Fixed price contact allowance overage

lzhwongDecember 11, 2012

Under a fixed price contract, are overages over allowance items charged at a profit or charged at cost?

Also, if an allowance is in the contract does that mean the profit percentage has already been applied? For example, if the contract provides for a 10K granite allowance and I choose granite costing exactly 10K, do I need to pay the profit percent? In other words, had the profit percentage embedded in the 10K or is that just the raw number? Sorry if that's a little confusing.

Thank you for all of your help!

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An allowance is part of the fixed price and the fixed price includes all OH&P. When the actual price is determined (with markups as specified in the contract) if the amount is higher or lower than the allowance amount, the fixed price is raised or lowered with the approval of both parties by a Change Order. If it is the same as the allowance, then there is no need to change the contract price.

    Bookmark   December 11, 2012 at 8:46PM
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Allowances are in effect miniature Cost Plus contracts inside of a Fixed Price contract. They are of no benefit to the homeowner and can be a major benefit to the contractor. Allowance are found primarily in home construction because larger projects must be designed by architects and therefore it is possible to get everything into the bid documents; this is more difficult when the designer is the builder or the owner's draftsman.

There are 3 issues associated with Allowances.

1) An allowance should not include labor or installation costs. For instance specify the quantity of the light fixtures so the installation can be in the base bid and only the unit cost of the fixtures is in the allowance. Or also specify the fixtures and revise them later. If labor is unavoidable ask for a unit cost in the base price. Get as much as you can into the base bid price!

2) Homebuilders are notorious for under estimating allowances and then marking up the higher final cost with their normal OH&P %. Their project OH should have been adequately taken care of in the Fixed Price so ask them to only mark up the overage by their Profit % or ask them to lower that % or even eliminate it.

3) Often homebuilders have a favorite material supplier and will require you to select the allowance items from that source. This can lead to "sweetheart" deals. I'm not saying that every builder gets a yearly kick back from their favorite suppliers but it happens more than you might suspect. I like to add to the Allowances contact clause the right of the owner to choose the material supplier or even supply the material themselves and have the allowance removed from the contract price. This can lead to the loss of a warranty from the installer but it is important to have that power. It is usually more important to save money up front than down the road.

    Bookmark   December 12, 2012 at 7:45AM
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Usually, any change orders come with the change order fee, plus the cost difference, plus the profit percentage. It can get quite pricy. Builders want to discourage changes. They like working with known quantity elements that they've worked with before and know and understand.

    Bookmark   December 12, 2012 at 8:06AM
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I agree but an Allowance is not the same thing as a change in scope; it is the buyout of work not fully designed when the contract was signed and if the builder gets to set the allowance amount low, the resulting additional markup can be a windfall so contractors usually love allowances and use them excessively IMO. A prudent owner will insist on being protected from excessive markups and limited sources for such work.

    Bookmark   December 12, 2012 at 8:16AM
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green designs is correct.

typical change order cost here is South GA

Cost difference x 1.54 which equals to a 35% margin.

    Bookmark   December 12, 2012 at 11:39AM
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If an Allowance was properly estimated in the contract, the Change Order that resolves the increase or decrease of the final buyout compared to that Allowance amount should not have any onerous charges or penalties only a relatively small markup if any.

    Bookmark   December 15, 2012 at 10:32PM
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