A credit change order, and why so few of them arrive

A credit change order is what should happen when scope comes out of a contract. Owners remove scope regularly and receive credits rarely, and the gap between those two facts is almost always about how the credit is calculated rather than about whether one is owed.

The asymmetry, stated plainly

Adding scope produces a change order within weeks. The contractor prices it, applies markup, and submits it, because there is money in it.

Removing scope produces nothing automatically. Somebody has to calculate what comes off, and that somebody is the party losing the money.

So on a project with three hundred additions and forty removals, an owner will typically see three hundred change orders and perhaps fifteen credits, and the credits will be smaller in proportion.

This is not usually deliberate. It is the predictable outcome of a process where one direction has an owner and the other does not.

The fix is administrative rather than adversarial. Every scope removal gets a change order number on the day it is decided, exactly as an addition does, and sits on the log until it is priced. An item with a number attached does not get forgotten.

Most of the value in this subject comes from that single habit rather than from any argument about calculation.

How a credit change order is calculated, and where it shrinks

A credit should be the cost that will no longer be incurred. Four things reduce it, and two of them are legitimate.

Work already performed. If shop drawings are done and material is ordered, those costs stand. Legitimate, and it is why timing matters so much.

Restocking and cancellation charges. Real costs from suppliers. Legitimate, and they should be evidenced rather than asserted.

Markup and general conditions retained. Contractors frequently credit the direct cost and retain the markup, on the reasoning that overhead was allocated to the project rather than to the item. Arguable, and it should be settled at signature rather than item by item.

Lost efficiency asserted on remaining work. The claim that removing part of a scope makes the rest more expensive per unit. Sometimes true on genuinely repetitive work, frequently asserted where it is not.

The last two together can reduce a credit to a third of the cost actually saved, and neither is visible unless the credit arrives with a build up.

The timing question that decides most of it

The value of a removal collapses over the life of a package, and the curve is steep.

Before the package is tendered, removal costs nothing and the full value comes out. Between tender and award, the credit is close to full value less a small amount of estimating effort.

After award and before shop drawings, the credit is the trade contract value less any mobilization and design work done, and it is still most of the money.

After shop drawings and material release, the credit falls sharply, because the fabricator has spent money and will charge for it.

After delivery, there is frequently no credit at all. The material is on site, it belongs to the project, and removing the installation scope saves only the labor.

Which means an owner considering a removal should ask one question before anything else: where is this package in that sequence. A decision deferred by six weeks routinely halves the credit, and that is a far larger effect than any argument about markup.

A worked example

A hotel project removes a rooftop terrace bar, a second guest laundry and 14 upgraded corridor light fixtures per floor, across months eight through fourteen.

The removed scope is carried in the contract at approximately $1.1 million.

The credits eventually agreed total $670,000.

The difference breaks down as follows. The terrace removal is decided in month eight and priced in month twelve, by which time the specialty glazing has been released to fabrication, costing $180,000 in cancellation and completed engineering. The laundry equipment has been delivered and stored, so only the rough in labor is credited, a further $90,000 of lost value. And on all three items the contractor retains markup and general conditions, $160,000.

Of that $430,000 gap, roughly $270,000 is a consequence of the four month interval between the decision and the pricing. Only the markup retention, $160,000, is a matter of contract language.

The timing cost more than the terms did, which is the usual pattern.

What to settle at signature

Three provisions, none of them contentious if raised before the contract is executed.

Credits are calculated on the same basis as additions. If markup is added on an addition, markup is deducted on a removal, at the same percentage. This sounds obvious and is frequently absent.

Every credit arrives with a build up showing the trade value, the costs incurred to date with evidence, and the deductions applied. Without it, a credit is a single number nobody can examine.

Removals are logged on the same register as additions, with a number and a date, and are reported monthly as open until priced.

That third one is the administrative habit that does most of the work, and it costs nothing at all. A monthly log showing eleven open removals awaiting credit is a very different document from a log showing only additions.

Netting, and why it hides the problem

Where credits are netted against additions inside a single change order, the owner sees one number and cannot see either side.

A change order showing a net addition of $40,000 may contain an addition of $180,000 and a credit of $140,000, or an addition of $46,000 and a credit of $6,000. Those are very different transactions and the document does not distinguish them.

The remedy is to require additions and credits to be stated separately within any change order, even where the payment is netted. This costs nothing and it makes the whole register readable.

It also matters for the cause analysis. An addition caused by an owner decision and a credit arising from a design gap are two different findings, and netting them produces one line that is neither, which defeats the reasoning in the cause that decides who pays.

Where an owner is tracking change by cause, as in claim vs change order, netted documents are the main thing that breaks the analysis.

There is one more reason to keep the two sides visible. Owners are frequently asked, by a lender or an investment committee, what the gross change position is rather than the net. A register that only carries net figures cannot answer, and reconstructing it late in a job is a week of work.

Gross additions, gross credits, net position. Three numbers, reported monthly, and none of them requires anything that is not already in the contractor system.

Finally, a note on value engineering. Scope removed as a cost saving exercise is the largest single source of credits on most projects, and it is also where credits are most often incomplete, because the exercise is presented as a package with one headline saving rather than as a series of removals.

Asking for that package to be broken into individual items, each with its own credit build up, is the difference between a stated saving and a verified one.

What we do

We settle the credit basis at signature so that removals are priced the same way additions are, and we require the build up and the separate statement inside netted change orders. During a project we read the removal log against the change register to find the scope that came out and never came back as money. That work is part of the cost and change exposure assessment. After signature, monthly owner cost assurance keeps the same reading running against each payment application.

Questions people ask