Construction Auditing: UTILIZING INDUSTRY STANDARDS, BEST PRACTICES AND CHANGE ORDER AUDITING APRIL 4, 2017

Transcription

1 Construction Auditing: UTILIZING INDUSTRY STANDARDS, BEST PRACTICES AND CHANGE ORDER AUDITING APRIL 4, 2017

2 OPENING REMARKS Kinney Poynter Moderator Executive Director NASACT Alan Pennington Speaker Vice President Matrix Consulting Group 2

3 PROGRAM OBJECTIVES Understand key phases of construction programs Understand approaches for managing change order Develop techniques for auditing change order Gain awareness of industry standards and best practices to utilize during the audit 3

4 Why Audit Construction Contracts? Construction projects are costly Delays can result in increased costs Provides a monitoring capacity not available elsewhere Provides a means of keeping projects on track or getting them back on track quickly The 2008 Association of Certified Fraud Examiners Report to the Nation on Occupational Fraud and Abuse noted that construction ranks as the 5th highest industry in median loss per fraud case ($330,000), and 8 th in terms of the number of fraud cases. 4

5 Goals of a Construction Audit Identify cost avoidance opportunities Ensure controls are developed and maintained Identify overcharges / undercharges Avoid litigation Identify opportunities to improve the future management of construction projects 5

6 Timing a Construction Audit: During Time Fix ongoing problems Implement internal controls Not getting in the way Safety - location After Memory recall Right to audit clause may expire Concentrate risks when you see the overall picture Quicker More efficient Getting to the contractor before he / she is gone More effective 6

7 Phases of Construction Projects Planning Conception Design Budget Estimates Contract development and administration Construction Change Orders Close out 7

8 How Should Projects Be Selected For A Construction Audit Size (dollar value, physical size, complexity) Type of project Cost Plus and Time and Materials versus Lump Sum Shared Services Features High profile or high risk projects Experience of owners representative / construction manager Experience with the General Contractor Number of change orders 8

9 Ability To Influence Project Costs Decreases Over Time Data Source: Construction Industry Institute Influence Relative Influence Cumulative Cost Cost Time 9

10 Composition of Contractor Project Costs 85% 90% OF COSTS Labor Materials Equipment (Contractor owned and 3 rd party rental Sub Contractors General Conditions 10 15% OF COSTS Insurance Bonds Bid, Performance, Payment, Warranty Small tools, expendables, and consumables Relocation and travel Home office charges Permits and licenses 10

11 Contract Risks (1) Labor Unlicensed workers Excess Reported Hours Unauthorized workers Time miscalculations Unauthorized rate changes Unauthorized rate changes Ghosts on the payroll Up-Billing Not-to-exceed limits ignored Materials Unauthorized material Substitute material versus specifications New versus like new Price extensions Trade and other discounts Excessive material Quantities not installed Improper construction methods / rework Materials Unauthorized material 11

12 Contract Risks (2) Equipment Charge exceeds purchase price or FMV Excess damage costs Sweetheart deals Taxes on fuel Equipment not on job Rental rebates not credited Rent-to-own Sub-Contractors Overbilling Invoicing Invoicing for material not used Invoicing / ordering material for other projects Back dated invoices Invoicing for material that was returned Reporting theft of material when no such loss occurred Time Schemes Unauthorized delay Phantom weather Change order to escape liquidated damages Charging for work performed on holidays or unauthorized overtime 12

13 Contract Risk (3) Duplicate Billing Invoice numbers out of sequence Date of invoice out-of-order for construction sequence Invoice date inconsistent with rest of invoices Duplicate invoice numbers Invoice numbers are backwards Time and Expense Expense Not justified for work performed Excessive/Elaborate expenses Invoices not consistent with expenses submitted Unauthorized delay Time Schemes Ordering OT for work that should be completed in normal course of business Change order to escape liquidated damages Charging for work performed on holidays or unauthorized overtime Phantom weather General Conditions Duplicate Charges Inaccurate prorating 13

14 Types of Contracts Lump Sum, Fixed Cost, Stipulated Sum Design, Bid, Build EPC (Engineer, Procure, Construct) Cost Reimbursable or Cost Plus Cost Plus with Fixed or Percentage Fee Cost Plus with Guaranteed Maximum (GMAX or GMP) Design Build Time and Material 14

15 Red Flags to Look for During the Audit Debarment or poor reputation Billing in a non-standard format Owner has no or an ineffective project management team Acceptance of poor performance Weak change order language Change orders unusually high Lack of clear lines of accountability Un-reconciled construction in progress account or incomplete reconciliation Repeated use of same supplier Use of liaisons or middlemen Close relationship with vendors Failure to obtain lien waivers and reconcile High commissions Disorganized work site Failure to disclose key information about key contractor stakeholders Contract omits right-to-audit clause 15

16 Elements of a Typical Construction Audit Program (1) Contract review Bid review Control assessment Contractor billing tests Labor rates, number of employees, and labor burden Materials quantities and use of new materials Equipment (Contractor owned and rented) Subcontractor charges Correct unit pricing 16

17 Elements of a Typical Construction Audit Program (2) Permits and licenses Miscellaneous charges (small tools and consumables) Overhead charges Contractor fee Retainage calculation Performance bond and insurance Payroll taxes Applied rates for G & A and for profit Relocation and travel 17

18 Elements of a Typical Construction Audit Program (3) Control verification Financial review Lead schedules Receivables Payables Construction in progress Fixed assets Change orders 18

19 A Construction Audit Is a Multi Disciplined Approach Conventional Audit Skills Knowledge of Construction and Construction Terms Ability to read and understand contract language Data Analytics 19

20 What is a change order? Called many things: Change Orders Change Directives Contract Modification Engineering Change Notice Field Change Request Scope Modification Technical Modification No matter what it is called, it represents the owner s authorization to change the contract s terms and conditions (typically related to the scope or timing of the project) 20

21 Impact of a change order? Scope change (increase or decrease) Quantity change Schedule change All of these modifications directly impact the contract between the owner and the contractor. Most importantly, schedule changes can have far reaching impacts on project completion and liquidated damages. 21

22 Why do change orders occur? Change in building codes / regulations Change in market conditions / requirements Change in field conditions Change in project specifications Change in construction conditions Contingency expenditures Unanticipated project work 22

23 Change Order Audit Program Planning: Documentation and control Authorization Staff approval Elected Official approval Price Analysis Scope Analysis Schedule 23

24 Change Order Audit Provisions: Clearly defined contract terms Definition of major versus minor change order Delineation of who approves each type Use of contingency budget prior to change order Documentation required for change orders 24

25 Change Order Documentation: Narrative on scope for change order What is covered? Why is it required? Relation to original scope of work Schedule revisions (if required) Who is conducting the work? Compensation approach Detail on rates, hours, and quantities of labor, equipment and materials required Profit 25

26 Change Order Evaluation Checklist Appropriately authorized by the appropriate entity Work not previously approved or rejected Approved and already paid for (original scope or prior change order) Rejected items resubmitted Evaluate change orders at the line item level Look for duplicate change orders / work tasks Verify all computations Ensure general conditions actually changed before accepting a GC fee adjustment 26

27 Change Order Pricing Evaluation Ensure materials covered at actual cost (or cost plus if provided for in contract). Verify quantities appropriate for scope of work and actually installed / utilized Be clear what is included in labor rate Are the rates utilized in alignment with contract? Are fringe benefits covered in labor rate or add ons? Is profit a separate line item? Evaluate hours charged By individual and classification Reasonable for work performed? Request supporting documentation for any lump sum payment 27

28 Change Order Audit Risks Unauthorized change orders Unnecessary change orders Work covered by original agreement Addresses risks assumed by contractor in original contract Not justified / authorized work Redundant or duplicate change orders Overpriced change orders 28

29 Unauthorized Change Orders No work should be performed, absent emergency situations outlined in the contract, without prior approval. Reasons these occur: Budget overrun Miscommunication between contractor and owner representative Procrastination Quality Issues / Rework Schedule delays Warranty work 29

30 Unnecessary Change Orders Change orders submitted without a valid business purpose. They may be approved but provide little value to owner. Key areas to evaluate: Existing scope of work Provision of unrequired add on services 30

31 Redundant or Duplicate Change Orders Change orders that have overlapping or poorly defined scopes of work. Key areas to evaluate: Existing scope of work Provision of unrequired add on services 31

32 Overpriced Change Orders Change orders that require compensation above reasonable level for scope of work covered. Key areas to evaluate overpricing: Inflated labor rates Inflated hours Excessive profit margins Inaccurate math (compounding calculations, incorrect fee add ons, inclusion of costs previously covered) 32

33 Contingency Budgets: Contractor s contingency: Contractors budget to cover in scope budget changes. Owner s contingency: Owner s budget to cover minor scope changes. 33

34 Red Flags related to Change Orders Too few change orders Too many change orders Changing contractors during construction Excessive material / equipment substitutions Project end change orders Bids prepared prior to availability of 100% construction documents No negotiated / rejected change orders Change order value greater than 10% of original budget Unclear narrative justification for change order 34

35 Key Resources American Institute of Architects (AIA) Model Contracts Starting point but may favor architect and contractor not owner AASHTO Cost of Construction Guidelines RS Means Construction cost estimating data source TRA SER (Trade Service by Trimble Company) Provides trades pricing data and product information Audits completed by peer auditors 35

36 Contractors know the impact of Change Orders! 36

37 Thank You 37

38 QUESTIONS AND ANSWERS Kinney Poynter Moderator Executive Director NASACT Alan Pennington Speaker Vice President Matrix Consulting Group 38