Owner s project control review 2014 Baker Tilly Virchow Krause, LLP
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Overview Today s topics EXAMPLE TEX Overview of construction program controls Common construction program risks Controls by project phase Audit Change activities orders Case studies 4
Learning objectives > Understand construction program control fundamentals > Identify how the project risks change throughout the construction lifecycle > Recognize audit red flags and under performance indicators > Evaluate audit program elements 5
Construction program controls What are construction program controls? > Construction contracts > Documented, implemented policies, and procedures > Designed to mitigate project and program risks > Controls can help organizations: Improve project return on investment Prevent realized losses from scope creep Maintain project schedule, avoid preventable project delays Improve communication of pertinent project issues Monitor projects 7
Construction program controls > Contract controls include good definition of terms such as allowable costs right-to-audit change orders self-performed work 8
Construction program controls > Policies and procedures should include controls for all project phases: Pre-construction Construction Post-construction 9
Construction program controls > Policies and procedures should be: Documented in a comprehensive construction program controls manual Detailed to reduce subjectivity in application and practice Distributed to all construction personnel Reviewed regularly for modifications 10
Construction program controls > Actual practices should be monitored and compared to documented controls > Monitoring helps ensure controls are: Implemented Adhered to by personnel Functioning as intended Effective > Controls that are not implemented, followed, or functioning properly are not effective in mitigating risks 11
Common construction project risks > Overcharges > Unwarranted change orders > Scope creep > Construction quality issues > Unauthorized material substitutions > Project schedule delays > Abuse of contingency funds > Unrealized credits and available discounts > Claims and liens > Project scope/requirements exceed funding > Poorly defined contract terms and/or program controls > Excessive billing rates > Undisclosed related party transactions > Inaccurate or insufficient project records > Inadequate staffing 13
Types of construction program controls > As the owner, you are ultimately responsible for everything > Detailed program controls to mitigate risks on construction projects are crucial to successful capital programs > One way to organize program controls is by project phase Pre-construction Construction Post-construction 15
Pre-construction controls Major responsibilities Control examples Design Design completion percentage before construction begins Design evaluation procedures (feasible, functional) Constructability review requirements Value engineering procedures Preliminary project schedule and budget requirements 16
Pre-construction controls (cont.) Major responsibilities Control examples Bid phase Sole source procedures Bidder prequalification requirements Standardized RFP templates Bid posting, advertising, distribution Bid analysis requirements 17
Pre-construction controls (cont.) Major responsibilities Control examples Contract awards Define basis of awards Required approvals, timing Purchase order procedures Contracting process Applicable notices (award, NTP) Standardized contracts Approvals and approval thresholds 18
Pre-construction controls (cont.) Major responsibilities Regulatory, economic development and business enterprise compliance Control examples Documentation of regulations applicable to the project Project business enterprise requirements (M/W/DBE) Compliance (Davis-Bacon, OSHA) 19
Pre-construction controls (cont.) Major responsibilities Control examples Pre-construction work Define cost estimate support requirements Determine basis for reimbursement/ contract types Standardized contract terms and conditions 20
Construction controls Major responsibilities Control examples Change order control Change request process and standardized forms Cost/pricing analysis requirements Allowed change order cost types Cost and schedule change support requirements 21
Construction controls (cont.) Major responsibilities Control examples Schedule management Narrative and approval requirements for baseline/active schedules Mandated schedule updates Approval requirements for schedule changes Comparison of schedule to actual completion Schedule reporting details 22
Construction controls (cont.) Major responsibilities Control examples Cost monitoring PM review of budget/commitment to actual Variance communications Invoice approvals Project reporting 23
Construction controls (cont.) Major responsibilities Control examples Safety Project safety requirements Distribution of owner requirements Contractor, subcontractor, vendor acceptance Compliance with OSHA, other applicable regulations Violations and corrective action plans Accident and claim procedures 24
Construction controls (cont.) Major responsibilities Control examples Contract accounting Invoice approvals and approval thresholds Subcontract billing requirements Expenditure processing (3-way match) Project financial reporting, frequency, distribution 25
Post-construction controls Major responsibilities Control examples Physical project closeout Substantial and final completion conditions Closeout submittal requirements Delineate walkthroughs and responsibilities Punch list monitoring and resolution Contract closeout procedures and final reporting 26
Post-construction controls (cont.) Major responsibilities Liquidated damages/shared savings calculations Allowance and contingency reconciliation Control examples Application of contract provisions Approvals of exceptions Calculation methods Timing of assessment/payments Responsible parties Verification of usage compliance Timing of reconciliation 27
Post-construction controls (cont.) Major responsibilities Control examples Accounting project closeout Project capitalization procedures Contract reconciliations Final cost audit Accounting system project close Warranty management Warranty log requirements Tracking/inspections Claim procedures 28
Case study #1: Change orders Facts > University housing project > GMP contract totaling $100 million > Contractor self-performing carpentry work > SPW was agreed to using lump sum pricing > Contingency fund usage requires owner authorization 31
Case study #1: Change orders (cont.) Key tests > Analyze payment applications to identify line item overages > Compare general conditions percentage complete to overall project completion > Review project change order approvals and test for contract compliance > Examine RFI and change order control schedules to capture and highlight duplicate submissions > Assess contingency logs and descriptions of usage 32
Case study #1: Change orders (cont.) Red flags > Contractor billing schedule of values reflects line item overruns (negative balance to finish amounts) > Change request using contingency to add funds to general conditions > Duplicate scope of work in change order 33
Case study #1: Change orders (cont.) Findings > Contractor overran the SPW budget > Change order increased general conditions for duplicate trade/craft scope of work to recover SPW overages > Owner s senior project manager approved this change order Program controls in place were not functioning as intended. 34
Case study #1: Change orders (cont.) Control recommendations > Contract change order controls > Multiple review and approval requirements for change orders prior to execution (VP, project executive, project manager, finance) > Discussion of pending changes (scope/amount) in weekly project meetings > Required communications informing program managers of line item overruns (PM and accounting) > Change order increased general conditions for duplicate trade/craft scope of work 35
Case study #2: Billing Facts > Hospital expansion project > GMP contract totaling $60 million > Contractor owned equipment is utilized on the project > Contract terms Include stipulated labor and equipment rates Allow for annual labor escalation of 3 percent 37
Case study #2: Billing (cont.) Key tests > Review payment application supporting documents for adequacy Contractor owned equipment daily project work logs or equipment usage tickets Labor timesheets > Trace cost support to payment application > Analyze support provided to owner showing annual rate increase calculations > Determine existence of rental rate comparisons > Assess contractor owned equipment rates in comparison to average of local rates 38
Case study #2: Billing (cont.) Red flags > Contract cost terms do not provide cost limitations or ceilings for contractor owned equipment Monthly rental rate restrictions Charge limits for total rental charges > Annual rate increase were not provided to the owner for review prior to billing with updated rates > Incomplete or insufficient cost support provided with monthly billings > Lack of rental rate comparisons 39
Case study #2: Billing (cont.) Findings > Owner was billed for contractor owned equipment at 115 percent of the equipment fair market value exceeding actual on-site usage > Labor billings were based on rates exceeding the stipulated escalation percentage > Project accounting controls did not include reconciliation of select cost support to amounts billed > Owner personnel did not validate the increased labor rates for contract compliance Contract controls were not favorable for the owner. Project controls were not adequate to help owner control costs. 40
Case study #2: Billing (cont.) Control recommendations > Contract terms should include restrictions on contractor equipment charges Require rate comparison to local rates Stipulate contractor rate does not exceed average rate Cumulative charges are not to exceed a stipulated FMV percentage > Contract terms should stipulate billing cost support requirements > Contract controls should require documented owner approval of increased rates prior to inclusion in billings > Program controls should mandate rate review/verification process 41
Case study #2: Billing (cont.) Control recommendations (cont.) > Project accounting controls should include reconciliation processes Accuracy of calculations Adequacy of attached support to validate all charges Contractual compliance of billing rates > Documented processes for the handling of unsupported or questioned costs billed to the owner 42
Case study #3: Collusion Facts > City parking structure project > Fixed price contract totaling $22 million > Bids received ranged from $18.5 to $23 million > Undisclosed related parties between the owner and contractor > Related owner employee participates in bid award process and decisions > Key bid details were shared between related parties such as how the bids will be scored and desired pricing/owner maximum 44
Case study #3: Collusion (cont.) Key tests > Review RFPs to ensure standardized conditions are included, such as disclosure of related parties > Examine project bid documents to verify: Pre-qualification was performed Bid files including bids, bid tabs, scoring and award documents Review exception detail assessing reason for deviation and approvals > Compare bid practices to documented controls > Additional work to confirm observations could include interviews and researching licenses and relationships 45
Case study #3: Collusion (cont.) Red flags > Winning bid was the last bid received and time stamped at midnight > Request for Proposal (RFP) did not require disclosure of related parties > Prequalification processes were not followed > Subjective scoring was used instead of award to lowest qualified bidder 46
Case study #3: Collusion (cont.) Findings > RFP did not include related party disclosure > Work was not awarded to the lowest qualified bidder in accordance with policies and procedures > Award exception was not documented in the bid files > Prequalification policies were not adhered to Implemented program controls were effective. 47
Case study #3: Collusion (cont.) Control recommendations > RFPs should include standardized conditions such as disclosure of related parties Providing incorrect data disqualifies company from bid > Policies and procedures should include additional controls such as Disqualification of all parties not prequalified Documentation requirements for all exceptions Requirement of C-suite approval on all exceptions prior to award Involvement of procurement or outside department in review prior to award > Regular reviews to assess compliance with controls 48
Case study #4: Shared savings Facts > Office tower project > GMP contract totaling $85 million > Contract savings split: 80 percent to owner, 20 percent to contractor > Savings included any unspent allowance or contingency funds > Contract contingency was 8 percent of the cost of work (high) 49
Case study #4: Shared savings (cont.) Key tests > Analyze cost support provided to validate the original GMP amount > Review contract contingency percentage to assess reasonableness Typically averages 5 percent > Examine cost support provided with change orders > Review contract allowance and contingency logs 50
Case study #4: Shared savings (cont.) Red flags > Lack of cost support for: GMP contract values Change orders > Excessive unused allowance and/or contingency funds 51
Case study #4: Shared savings (cont.) Findings > Original GMP costs were not supported with bids or estimates to validate pricing was not inflated > Change orders were not supported with cost estimates, bids or actual cost support > No independent cost estimates were performed > Contract work was completed for 90 percent of the GMP value > High contractor contingency percentage inflated contract value Contract controls were not favorable for the owner. Project controls were not adequate to help owner control costs. 52
Case study #4: Shared savings (cont.) Control recommendations > Contracts with split savings should require one of the following: Cost support (bids, estimates, historical support, etc.) Performance of an independent cost estimate > Contract terms should exclude unspent allowance and contingency funds from the savings calculation > Program controls include: Establishing contingency percentage guidelines (NTE %) Cost support reconciliations or third party estimates prior to contract approvals Verification of savings calculations 53
Case study #5: Change orders Facts > Hotel renovation project > Cost plus fee final contract totaled $44 million > Change orders were issued as lump sum changes 54
Case study #5: Change orders (cont.) Key tests > Detailed change order analysis Review change order cost type Assess cost support to validate change amount Total cumulative change order value to date Calculate change order value percentage Review change order approvals 55
Case study #5: Change orders (cont.) Red flags > Excessive change orders 10 percent or more of contract value Large volume or number of changes > Change orders lacking cost support to validate change amount > Charges that are not in compliance with the contract terms 56
Case study #5: Change orders (cont.) Findings > Change orders accounted for 27 percent of the final contract amount > Change orders were lump sum changes > Cost support was not adequate to validate the amount of the change > Independent cost estimates were not performed > Change order markup was not contractually compliant Change order contract controls and program controls were not adequate help owner control costs. 57
Case study #5: Change orders (cont.) Control recommendations > Contract change order controls Support requirements Stipulated change order markup percentages > Program definition of excessive change order amounts > Guidelines for addressing excessive changes > Program controls requiring Validation of compliance with contract terms (rates, fee calculations, markups, etc.) Lump sum change order qualifications (allowable circumstances for use) Change order contract controls and program controls were not adequate help owner control costs. 58
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