How allowance overruns eat the savings pool

An owner who has been told the project is tracking $800,000 under the GMP can be surprised at closeout to find the savings are half that. Often nothing went wrong on site. The allowances simply came in over, and each overrun was absorbed somewhere the owner was not watching. Allowance overruns rarely announce themselves. They accumulate.

Two routes to the owner

When an allowance reconciles over, the variance has to go somewhere. Under most AIA A133 based agreements, it goes to a change order that raises the GMP. The owner pays more, now, and the savings pool is untouched because the GMP and the cost moved together. That is the clean route and the one the standard forms assume.

The second route is that the contractor absorbs the overrun inside the GMP, either from contingency or from buyout savings on other lines. The GMP does not move. The owner pays nothing extra now. But the cost has risen and the GMP has not, so the gap between them, which is the savings pool, has shrunk. The owner pays at closeout instead, through a smaller share of a smaller pool. Check your contract for which route applies, because some agreements allow the contractor to choose.

Why the second route is harder to see

A change order is a document. It has a number, a value, a signature, and it appears in the change order log. An overrun absorbed inside the GMP appears, if at all, as a contingency draw with a brief description, or as a reduction in a savings line that the owner never saw itemized. The pay application total is unchanged. The anticipated final cost, if the owner is computing it from the GMP and the change orders, is also unchanged. The only place the movement shows is in the contractor's internal cost report.

A fictional $38 million community center carries five allowances totaling $1.4 million. Over the project, three reconcile over by a combined $320,000 and the contractor covers all of it from contingency rather than by change order. The owner's anticipated final cost never moves. At closeout the contingency is exhausted and the pool is $320,000 smaller than the owner's projection. The owner's share, under a 75 to 25 split, is $240,000 less than expected.

Why it matters which route is used

The two routes cost the owner different amounts. Under the change order route, the owner pays the full overrun plus markup. Under the absorption route, the owner pays only its share of the lost pool, which under a split in the owner's favor is less than the full overrun. So in pure dollars, absorption can be cheaper for the owner. The contractor, though, has given up its share of the pool and used up contingency it might have needed.

The problem is not which route is better. It is that the owner often does not know which route was taken, and so cannot reconcile the closeout. The contractor's choice to absorb an allowance overrun is a financial decision that affects the owner's closeout figure, and it should be recorded when it is made.

Markup on the change order route

If the contract sends allowance variances to change orders, ask what markup applies. Some agreements allow fee and general conditions on allowance adjustments, which means the owner pays more than the bare overrun. Others allow fee only, or none. The answer changes the comparison between the two routes and should be known before the first reconciliation.

Keeping the pool honest

The owner's allowance register should record, for each reconciliation, the variance and the route: change order number if the GMP was adjusted, or the fund that absorbed it if not. The savings projection should then reduce the pool for every absorbed overrun. An owner who does this will see the pool shrink as allowances reconcile, which is the true picture, rather than seeing a flat pool until closeout.

Costwitness asks for the route on each allowance reconciliation and posts the matching entry to the change order register or the contingency ledger, so the projected pool moves when the overrun is absorbed rather than at closeout. The software keeps the pool current. Whether the overrun should have gone by change order instead is a question for the owner to raise with the contractor.

In the product

Allowance register, Shared savings, Contingency ledger. Free tool: Allowance Confidence Band, Shared Savings Calculator.

Keep reading

Earlier: Subcontractor default and the buyout risk an owner carries. Later: The sensitivity table: what the pool becomes if open items land either way. All articles on buyout and shared savings.