What You Should Know For Auditing Capital Projects Presented by: Robert S. Bright, President September 1, 2009 1
Part One Agenda Why the Session? Audit Themes Increasing Your Value Establishing Objectives Knowing Project Risks Capital Development Process Project Controls ( PC ) Project Reporting Financial Reporting September 1, 2009 2
General Audit Themes Lack of project oversight by System. unaware of industry practices Non-compliance to processes Failure to reconcile project financial reporting Contractor not managed. Too close to Mgmt. Inconsistent project reporting Cost estimates / contingency inadequate Reports lacked critical information September 1, 2009 3
INCREASING YOUR VALUE Improve early risk recognition skills Focus on more than Cost Recovery Know the Champions / project team Establish focused objectives Enhance contractor audit skills Identify issues adversely impacting contract close-out and project start-up Increase knowledge of Project Controls September 1, 2009 4
Establishing Audit Objectives Compliance to Control Points Process Improvements Financial Control / Cost Management Cost Recovery / or Prevention Reporting Accuracy Risk Identification Create Awareness Transparency September 1, 2009 5
Project Risk Budget: Financial Control: Design: Impact on approved project budget Lack of adherence to financial management policies i and procedures, disbursements, contract t approvals Impact on design completion, project scope and specialty items Completion: Impact on construction schedule / turnover to operations, material procurement September 1, 2009 6
Project Risk Political / Environmental: Issues relating to competition, state and federal courts, local communities, market conditions, governments Litigation / Disputes: Issues relating to trade disputes, contract changes, liabilities due to delayed opening Funding: Issues relating to funding sources September 1, 2009 7
Understanding the Process Capital Development Process Definition: Decision making process aligning System s s strategic goals and business objectives Project Phases Decision Points Certificate of Need/Approvals Build-out September 1, 2009 8
Understanding the Process The Influence Curve Project tapproval INFLUENCE COST TIME September 1, 2009 9
Project Controls Discussion Items Change Management Cost Schedule Contingency Progress Forecasting September 1, 2009 10
Project Controls Role: Timely analysis, reporting and INTEGRATION of essential data Early warning responsibility for adverse and favorable project trends Essential to all successful projects Essential Elements: Change Management Cost Management and Financial Reporting Progress and Schedule Management Contract / Vendor Procurement September 1, 2009 11
Project Controls Organization True Meaning Owner/System: The Buck Stops Here Enforcement sets the tone 3 rd Party Vendor/ Doing the Time / Owner s eyes and ears Facilities Management Critical to success Owner s Representative: ti Contractor: An expense item if done right Never receive or provide 100% information Will not anticipate for owner September 1, 2009 12
Project Controls System: Change Management Definition: Process is to be used by all disciplines that change the initial issue of project documents. Expectation: All projects have change Procedures: Know them or lose control September 1, 2009 13
Project Controls Change Management Non-Discretionary: Essential to achieve regulatory compliance or project as initially defined. Typically adverse impact on schedule & costs. Discretionary: Any change in project that is not nondiscretionary. Who is the Champion of Impact? All Changes are Disruptive September 1, 2009 14
Project Controls Change Evaluation S Y S T E M Baseline: Guidelines: Type: Approval Authority: Documentation: Certificate of Need / Vendor Contract Policies & Procedures Elective or required change Individual (PE, PM) or organization limits Change request forms and request tracking logs A U D I T O R Timing: Date from origination to approval Cost: Methodology rough vs. detailed d estimates t Contingency: How impacted for both cost & schedule? Contracts: What are the cumulative impacts? September 1, 2009 15
Project Controls: Cost System Industry Meaning CON Budget = Initial Budget = $$ + + + Scope Changes/ = Project Changes = $ Addt l Funding Current Approved = Revised Budget = $$$ Budget September 1, 2009 16
Project Controls: Costs Cash Flow vs. Project Time Cash Flow vs. Progress Plan Actual $ $ Plan Actual Time Contingency Drawdown % Progress Committed vs. Budget Budget Plan Actual $ $ Committed Time or % Progress Time September 1, 2009 17
Project Controls: Schedule Terminology Management Summary or Project Master Schedule (PMS) Representation of total project Will be divided into subprojects Critical path identified Target Schedule Project team approval of PMS Establishes a basis for performance Detailed Working or Contractor Schedule Contractor deliverable Fall within guidelines of Target Schedule September 1, 2009 18
Project Controls: Schedule Terminology Milestone Date Agreed upon dates for completion of significant activity Milestone Schedule Contractor deliverable typically system generated Primavera / P6 Industry software to develop detailed schedule September 1, 2009 19
Project Controls: Schedule CRITICAL PATH: FLOAT: A B C PROJECT MILESTONE Any duration change in A, B, C will change completion date A B PROJECT MILESTONE C Available schedule not impacting completion September 1, 2009 20
Project Controls: Contingency Definition: Amount of budget added to base estimate that is expected to be expended for known unknowns Why? Changes are expected/design growth is real Account for design completeness/errors/omissions Account for changes in construction execution Account for Murphy s Law NOT USED FOR SCOPE CHANGES September 1, 2009 21
Project Controls: Contingency Typical Issues: Contingency not added to schedule duration Lack of formal Contingency Management Plan Everyone believes contingency is theirs September 1, 2009 22
Project Controls: Progress Key Points: (1) Know Target Schedule and Vendor Methodologies (2) Focus on Trends (i.e., rate of progress, $ / % complete) (3) Do Not Forget Changes to Baseline Schedule (4) Understanding Timing of Updates (weekly, monthly) September 1, 2009 23
Project Controls: Forecasting Project Status Forecasting Factors to Consider Is design complete? Major open issues Are all major contracts / P.O. s committed? Does construction % complete make sense? Where is Murphy s Law? Expenditures Project Trends Excessive open change orders Actuals greater than cost estimates Contingency draw-down too fast Missing milestone dates Is overtime the standard? Does $ expended make sense to % complete? September 1, 2009 24
Project Controls Critical Outputs Reconciled Project Cost Report Integrated analysis of cost information and schedule progress Identification of critical issues impacting project delivery Project trend assessment Realistic budget and schedule forecasts Discussion of open items / pending changes Risk identification / quantification / mitigation Illustrative analysis of project progress September 1, 2009 25
Project Controls Audit Red Flags Continuous updating of baseline schedule Lack of team knowledge Significant changes due to errors / missing data Lack of total analysis / Data inconsistency Non-compliance to project change procedures Contingency draw-down not analyzed Continuous project forecast creep Missing Milestone dates Capex expenditure rate not in acceptable range September 1, 2009 26
Project Reporting System: Financial Reports for Funding Source Overall Project Status/Major Updates Monthly Invoicing / Payment to Fund Project Monthly Progress Reports: Contractors per contract deliverable 3 rd Party Services - per contract deliverable September 1, 2009 27
Project Reporting Audit Points Data consistency between reporting periods Issuance of reports (timing and production) Report completeness (all sections) Verify project correspondence to monthly reports Project team unaware of report contents Lack of updates Contractor s unwillingness to produce reports Missing key report details September 1, 2009 28
Financial Reporting Sources of Information Consultants t Contractors Project Team System (SAP, Lawson, Oracle) Purchasing Project Cost Center September 1, 2009 29
Financial Reporting AFE/CAPEX: Defines total project budget Project Manager: SAP/Oracle/ Lawson: Contractor: Project budget updates Changes Commitments to date Variances Paid to date Cost to complete Current forecast Reporting of expenditures/cash paid to date Project Cost Report per contract deliverable September 1, 2009 30
Financial Reporting Typical Missing Information: Contingency Analysis Monthly Reconciliation between Health System and Contractor Change Order Analysis Pending issues not shown September 1, 2009 31
Financial Reporting Consistency of data Audit Points Completeness of information - Home Office & Project Site Does data match Cash Flow Analysis? Is everyone using the same definition for commitments? What is the value of the pending change orders? Why are there ad-hoc (Excel) reports? Significant changes in monthly data Inability to reconcile data Excessive pending change orders not reported September 1, 2009 32
Part One READY FOR PART TWO? THE CONTRACTOR AUDIT September 1, 2009 33
What You Should Know For Auditing Capital Projects Presented by: Robert S. Bright, President September 1, 2009 1
Part Two THE CONTRACTOR AUDIT September 1, 2009 2
Part Two Agenda Part One Recap/Questions Design and Construction ti Process The Contract and Audit Success Planning the Audit Contract Types and Audit Point Contract Close-outout Contractor Tricks of the Trade Recognizing A Claim Audit Focus Best Practices September 1, 2009 3
The Process: Design & Construction Architects / Design Agreements Feasibility Detailed Design Construction Documents/ Bid Documents Personnel: In-house and outside specialists / consultants Fees: Fixed / multi-phased, percent of construction, volume, markups Construction Agreements Pre-Construction Construction Turnover Personnel: In-house, trade subcontractors, union / non-union Fees: Fixed, percentage of costs, allowable markups September 1, 2009 4
The Contractor Audit What is a Contract? Audit Success September 1, 2009 5
The Contractor Audit What is a Contract? Agreement to Perform Services or Deliver Goods Creation of Expectations Financial/Payment Services/Products Procedures / Reporting Identification of Key Players Sets Baseline/Guidelines for CHANGE September 1, 2009 6
The Contractor Audit Standard Contract Provisions Right to Audit : Timing and Documentation Scope of Work / Performance, Specifications Definitions-Technical and Financial (e.g. Cost of Work ) Payment Terms / Subcontractor Payment Schedule of Work / Deliverables Identification of Signature Authorities September 1, 2009 7
The Contractor Audit Project Success Successful ventures are often defined by sound business practices along with an understanding of the project s history, scope and a team dedicated to succeed. Cost Recovery or Prevention Opportunity It is commonly known that approximately 1-3% of the cumulative cost of most projects is unallowable due to a lack of contractual and financial oversight by the owner and contractor. Risk Identification No contract t is without t risk. However, early identification of these risks provides the opportunity for mitigation and settlement at a significantly reduced cost. September 1, 2009 8
PLANNING THE CONTRACTOR AUDIT September 1, 2009 9
Planning the Audit The TEAM Client Auditor Experts Contractor Personnel (technical, accounting, etc.) Management Together Everyone Achieves More September 1, 2009 10
Planning the Audit Timing is Key General - It Depends on Objectives Construction - Early for Full Compliance Financial - Contract Close-out out Performance Based Contracts - Key Milestones September 1, 2009 11
Planning the Audit Factors to Consider Contract Type Project Status Owner/Contractor Relationship Changes to Contract Engineering Quality Construction Quality Access to Data September 1, 2009 12
Understanding the Project Planning the Audit Scope: New, Expansion, Renovation Timing: i Flexible vs. Fixed Delivery Dates CON Schedule Priorities: Safety/Cost/Schedule/Quality Organization: Corporate or Local Office Facilities Management Department September 1, 2009 13
Planning the Audit Essential Documents Executed Contract w/ Exhibits Update Project Logs/ Reports / Schedules Request for Information Change Orders Subcontracts Quality Reports List of Key Contractor Personnel September 1, 2009 14
Planning the Audit Essential Team Elements Read the Contract Read the Contract Read the Contract September 1, 2009 15
THE CONTRACT September 1, 2009 16
The Contract Contract Type Design Status Owner PM Style/Focus Lump Sum / 95 100% Minimal / Contract Deliverables Fixed Price Guaranteed Maximum 65 85% Price (GMP) Standard / Timely Decisions September 1, 2009 17
The Contract Typical Components Construction Trades + Electrical Finishes HVAC/Plumbing Civil/Structural General Conditions ( GC ) = Sub-Total + Markups / Fees / Taxes TOTAL CONTRACT VALUE = Field Support Home Office Support Permits Field Expenses Field Supervision Temporary Facilities Overhead + Profit Taxes Insurance Bonds September 1, 2009 18
Audit Points Lump Sum / Fixed Price Scope of Work / Fixed vs. Allowances Interim & Final Contractor Deliverables Change Order Pricing Compliance to Quality Potential Claims Owner Disbursements / Contract Incentives Insurance / Bond Compliance Subcontractor Compliance September 1, 2009 19
Audit Points GMP Contract Verify Contract Value per defined Cost of Work Test Areas: ACTUAL INCURRED COSTS Contractor and supervision wages / Reimbursable expense Disbursements to subcontractors Change orders / Markups Review End-Job Cost Reconciliation Contingency / Allowances Assess Cost Saving Incentives Verify Final Payment Deliverables September 1, 2009 20
Audit Points Financial No open change orders Contract Close-Out Retention properly released / final waivers of lien Resolution of credits, allowances, contingency, if applicable Technical / Turnover Punchlist complete Performance guarantees Receipt of final documentation (e.g., as-built drawings, certificate of occupancy, inspections, testing reports, etc.) Completed maintenance / operating manuals / warranties September 1, 2009 21
Contractor Tricks of the Trade FINANCIAL Lack of defined reimbursable costs Cost of the Work Use of unknown markups on change orders Accrued costs vs. actual costs / Lack of reconciliation Overhead and benefits as a percentage of trade cost Premium / overtime charges at incorrect rates Rework paid for by owner Bonuses, training and other unallowable expenses included in hourly rates September 1, 2009 22
Contractor Tricks of the Trade PROCEDURAL Non-Submittal of Baseline Schedule and / or Estimates Untimely Project Control Reporting Inspection / Non-conformance Reports Not Updated Lack of Insurance / Bonding Compliance Final Close-Out Documentation Incomplete September 1, 2009 23
Recognizing a Claim Potential Claim / Disputes Issues Excess Change Orders Changed Existing Conditions Errors & Omissions Poor Work Quality Contractor Termination Excessive Delays Force Majure Act of God Ask Counsel Advice September 1, 2009 24
Audit Focus Management Focus / Project Controls Financial Focus Non-Financial Focus September 1, 2009 25
Audit Focus Management Focus / Project Controls Does the activity make sense to you? Is the project management team competent? Is there a system of financial checks and balances? Accuracy of reporting Are critical procedures being followed? Are budget or schedule changes difficult to follow? September 1, 2009 26
Audit Focus Financial Focus Change order- credits and increases Contractual mark-ups Reimbursable bl items travel, t general conditions Subcontractor payments release of retention Bond, insurance costs, taxes Sales tax exemptions Benefits, burdens, union fringe costs Allowance reconciliation Accrued vs. actual costs September 1, 2009 27
Audit Focus Non-Financial Focus Project control reporting (weekly, monthly) Change order documentation / Logs Contractor / vendor deliverable Final close-out requirements Insurance / bonding compliance Bid / award procedures Waiver of lien submittals 3 rd Party inspection / Non-conformance reports Safety Records September 1, 2009 28
Audit Best Practices Know your Objectives Know the Contract Know the Contract Involve Key Players Use the Experts Identify the Risk Play the Hunch --- Peel the Onion Don t Ignore Audit follow-up September 1, 2009 29
Part One & Two Summary Early Project Compliance to Procedures Critical Understand the Project / Know the Dynamics Effective Project Controls is Key to Success Convert Observations to Real Risks Look For and Understand Red Flags IA is Value-Added and Saves $$$ Play Your Hunch September 1, 2009 30