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Why construction audits are important to organizations

July 19, 2018

By Matt Gardner, CCA, CICA
Partner, Construction Audit Practice Leader

Construction projects incur risk

Billions of dollars are spent each year by organizations on capital expenditures. Construction projects are often a business’s greatest single expense, so they naturally incur a great deal of risk. Regardless whether an organization is a frequent or one-time builder, investing in capital projects makes them vulnerable to construction fraud and unnecessary costs. Lack of resources, sound processes and oversight by the project management teams assigned to the project can hinder the organization’s ability to properly manage time, cost, quality, safety and environmental sustainability. The consequences of such unmanaged risk can be loss of capital funds, loss of management or committee trust for future expenditures, and litigation.

An auditor’s role within an organization is to improve internal controls around key and high-risk processes, and the project management function is no exception. The job of a construction auditor is to mitigate the risk associated with construction projects and provide assurance the organization’s money is handled appropriately. Auditors can even help negotiate a favorable contract, which means a sound budget figure and increased efficiency with fewer disputes as the project develops. An auditor’s involvement throughout the course of a project sets a tone of governing oversight, resulting in fewer cost overruns, overcharges and billing errors.

ROI of construction audits

Just how much money is at stake? Typical recoveries are one to three percent of the total project cost. In some organizations, cost recoveries exceed the entire annual budget for the internal audit department.1 Construction audits are typically an effective cost management tool that reduces total project costs and promotes consistency and transparency in the makeup of contractor billings.

Importance of collaboration

The intent of the audit is to recoup funds billed, and ultimately paid in error, by your contractors secured on the project. However, a relationship is at stake, which could ultimately cost your organization more money if not approached in a professional manner.

A lack of understanding about an owner’s construction management department/team and a contractor relationship is what can give an auditor’s role a bad name. Construction auditors must understand the importance of collaboration and relationship building between the key parties on any given construction project, and the difficulties a strained relationship can cause on an owner.

An auditor’s focus should be to ensure costs charged to the project are in line with the contract/agreed-upon requirements and are fair and reasonable. While conducting their audit, they should avoid causing stress to the owner/contractor relationships with frivolous requests. Getting involved early in the process ensures expectations from all parties are discussed to limit potential conflicts and disputes later during the construction process. The auditor’s goal is to engrain him/herself into the process and be a part of the collaborative team effort to ensure owners are charged fairly and accurately. Best practice is for the overall process to be established on the front end to limit any misunderstandings or delays during peak construction, when costs are often more likely to be charged in error.

Fraud is not the only risk

Generally, overcharges or unallowable costs are not due to fraudulent activity. Some mistakes, such as mathematical errors, may be innocent, but costly nonetheless. Projects, specifically those built on cost plus or time and material contracts, involve a tremendous amount of paperwork, which is often handled by project management systems outside the organization or other forms of project cost tracking software.

Oftentimes contractors bill in accordance with their standard billing practices, which do not take into consideration a specific contract or the cost containment language built into it. The contract negotiation period is often months, and sometimes years, prior to construction even occurring. As so much time has passed, at times, neither party goes back to review the contract requirements once construction starts and payment applications are being received by the owner. Work performed by outside or inside legal counsel on the front end goes wasted when no one is there on the back end to make the contractor billings match the requirements.

Unexpected issues arise with any project and must be handled accordingly. A construction auditor helps recognize whether a change order is legitimate or just a hidden profit center for the contractor. The auditor not only helps create a contract that anticipates and dissolves potential disputes, but should be engrained in the process to consistently monitor and set expectations with contractors ensuring any issues identified are supported by sound financial analysis of proposed changes.

Under budget, overcharged

Many projects may be under budget while still including erroneous or inappropriate charges. It must first be ensured the original budget is a sound figure, which requires sound bidding and budget policies and procedures. It’s easy for a general contractor to meet a budget if the original figure is higher than the actual project cost. Contractors may neglect details outlined in the scope of work or use materials of lower quality without issuing the proper credit for reduction in cost. Additionally, establishing aggressive general contractor savings goals within a contract provides an incentive to come in under budget and share in cost savings with an owner, especially if the savings is not capped by a maximum amount.

Value in vigilance

Expensive pitfalls and hidden costs are rampant in capital expenditures. Construction auditors prevent contractors from cutting corners and sweeping details under the rug by staying involved in every phase of the project lifecycle. A jobsite inspection may identify altered or eliminated materials or scope of work even to the untrained eye.

Construction audits are essential to maximizing the value of an organization’s construction project. Attention to detail, ability to dissect contracts and willingness to ask questions are some of the most important qualities an internal auditor should possess to effectively manage their organization’s risk when undertaking a capital expenditure.

1 Cashell, James and Eichmann, Rick “Construction Contract Auditing” Internal Auditor, February, 1999

For more information about Honkamp Krueger’s construction audit services, contact us at 888-556-0123 or submit our online form.

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