A recent note:

“I have both of your books but haven’t seen a good plan or section on how best to work allowances with a client. Currently we show our cost as the allowance on our contracts, estimates and design agreements. What happens when they go over the allowance, or under the allowance? If they go under should we refund them cost + markup? If they go over should we apply full markup to the overage? I have ran across this problem on every project we have done and I’m still without a good solution or verbiage to include in my contracts, help would be appreciated.”

Construction Contract Allowances

There isn’t one right way to handle allowance items that works for all contractors and all clients. Plan A may work for most clients, but then you meet Mrs. Oddball who seems to work at being difficult. So you derive Plan B and hope it works.

Allowances are a dollar amount that you include in a construction contract for a particular item. There are two types of allowances: material allowance amounts and installed allowance amounts. They are most often used when a client hasn’t finished all their selections. A material allowance would be given for carpeting. An installed allowance would be given for countertops or cabinets, where the final selection can impact the installation time as well as the material cost.

Allowances need to be clearly defined in your contract, and that includes how you’ll handle any overage or underage on the allowance amount. If you’re going to add markup to any overage, be sure to state that and the markup percent. If they come in lower than the allowance amount, you should probably credit markup as well.

Here is some possible verbiage that defines allowances:

INSTALLED ALLOWANCE: The amount of money allocated to cover the cost of both material and labor to install the specified material(s) and any applicable sales tax, overhead and profit not included. Owner understands and agrees that the final billing for an INSTALLED ALLOWANCE AMOUNT may be more or less than the figure specified in this Contract, and that any adjustments will be made on the final billing for this job.

MATERIAL ALLOWANCE: The amount of money allocated to cover the cost of material(s) and any applicable sales tax only, excluding the labor to install the specified material(s), overhead and profit not included. Owner(s) understand and agree that the MATERIAL ALLOWANCE AMOUNT may be more or less than the figure specified in this Contract, and that any adjustments will be made on the final billing for this job.

Here is other verbiage that includes markup. You can list your actual markup, but that might open a can of worms that you don’t want to deal with. It might be smarter to use an arbitrary figure like 20% or 30%. That allows you to recover some markup without leading to an argument.

INSTALLED ALLOWANCE AMOUNT: An amount designated by CONTRACTOR to approximately represent CONTRACTOR’s cost for all labor and material to install that particular item(s) and any applicable sales tax. This amount, at its final accounting, could be more or less depending on Owner’s selection(s) and/or a third party’s actual charges to CONTRACTOR. CONTRACTOR will add % markup to the final billing for the IAA.

MATERIAL ALLOWANCE AMOUNT: An amount designated by CONTRACTOR to approximately represent CONTRACTOR’s material cost for that particular item(s). This amount, at its final accounting, could be more or less depending on Owner’s selection(s) and/or a third party’s actual charges to CONTRACTOR. CONTRACTOR will add % markup to the final billing for the MAA.

The contract also needs to state what happens when a client runs over or under an allowance amount:

If the cost of the Owner-selected materials exceeds the MATERIAL ALLOWANCE AMOUNT, then that amount will be added to the next progress payment or final payment. If the amount is less than the MATERIAL ALLOWANCE AMOUNT, then that amount will be subtracted from the final amount of the Contract.

If the cost of the INSTALLED ALLOWANCE AMOUNT exceeds the amount specified, then that amount will be added to the next progress payment or final payment. If the amount is less than the INSTALLED ALLOWANCE AMOUNT, then that amount will be subtracted from the final amount of the Contract.

Before they sign your contract, make sure they read the definitions. Explain what happens when they run over or under an contract allowance amount, and let them know you’ll write a change work order at the time for the change in contract price. Ask if they have any questions. If they are clear on how the allowances work, have the initial the page with these clauses to reduce the risk of arguments down the road.

There are a few more important things on allowances.

  • Allowances should be avoided when possible. The fewer, the better. That means you need to encourage your client to make decisions on their selections before signing the contract. If you have too many allowances, it might as well be a Time and Materials or a Cost Plus contract, and you know what I think about those.
  • It’s important to educate your client on what allowances are and how they work. Even if you aren’t going to have allowances in your quote, another contractor might, and what they provide for an allowance can skew the price significantly. If someone else is giving them a $5,000 allowance for kitchen cabinets and you’re giving them a $35,000 allowance for the same cabinets, make sure they understand they’ll probably pay $35,000 for kitchen cabinets eventually.
  • Allowances need to be within a reasonable range. Setting a $4,000 allowance for appliances in a $800,000 home is just asking for a fight, and you stand a good chance of having to make up the difference out of your own pocket. Keep the unwritten law of “Good Faith and Fair Dealing” in mind. If you’ve asked enough questions, you should be able to get within 5% of their final selection.
  • Clearly explain how much you’ve provided for each allowance area. For example, if you’re including a material allowance for carpets, let them know the allowance assumes carpeting at $50/square yard, and they’ll need 12 square yards.
  • Always write a change work order when an allowance is over or under to clearly document how the final project price has changed. Do it immediately; don’t wait until the end of the job to catch up on the paperwork.
  • Be sure that you have the additional or change work order procedure clearly defined in your contract, and follow it. You should be paid up front for changes of $2,500 or less, and only make changes when the customer has signed your additional or change work order. No verbal changes.

Allowances are a great way to handle selections that haven’t been made yet. They reduce the risk of underestimating the cost of getting items installed. On the flip side, they can result in arguments if the ground rules aren’t clearly established. They can also reduce your overall markup if the variance between the allowance and the actual amount is too great.

There are many ways to handle allowances; this is my thinking on the subject. I look forward to hearing from others.

Disclaimer: Nothing in this article or on our website is intended to be, or may be construed as, legal advice. I am not an attorney. You must consult an attorney before using any suggested language or any other information contained in this article or on our website to determine if it conforms to your state laws or your particular situation.

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greekguy9999
greekguy9999
May 31, 2017 10:12 am

Question for you. If a contract calls for an allowance on windows and doors and the contractor claims the materials bought were in excess of the allowance, does he by law A) have to notify the client in writing or verbally before purchasing the items of the shortfall
so the homeowner can perhaps forgo some of the purchases, B) if he has purchased it without approval of the homeowner, provide a receipt to prove there was overage? If so, what law specifically states that allowance excesses are considered change orders?

K Marie
K Marie
July 3, 2017 2:39 am
Reply to  greekguy9999

This should be stated in detailed in the contract how they will be handled

K Marie
K Marie
July 3, 2017 2:42 am
Reply to  K Marie

Also, i think its best if it’s handled as a chang order, You know the client will be happy with the price & the materials & you reduce your risk of liability & loss

cinm54
cinm54
February 12, 2017 10:05 pm

after a fire, the contractor I hired had a crook for a salesman. My floor allowance for a 1500 square foot home is 24k. Company I hired said $6.00 per square foot. That comes to $9k. So is the contractor keeping 14k for installation?? Over my dead body. This has been a nightmare and this man came recommended by two people and had a good BBB rating. Until recently when his last two jobs didn’t go well. I stupidly gave him more than 50% down so he now has 110k of my money and so far had roof put on… Read more »

K Marie
K Marie
July 3, 2017 2:44 am
Reply to  cinm54

Requiring bonds are always a good idea to add collateral to the contract. Being the owner this is allowed

John Rogers
John Rogers
July 27, 2016 12:29 pm

Well said Michael, basically have a process for everything and stick to it.

Jimmie Randall
Jimmie Randall
July 27, 2016 8:30 am

Good points and advice but,I am not sure about writing change orders for allowances. As was pointed out to me years ago. As green superintendent I asked the builder I worked for to write a change order for upgraded counter tops,he rolled out the plans and asked “what changed?,Are there counter tops on the plans? Does the budget show a dollar amount for the counter tops? ” Since the answer to the first question was “Nothing” and all if the other questions the answer was ” Yes”,then what I actually needed was a variance PO based on the budget allowance.… Read more »

Scott
Scott
July 27, 2016 7:56 am

Good point Nancy, I also question the sincerity of people who cant take the time to select items for their own home. Most turn out to be tire kickers.Also agree not to reimburse mark ups as most of the work has already been done at the desk. Another reason to keep allowances to a minimum. More allowances mean more opportunities for a customer to question mark ups. In my area its best to keep customers thinking your not making a dime. Most don’t understand the need for mark ups. Amazing since most of my customers are Chicago business people with… Read more »

Paul
Paul
October 19, 2020 2:10 pm
Reply to  Scott

Scott,
Your wealthy Chicago business people understand full well your need to charge a markup. They just don’t want to pay it…They don’t see any need or benefit for you to profit from them.

Nancy Benson
Nancy Benson
July 27, 2016 6:19 am

I also agree with every sentence and plan to use some of that when meeting with prospects! We do not put together proposals without items that need to be selected – exception being shower glass doors – and we explain why. If they don’t want to select, we tell them it was nice to meet them and move on.
We add markup to the additions and our contract states that we do NOT reimburse any of our markup for reductions – because even those involve office staff processing and keeping straight.

Scott
Scott
July 27, 2016 6:05 am

I agree with every sentence. Especially keeping the allowances to a minimum.I always have an allowance for say the heavy swinging shower door ($2,000). I can come within a few hundred dollars depending on glass type and finish. I include my cost in the proposal and apply my standard m.o. of 1.4 and include verbiage that there will be a 10% mark up added to the actual cost. (10% seems to be a happy number for folks around here).2000+1.4= $2800. actual cost= $1900 +10%= $190 Total=$2,990 I know, seems like double dipping but when selections are not made by the… Read more »

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