Variations, claims and disputes in contract price

Treating a submitted but unapproved claim or variation as certain revenue is one of the most common ways construction companies overstate profit: it front-loads margin that may never be collected, misleads lenders and sureties who rely on backlog and margin figures, and creates a painful reversal (and possible restatement) if negotiations or arbitration ultimately fail. Conversely, refusing to recognize any variation revenue until final settlement understates performance and can distort bid/no-bid and resourcing decisions on future work.

Has the customer approved the scope, the price, or both for this change order or claim, even orally or through consistent past conduct? Is there a reliable basis to estimate the amount using the expected value or most likely amount method? Is it highly probable that a significant reversal of cumulative revenue will not occur once the claim or variation is finally resolved? Is the claim enforceable under the contract terms and applicable local law?

1. Classify the item first: is it an agreed scope change awaiting price agreement, a priced variation awaiting formal approval, or a contested claim (e.g. for prolongation, disruption or acceleration)?
2. For scope agreed but price unresolved, recognize costs as incurred and estimate transaction price using expected value or most likely amount, applying the constraint.
3. For claims, assess enforceability under the contract and applicable law, and whether there is a reliable basis to estimate the amount.
4. Apply the constraint: include in the transaction price only the amount for which it is highly probable a significant revenue reversal will not occur when the uncertainty is resolved.
5. Reassess the constrained amount every reporting period as negotiations, expert reports, or arbitration proceedings progress, do not leave a stale estimate in place.
6. On formal approval or settlement, true up the transaction price and record any cumulative catch-up in the period of change.

Use the expected value method (probability-weighted outcomes) when the entity has a large number of similar claims/variations, or the most likely amount when the outcome is essentially binary (win/lose a specific claim). Discount the estimate for the time value of money only if settlement is expected significantly beyond normal terms. Reassess at each reporting date and disclose the sensitivity of the estimate where the amount included is material and finely balanced.

Disclose: (1) nature, status and amount of significant unresolved claims and variations; (2) the method used to estimate variable consideration (expected value or most likely amount) and how the constraint was applied; (3) amount of revenue recognized in the period relating to changes in transaction price from prior periods; (4) qualitative description of the main sources of estimation uncertainty (e.g. arbitration in progress); (5) accounting policy for distinguishing claims from priced variations.

• Booking the full claim value on submission to the client or engineer without assessing the constraint
• recognizing costs of disputed variation work while deferring all revenue indefinitely instead of reassessing the constraint each period
• treating an engineer'
• s provisional or '
• without prejudice'
• certification as final approval
• not distinguishing claims (adversarial, uncertain) from agreed scope variations awaiting only price negotiation (much higher probability of recovery)
• double counting the same claim amount in both the contractor'
• s revenue estimate and a separate contingent asset disclosure.