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May 2, 2013

Making sense of construction cost audits

  • A cost audit or review typically saves 1 to 3 percent of total construction costs.
    Clothier & Head PS


    Every year around this time my family asks me for the latest tax advice — and every year I explain to them that I am an auditor.

    As auditors, our role is to give financial assurance to investors, owners, contractors, managers and other stakeholders. Still, each April my grandmother insists on asking me which costs are deductible on her rental property.

    Just because someone is an expert in one area of their industry, does not mean they are intimately involved in all areas of that industry.

    Likewise, just because someone — or some company — may be an expert in construction, does not necessarily mean they are also an expert in billings and costs. In fact, oftentimes they are inversely related.

    A construction cost review or audit can be a critical component of expert project management. Despite this, it is an area that is often overlooked.

    Construction cost reviews and audits are unique from most other financial audits because they can accomplish one very special thing: savings. Other audits can add intrinsic value to a project and assure compliance, but a cost audit or review offers the unique potential for money back; typically around 1 to 3 percent of total construction costs.

    A question we sometimes hear is: “Why would I incur the cost of an audit if some sort of savings is not guaranteed? I have confidence in my GC and project manager.”

    This is a great question, worth exploring in more detail.

    When do audits make sense?

    Not all contracts are created equal. While all jobs can benefit from excellent oversight of construction costs and billings, an actual review or audit first depends on the type of contract.

    Typically, it makes the most sense if there is a guaranteed maximum price (GMP) contract or construction manager at risk (CMR) contract. I usually shy away from cliche phrases, but I cannot help myself when it comes to construction cost audits. My favorites are: “Never sign your name without reading the contract” and “Another day, another dollar.”

    Really understanding the contract is the first and most important step in deciding whether you should do an audit. It will also be the first step we will perform as auditors, to help us decide which areas of your project need to be audited.

    We recommend summarizing the key components of your contract in a short brief. Pay special attention to the terms of the contract that have the potential for a silver lining, like allowances, owner-provided items, contingencies, equipment owned versus rental rates, provisions for self-performed work, labor and burden rates, as well as the specifics in the general conditions like allowed and disallowed costs.

    There is almost always going to be erroneous billings, mistakes on change orders and discovered overpayments, but will these items add up to worthwhile savings?

    First, consider your contract. Are the terms vague? If so, this could be a difficult road to travel. Maybe there is a savings clause. If so, where is the project at right now?

    Timing is very important. The timing of your audit should make logical sense with your contract. Is the job close to breakeven, or is it totally over budget? Risk control is often most effective when performed in a timely manner.

    The next step will be consideration of internal controls. How are the records being maintained? Are they quickly accessible and well organized? If so, this could reduce the price tag on your audit, which leaves more room for value-added savings.

    On the other hand, if things are a mess, your audit could be more expensive; but there is a much higher likelihood considerable savings will be found.

    Careful consideration is important. You want to maximize value and make sure you weigh not just the potential cost, but also the potential benefits. If you determine an audit makes sense for you, be up front with your auditor about the state of books and records, and they can help you strategize the best way to maximize value.

    The bottom line is if no one is asking questions, it is likely there is not enough expert oversight, which leads to the potential for savings.

    Clothier & Head’s audit team and our affiliates have found liquor, parties, gifts, disallowed trainings and all sorts of team-building personnel costs, some even evidenced by videos on YouTube!

    There is a good chance your auditors will identify cost savings if someone on your team doesn’t:

    • Compare contractor billings to actual payments.

    • Reconcile subcontracts to subcontractor bid proposals.

    • Make sure specific bonds and insurances are actually being purchased for the work.

    • Ensure equipment rental rates are consistent with local prevailing rates.

    • Make sure contractor-owned equipment isn’t charged to the project if not allowed per the contract.

    If some of the basic cost-control procedures are not taking place, then a cost audit might make sense for your project.

    From an audit standpoint, we have many procedures we consider performing based on your job. Some common questions are:

    1. Is there a limit on small tools in the contract? If so, how close to the limit are the costs getting?

    2. Is anyone checking that certified payroll records agree with wages actually paid to employees or that jobsite activity corresponds to payroll charges incurred?

    3. Are taxes being appropriately calculated and charged out?

    4. If a change order increases the contract sum, did the bond coverage also increase? If so, where are these costs being reflected?

    5. Are material purchases in excess of what is needed for the project?

    6. Are cash discounts being reflected and applied to the contract or mysteriously missing?

    7. Are all of the above costs, or other obvious cost items, even defined as reimbursable in the contract?

    How can it save me money?

    In general, a cost audit or review, properly scoped in advance, will usually translate to 1 to 3 percent in savings. Conducted properly, an audit will at least keep the contractor on his toes and eliminate erroneous charges. However, understanding the relationship between the owner, contractor and subcontractors is also important.

    We have clients who have received considerable savings, but because of the relationship with their contractor, they decided to demand only a minimal amount of the savings credited back to the job in order to maintain their strong relationship.

    It is important to evaluate what you would do with audit findings and how that might impact your existing relationships as well.

    Each situation is unique, and your CPA or cost auditor can help you make the most informed decision. It never hurts to have a professional look over your contract or contract brief, tell them about your project and ask their opinion. As auditors, issuing opinions is our specialty.

    However, as with life, the most important opinion is your own, and only you know the level of assurance right for your company. The most important element is your confidence in a job well done and well accounted for.

    May the costs be ever in your favor.

    Melissa Scott, CPA, is an audit supervisor at Clothier & Head PS in Seattle.

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