Valuation matters: valuing variations

I will look to achieve this by covering the basics of entitlement to a variation, considering and selecting the applicable valuation rule(s), understanding the impact of the change, and then, finally, valuing the change.

I have set it out this way because, sometimes, there is a temptation to jump to the end, but if you follow the simple steps laid out and document those steps in a concise narrative, then it will help you make a valuation that is robust and stands up to scrutiny.

Entitlement

When valuing a variation, you should first check that you have an entitlement to be paid for the variation.

If a variation instruction has been issued, then the answer to that question is straightforward. However, if the instruction has been received in some other way (e.g. in a meeting or through an email), then you will need to show how the change is a variation to the contract.

To do this, in simple terms, you will need to establish that something has changed, such as the scope of work, and that the cause of that change is a risk that your employer retained under the contract.

If you happen to go through this thought process, I recommend setting it out in a written document both so that you can explain to the other side how you arrived at your conclusion and because it will act as an aide memoir for you in the future.

Valuation Rules

The contract will contain agreed rules, which you should follow when valuing variations.

When valuing a variation, you will need to select the appropriate rule (or rules) that are applicable to your valuation, and you should explain why you have selected those rules and overlooked other rules.

The rule you have selected might require you to follow rates in the contract or might entitle you to recover cost plus margin. You should follow this to the letter and, where possible, demonstrate that you have complied with these rules.

It might be tempting to select or, even, create rules that work best for you but try and resist that temptation. If your valuation is compliant with the contract valuation rules and you can demonstrate this, then it will stand up to the scrutiny that might come your way.

Impact

What is the impact of the change?

You might be able to ascertain this if it is a relatively straightforward change; however, I would always recommend speaking to construction managers, planners, design managers, etc. to get their thoughts or views on the change. Be curious and interested in the engineering and construction aspects because you will bank knowledge that will help you in the future.

A good example is a window specification change from one type to another type. It might seem like a simple change, omit window type 1 and add window type 2, but, before you reach that conclusion, find out what impact it had.

Start with design. Has abortive design occurred, or is there anything special about this window that will mean it is more complicated to design than anything else in the contract scope? Has this new window type caused issues with the things it interfaces with, such as the external walls, internal walls, or MEP services (e.g. if more heating or lighting is required)?

The change might impact the construction process. If the original window is manufactured, on site, or installed, then it will cause costs to be incurred. The installation of the window might involve a different methodology or require special access. It might involve going back into an area that was previously finished, which would cause increased costs.

All of this and more before you get to the even more complicated matter of determining whether the change has caused a delay to the critical path and are entitled to recover your time-related costs.

Do not underestimate the importance of undertaking this research at the time of making your valuation and documenting it fully because it will become a framework for your valuation.

Valuation

Once you know or have described the impact, you can start to quantify and cost the various aspects of the change. You should consider the valuation rules against the impact where you can and apply these accordingly.

Your quantities will normally be determined by the type of cost you are valuing. If it is design-type activity, then it will often either be quantified using hours or by number. Whereas if it is physical on-site work, then you should refer to and use, the method of measurement stated in the contract and demonstrate how you have complied with the method of measurement in making your valuation.

When it comes to rates, these will, more often than not, be either contract rates or actual costs. If you are using contract rates, then you should check the basis of the rate and adjust it to reflect the change, whereas if you are using actual costs, you should ensure that you capture all of the costs relevant to the scope of the change.

Final reflections

In theory, the valuation of a variation should be straightforward; however, in practice, it is rarely this straightforward.

You will often be trying to pick up these changes and understand them whilst setting up a project, onboarding a commercial team, procuring subcontracts, processing payments, staying on top of your financial reporting, and servicing your client.

This can become very challenging, especially when there is a large volume of change, but, no matter what is happening, try and keep on top of the variation account and prepare high-quality variation valuations as the changes occur. Include them in your application for payment so that you stay on top of revenue recognition and cash flow risks.

It only becomes a lot harder and more expensive to do this later in the construction process.

Next week, we will continue the focus of this valuation matters mini-series with a focus on the valuation of disruption costs.

Keep an eye out for that, and, in the meantime, enjoy the rest of your week!

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