Post-construction auditing and fraud detection - Baker · PDF fileAudit Program Development Construction Fraud 6. ... Closeout construction audit ... Construction audit program development

Post-Construction Auditing and Fraud Detection

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Post-Construction Auditing and Fraud Detection

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About Baker Tilly

> Established in 1931> 16th largest accounting and advisory firm in> 16th largest accounting and advisory firm in

the United States*According to Accounting Today’s 2011 list of “Top 100 Firms ”Top 100 Firms.

> More than 1,300 professionals> Baker Tilly Virchow Krause, LLP is the largest

U S B k Till I t ti l i d d tU.S. Baker Tilly International independent member firm

> Baker Tilly International is the eighth largest bli ti t k ith t tipublic accounting network with representation

in more than 110 countries> Convenient, seamless resource for worldwide

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needs

About Baker Tilly

From concept and funding to controls and compliance, Baker Tilly has more than 250 dedicated construction and real estate industry professionals toconstruction and real estate industry professionals to assist with your facility development project through all stages of the development lifecycle.

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Introductions

Tony Ollmann Erik SchuchardtCCA, Director CPA, Manager608 240 2618 608 240 [email protected] [email protected]

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Overview

Today’s topics EXAMPLE TEXPros and Cons ofCloseout Auditing

Closeout Audit Timing

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Risk Analysis and Exposure

Audit Program Development

Construction Fraud

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Polling question #1

AA. YesB. NoC. Not yet, but I plan to view it

Were you able to attend the second webinar in this series: “Construction

bakertilly.com/construction-audit-webinarFinancial Controls and Contract Compliance”?

Please respond using the polling section in the WebEx screen to the right.7

Learning objectives

1) Recognize which projects to audit at completion2) Know when to do a closeout audit2) Know when to do a closeout audit3) Assess project for risk 4) Develop a closeout audit program5) Identify construction fraud

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Construction project lifecycle

Construction progress to date

Design and construction team has been selected (Facilities)

Construction is substantially complete

Mo e in date is setMove in date is set

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Owner’s responsibilities

Previously discussed: Preconstruction activities (prevention)> Contractor due diligence> Contracting and negotiationContracting and negotiation> Contract risk matrix development

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Owner’s responsibilities (cont.)

Previously discussed:During the construction phase> Controlling capital expenditures> Monitoring change ordersMonitoring change orders> Scheduling thousands of activities for hundreds of people> Maintaining an ethical and safe work environment

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Pros and cons of post-construction audits

Pros> E i t tif th l f th dit> Easier to quantify the value of the audit> Requires fewer resources> Easier to identify policy and procedure

ivariances

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Pros and cons of post-construction audits (cont )(cont.)

Cons> G t i k f d d t> Greater risk of memory and document

loss> Forfeit the opportunity to prevent

something from occuringsomething from occuring> Higher probability of contractor conflict

while negotiating issue resolution

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Polling question #2

A O ti d lA. Operating room remodelB. CEO office remodelC. New research library

Which of these projects carry the greatest

t ti i k? D. First major capital project in 30 years

construction risk?

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Please respond using the polling section in the WebEx screen to the right.

Selecting a construction project for closeout or post construction auditingcloseout or post construction auditing

P.R.E.T.T.Y. attributes should be considered hen e al ating projects for a ditwhen evaluating projects for audit

P – Perceived project satisfactionR – Record keepingE – Enterprise riskT – TimingT – Total construction budgetT Total construction budgetY – Your ability to act upon audit findings

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Project Selection

Attributes of a good closeout project> C it l dit t th $5 illi> Capital expenditures are greater than $5 million> New building experience with the contractor> One time event> High profile project with multiple stakeholder groups> Regulatory requirement

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Closeout construction audit expectations

Rules of thumb to followCl t dit t i ll i ld fi di i f 1% f thCloseout audits typically yield findings in excess of 1% of the construction budget> For instance, a $50 million project should identify $500,000 or more in

fi difindings> Negotiating settlement will return thousands of dollars back to the institution> This assumes a well-managed project with good project controls. The

fi di b hi h l d j tfindings can be even higher on a poorly managed project.

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Construction audit program development

Key risks> Ch f ll bl t> Charges for non-allowable costs> Failure to deliver contracted scope> Lost incentives and credits> Overcharging for labor and materials> Over priced change orders

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Construction Audit Program Development

Risks that arise during project closeoutO ll di> Owner allowances disappear

> Excess supplies are not properly credited> Shared savings calculations are erroneous> Final lien waivers are missing> Contractor billings exceed contractor’s costs

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Construction Audit Program Development

Risks that arise during project closeoutFi l j t t t k f ttFinal project management tasks are forgotten

> As-built drawings are not delivered> Equipment warranty documentation and operating manuals are lost> Equipment warranty documentation and operating manuals are lost> Project documentation is not completed

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Expectations Management

Greater AssuranceLower Assurance

Compliance Oriented Audit Project Controls Oriented Audit

> Variance from policies and procedures

> Major budget deviations

> Everything in a compliance oriented audit plus

> Detailed financial analytics> Major schedule deviations> Limited financial analytics> Unplanned construction cost recovery

> KPI variance analysis> Variance investigation> Anticipated construction cost recovery

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Construction audit program development (cont )(cont.)

> Obtain consensus on the audit objectives:Closeout audit program fundamentals.> Obtain consensus on the audit objectives:

– Compliance effort– Cost recovery effort

> Reconcile pa applications recei ed ith contractor> Reconcile pay applications received with contractor costs incurred

> Obtain copies of completed final construction punch listslists.

> Confirm visually, with interviews and analytically that the entire contract scope was delivered.

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Construction audit program

Collect and Log Construction Compliance D tDocuments> As-built drawings> Final lien waivers> Final subcontractor pay applications> Permits and certificates of inspection

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Closeout Construction audit program

Quality Control> Obt i i f ll i ti t> Obtain copies of all inspection reports> Confirm all violations or variances have been rectified> Confirm all punch list items have been satisfied> Tour the facility and visually confirm the project is complete> Analyze project financial performance

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Closeout Construction Audit Program

Auditor’s Site InspectionM i d j b it hid lit th i> Messy or unorganized job sites may hide quality or other issues

> Look into the dark corners and covered areas> Listen for excuses> Look at doors, windows and corners for straight lines> Look at wall and flooring finishes for inconsistencies

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Subcontractor’s interviewA k if th id ti l b i> Ask if they were paid on a timely basis

> Ask about any rework they may have done> Ask if they proud of this project and would they showcase it in a project

tf liportfolio

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Polling question #3

AA. Part of the construction budget

B. Part of the contingency budget

What is a construction allowance? budget

C. Discretionary contractor’s budget

D Owner directed activities

allowance?

D. Owner directed activities budget

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Reconcile Construction AllowancesE h ll h ld b il d i d d t f h th> Each allowance should be reconciled independent of each other

> Do not comingle the allowances or let them be treated as part of the contractor’s construction budget. All t “f ” t ti b d t t b ll t d t th> Allowances are not “free” construction budget to be reallocated at the contractor’s discretion.

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Construction audit program (cont.)

Reconciliation of project expenditures> Obt i ll j t l t d fi i l ti t ti th t d t> Obtain all project related financial or accounting transactions that document

owner expenditures> Reconcile the sum of the total payments made to each vendor to the

various contract amounts as adjusted by change ordersvarious contract amounts as adjusted by change orders> Review itemized payments made to each vendor for each project and vouch

a sample of vendor payments to canceled checks other support> Review a sample of invoices paid direct by the owner for services materials> Review a sample of invoices paid direct by the owner for services, materials

or other costs which may have been the responsibility of the general contractor

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Construction audit program (cont.)

Shared Savings Calculations> Review the contract and identify all allowable and non-allowable costs for

the calculation> Adjust the contract budget amount for change ordersj g g> Adjust the contract budget for non-allowable shared savings> Remove allowances from the contract budget> Adjust the contract budget for scope reductions> Adjust the contract budget for scope reductions

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Construction Fraud Discussion

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Working Definitions

Fraud – by definitionD it t i k h ti b h f fid t t d f> Deceit, trickery, sharp practice, or breach of confidence, perpetrated for profit or to gain some unfair or dishonest advantage

> A particular instance of deceit or trickery (e.g., mail fraud, election fraud)A h k d itf l t h> A person who makes deceitful pretenses; sham; poseur

Fraud – broad legal definition> There must be a deliberate misrepresentation of the product’s conditionThere must be a deliberate misrepresentation of the product s condition

and actual monetary damages must occur

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Types of Fraud Relatedto Construction

Category Description StatisticsBilli S h A f d h i hi h M di L $128 000Billing Schemes Any fraud scheme in which a

person causes his or her employer to issue an irregular payment for goods or services

Median Loss: $128,000Median Duration: 24 Months

Non-Cash Misappropriations

Any scheme in which an employee steals or misuses a non-cash asset


Corruption Employee’s use of his or her i fl i b i t ti

Median Loss: $375,000M di D ti 18 M thinfluence in business transactions

for the purpose of obtaining a benefit for him or herself or someone else

Median Duration: 18 Months

Payroll Any scheme in which an employee causes an irregular compensation payment


R t t th N ti A i ti f C tifi d

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Report to the Nations, Association of Certified Fraud Examiners, 2010

Fraud Case Studies

R t t th N ti A i ti f C tifi d

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Report to the Nations, Association of Certified Fraud Examiners, 2010

Fraud Case Study: Repairs and MaintenanceMaintenance

FactsA l i b d t $30 illi> Annual repair budget $30 million

> Repair work is sole sourced to a large local contractor who is a major donor to the institutionthe institution

> Work orders with budgets are issued for each repair project

> The price for the work is competitive> The price for the work is competitive and consistent with other construction estimates

> Supporting documents for invoices areSupporting documents for invoices are verified and appear to be in good order

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Where was the owner defrauded on this work?R i d b l i t i l f th i it d i> Repairs were made by salvaging materials from the repair site and reusing them to make the repairs

> Materials and supplies that were purchased for the repair work and billed to the owner were stockpiled into the contractor’s inventoryto the owner were stockpiled into the contractor s inventory

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How was this detected?B k Till k d ith F iliti t i t th l t d k d> Baker Tilly worked with Facilities to inspect the completed work and identified window casings that were nicked and cracked

> Our follow up review of the waste removal invoices uncovered too little waste had been sent to the landfillwaste had been sent to the landfill

> Our subsequent interviews with construction crews discovered they had been instructed to salvage and reuse as much material as possible

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What was the estimated cost of this scheme?Over a three year period, the Owner had been defrauded by more than $1,000,000.

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Billing Schemes

Methods> Billi i t l t t> Billing equipment or personnel at rates

that are higher than agreed upon rate tables

> Miscalculating rate increases> Miscalculating rate increases> Pay application or invoice arithmetic

errors> Billing for costs not associated with the> Billing for costs not associated with the

project

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Fraud Case Study: Billing

Facts> T t d t t ith 20> Trusted contractor with over 20 years

invested in the relationship> Major contributor to the institution’s

charitable foundationcharitable foundation> Trusted personal friend of the

President and Chairman of the Board> New Facilities Director coming on> New Facilities Director coming on

board asks for a construction audit as due diligence effort

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Where was the Owner defrauded?Th l bb d fi l th t h d b d t d b th t t f th> The lobby and fireplace that had been donated by the contractor for the building had been billed to the Owner

Additionally, what did the construction audit find?> Construction contracts were poorly written and very one sided> The Owner had agreed to pay a two percent warranty fee when industry> The Owner had agreed to pay a two percent warranty fee when industry

practice is there is no charge for warranty work

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How did these findings change business ti ?practices?

> New construction contract templates were written based on well controlled contracting practices

> The contractor has been banned from future work at the institution> Gift and entertainment policies were changed to prevent employees and

officers from accepting high value gifts> Owner refused to accept the terms of the financial settlement > Owner shares this story with peers at association meetings

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FactsO h l t ti b d t i> Owner has an annual construction budget in excess of $100 million

> Master services agreements have been negotiated with several contractors to help ensure competitivewith several contractors to help ensure competitive pricing and reliable resources

> Internal audit performs a limited construction audit of the projects on a annual basisthe projects on a annual basis

> Audit reports never revealed any significant findings > Project is on time and on budget; correct arithmetic

on invoices and change orders followed policy andon invoices and change orders followed policy and procedure

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Where was the Owner defrauded?E i t bill d hi h t th d t i th t> Equipment was billed as higher rates than were agreed to in the master services agreement

> The billing rates used were newly negotiated with an effective date in the future from the date of workfuture from the date of work

> Invoices were billed late to imply the work dates coincided with contract effective dates

> Invoices were intentionally mislabeled with the wrong contract code linking> Invoices were intentionally mislabeled with the wrong contract code linking the invoice to contracts with higher billing rates

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How was this detected?A b t j t ti d th t i i h d diff t billiAn observant project manager noticed that one invoice had different billing rates for the same piece of equipment, which was also used during the same time period and at the same location and became curious.

Baker Tilly then worked with the institution to perform a full construction audit. We tested 100% of the billed transactions from a particular vendor and helped to identify items for a multi-million dollar settlement.to identify items for a multi million dollar settlement.

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Polling question #4

AA. Project managersB. Accounts payable clerksC. Internal audit

Who is responsible for detecting construction f d? D. All of the abovefraud?

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Material Fraud

Methods> M t i l b tit ti> Material substitution> Incorrect material measurements> Failure to credit for unused materials and supplies> Failure to credit for Owner direct purchases> Installation of substandard materials

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Fraud Case Study: Materials

FactsO t t d t b ild $12 illi ki t t> Owner contracted to build a $12 million parking structure

> Significant excavating and site preparation was required due to site conditions

> Site preparation budget was over run by 100%> Poor ground quality required many extra trucks of gravel> Unusual amounts of rain compounded the site condition problems> Unusual amounts of rain compounded the site condition problems

and delayed the construction schedule

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Case Study: Material Fraud

Where was the Owner defrauded?Thi lt d i hi h i t f l th th t ki> This resulted in a higher price per ton of gravel than the trucking tickets represented> Gravel is typically sold by the ton > The unusual weather had significantly raised the moisture content in

the gravel increasing the weight of a cubic yard of gravel

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Case Study: Material Fraud

How was this discovered?I t l dit f i i t i dit f th j t d ti d th> Internal audit was performing an interim audit of the project and noticed the major site preparation budget overrun

> After Internal Audit and Baker Tilly interviewed the project manager the auditor learned that the project had been affected by the recent rainsauditor learned that the project had been affected by the recent rains, which explained the overrun. This prompted the auditor to ask the project manager, why does rain cost a project so much money?

> The project manager went on to explain all of the tasks impacted by rain.The project manager went on to explain all of the tasks impacted by rain. > During the course of this discussion they realized that the aggregate they

had been purchasing hadn’t been price adjusted for moisture content.

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Polling question #5

A. In return for awarding the work, the contractor gives the Owner’s son a job on the construction crewjob on the construction crew.

B. To facilitate a building inspection, the contractor provides the inspector transportation and a box l h t t t ti it

Which of these is corruption?lunch to a remote construction site.

C. The Owner has lunch brought to the site for the construction crew to celebrate reaching a major project milestone.

D. All of the above.

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Fraud Case Study: Corruption

Facts> Owner uses competitive bidding to procure contractors> Owner uses competitive bidding to procure contractors> Bids are submitted sealed and opened under strict observation and

recording procedures> Bids are closely grouped and prices reflect historical experience> Bids are closely grouped and prices reflect historical experience> Project is awarded to low bidder> The owner has a great experience with the contractor and is happy to give

the contractor a referencethe contractor a reference

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How was the Owner defrauded?Th i i t t h d b b ibi j t t t f th iThe winning contractor had been bribing project managers at two of their closest competitors to share confidential bid information enabling the contractor to prepare and submit the lowest bid.

Let’s consider the ethics of how an Owner operates.

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How was this detected?D i th l f i t t f th t> During the annual process of approving contractors for the next year a project manager noticed one contractor had been awarded an unusually high number of bids

> This prompted Internal Audit and Facilities working with Baker Tilly to> This prompted Internal Audit and Facilities, working with Baker Tilly, to analyze the bid tabulations from each project awarded the last twelve months

> The analysis found too many close bids, which lead to a deeperThe analysis found too many close bids, which lead to a deeper investigation and ultimate discovery of information leaks

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Polling question #6

A. Construction contract terms and conditions

BB. Construction contract administration

C. Project document controlWhich of these topics would want to see a f t bi ? D. All of the abovefuture webinar?

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Polling question #7

A. Change order analysisB. Labor burden analysisC. Project performance analysis

and trackingD. Schedule analysis and tracking

Which of these topics would want to see a f t bi ? E. All of the abovefuture webinar?

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Disclosure

Required firm disclosure and Circular 230 Prominent Disclosure The information provided here is of a general nature and is not intended to address the specific i t f i di id l tit I ifi i t th i f f i lcircumstances of any individual or entity. In specific circumstances, the services of a professional

should be sought. Pursuant to the rules of professional conduct set forth in Circular 230, as promulgated by the United States Department of the Treasury, nothing contained in this communication was intended or written to be used by any taxpayer for the purpose of avoiding penalties that may be imposed on theto be used by any taxpayer for the purpose of avoiding penalties that may be imposed on the taxpayer by the Internal Revenue Service, and it cannot be used by any taxpayer for such purpose. No one, without our express prior written permission, may use or refer to any tax advice in this communication in promoting, marketing, or recommending a partnership or other entity, investment plan or arrangement to any other party.

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Additional resources

> www.bakertilly.com/construction-audit-webinar> http://www.theiia.org/p g> https://www.thenaca.org/> http://www.caacci.org/> http://rsmeans reedconstructiondata com/> http://rsmeans.reedconstructiondata.com/> http://www.auditnet.org/> http://www.csinet.org

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Questions?

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We will answer as many questions as time permits.

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Contact information

To receive CPE credit for today’s presentation, you must complete the survey following the webinar CPE certificates will be mailed to you insurvey following the webinar. CPE certificates will be mailed to you in

about three weeks.

Thank you for participating today!

T Oll E ik S h h dtTony Ollmann Erik SchuchardtCCA, Director CPA, Manager608 240 2618 608 240 2439608 240 2618 608 240 [email protected] [email protected]

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