscrupulous contractors have used allowances for fraudulent purposes. So it’s important to emphasize your construction company’s ethical approach to business.

State clearly that you’ll make your best effort to obtain fair prices, terms and conditions of purchase. Assure owners that you’ll pass along savings from rebates, refunds and discounts. In some cases, you may want to obtain written instructions from the owner on how each cash allowance should be spent.

Writing up changes
If there’s a substantial price deviation to an allowance amount, you’ll need to issue a change order. This holds true whether the job cost is over or under the stated allowance.

Make sure owners are aware of this possibility going into the project. Should a change order become necessary, write it up immediately. Don’t wait until completion to do so or you’ll risk dealing with a surprised and unhappy owner.

“Write” is the operative word. Put the price variation in writing and follow your established procedures for change orders. Simply discussing the change verbally is, again, a risky move that could lead to conflicts and higher job costs for you down the line.

Getting it right
If you’re tired of “talking down” irate owners and absorbing excessive job costs, your contract allowances may be at least partly to blame. Regularly review the numbers you’re using and the procedures your employees are following.

We welcome the opportunity to put our construction industry expertise to work for you. To learn more about how our firm can help advance your success, please contact Dave Wolfenden at (302) 254-8240.

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