Accounting for Construction Allowances

It’s obviously a good idea to carefully plan every aspect of a construction project beforehand. But sometimes, a job will be started while there are still decisions to be made. When that happens – how do homeowners and contractors plan for uncertainty? That’s when construction allowances come into play.

Construction allowances are common provisions contained in agreements between contractors and homeowners to cover costs not explicitly accounted for in the final contract. They are commonly found in contracts for new homes or remodeling projects. For someone not familiar with the process, the purpose for a construction allowance may be unclear. However, understanding why these allowances exist and how they are applied can save a homeowner a few surprises when the final bill comes due.

Construction Allowance Defined

When the price of materials or supplies can’t quite be determined, but a price needs to be put to paper, a construction allowance provides some flexibility. Essentially, it’s an estimate that serves as the placeholder for an amount that can’t be determined quite yet. During the life of the project, presumably, the decision leading to the construction allowance will be made – and a price will be determined. With any luck, the construction allowance will be very close to the actual cost.

Types of Construction Allowances

Material Allowances: This type of allowance is built into the contract price when the homeowner hasn’t yet selected the materials that will be used. Depending on what materials are used, costs could be very different than what a contractor, sub, or supplier expected in their initial estimate.

For example, you may see a line item called: Millwork: all cabinets and accessories. Next to it there might be a dollar figure like $15,000 (M). This means that your builder has allowed $15,000 toward the purchase and delivery of millwork (cabinets) and the accessories, (crown, knobs, features). Once you choose your cabinets and accessories, the cost is computed against the budgeted amount, or the allowance. If the actual cost of the millwork is $13,942, the builder will subtract that cost from the allocated allowance. The equation looks like this: $15,000-$13,942=$1,058. You would receive a $1,058 credit that can be used elsewhere on your job. Normally, allowance additions or credits are figured on the net increase or decrease.

Labor Allowances: Most construction allowances will cover only materials. But what happens when the material selection also changes the scope of work? There may not be a large discrepancy between the price of materials, but it may involve an extra level of skill or time to complete. Changes to the scope of work should allow the contractor to adjust their price accordingly. When labor allowances are accounted for from the start, costly misunderstandings or even disputes can be avoided.

Material and Labor Allowances: Some aspects of work are best accomplished by having the supplier or fabricator provide both the materials and labor. One example is granite countertops. The granite company will supply and fabricate (field measure, cut and polish) the tops and also install the final product at the job site thus making one trade responsible for the proper completion of the entire task.

Important Considerations Regarding Allowances

• Construction allowances should be minimal. The more construction allowances, the more opportunities for misunderstandings between the two parties. Homeowners should come into the project with a clear vision of the finished project. Contractors should encourage their homeowners to make all material selections before submitting the bid.
• If it becomes clear that important decisions will need to be put off until after the work has begun, contractors should educate homeowners about the allowances and the way they may affect the bid. Homeowners should ask questions when they see construction allowances existing in their contractors’ bids.
• Homeowners should familiarize themselves with material costs. In most instances, contractors will be able to clearly explain where an allowance is contained in the contract and how the final price will be affected.
• Contractors should provide a change order for the allowance prior to purchasing the material or beginning the work. Homeowners should insist on seeing change orders for every instance where allowances come into play, as this is the accounting of costs as well as the modification of the scope of work in relation to the contract.
• Contractors should insist that changes, as pertaining to cost allowances, are approved by the client before they lay out any money for the new materials or labor. Homeowners should request that the contractor secure approval before spending additional funds for materials or labor costs. This prevents surprises as well as informs all parties as to intent, scope and costs.

While far from an ideal, construction allowances serve a purpose in home building and remodeling. Preparing beforehand for the unexpected or unplanned can make the process run much smoother for both parties.