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Construction Financial Controls and Contract Compliance

Baker Tilly refers to Baker Tilly Virchow Krause, LLP,


an independently owned and managed member of Baker Tilly International.

2010 Baker Tilly Virchow Krause, LLP

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About Baker Tilly

> Established in 1931


> 16th largest accounting and advisory firm in
the United States*
According to Accounting Todays 2011 list of
Top
Top 100 Firms
Firms.

> More than 1,300 professionals


> Baker Tilly Virchow Krause, LLP is the largest
U.S.
U
S B
Baker
k Till
Tilly International
I t
ti
l iindependent
d
d t
member firm

> Baker Tilly International is the eighth largest


public
bli accounting
ti network
t
k with
ith representation
t ti
in more than 110 countries

> Convenient, seamless resource for worldwide


needs
3

About Baker Tilly

From concept and funding to controls and


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

4
4

Introductions

Tony Ollmann

Erik Schuchardt

CCA, Director

CPA, Manager

608 240 2618

608 240 2439

Tony.Ollmann@bakertilly.com

Erik.Schuchardt@bakertilly.com

Overview

Todays topics

EXAMPLE TEX

Owners responsibilities

Understanding Construction Costs

Project Financial Controls

Leading Indicators of
Control Problems

How to Budget and Pay for


Construction Controls

Polling question #1

A. Yes

Were you able to attend


the first webinar in this
series: Construction
Contract Fundamentals?

B No
B.
C. Not yet, but I plan to view it

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

Learning objectives

1) Recognize source of construction costs


2) Where to look for financial control variances
3) Identify gaps in your project controls
4) How to select projects for continuous monitoring
5) Recognize leading indicators of control failure

Construction project lifecycle

Construction progress to date


Design and construction team has been selected (Facilities)
Contracts have been executed (Legal)
Gro ndbreaking ceremon
Groundbreaking
ceremony is complete

Owners responsibilities

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

10

Owners responsibilities (cont.)

During the construction phase


> Controlling capital expenditures
> Monitoring change orders
> Scheduling thousands of activities for hundreds of people
> Maintaining an ethical and safe work environment

11

Owners responsibilities (cont.)

Common construction risk


managementt myths
th
> Our architect is analyzing
y g and approving
g payy applications
> If the architect approved the change order it must be okay
> We have a shared savings provision, our contractor has incentive to
minimize p
project
j
costs

12

Polling question #2

How would y
you rate
your organizations
project controls?

A. My organization has strong


construction p
project
j
financial controls.
B. I have never evaluated our
constr ction project
construction
controls
C. Im not certain whyy I would
monitor project controls

Please respond using the polling section in the WebEx screen to the right.
13

Understanding Construction Costs

Designing and implementing project financial


controls
t l requires
i
understanding
d
t di
the
th ffollowing:
ll i
> Where costs originate
g
> Why costs change
> Who can authorize change
> What are leading indicators
of change

14

Understanding Construction Costs

Where do construction costs originate?


> Contractors budget or Schedule of Values
> Contract definition of allowable costs
> Pay applications
> Project change orders

15

Understanding Construction Costs

What is a Schedule of Values?


> Macro construction budget
> Line item budgets organized around 16 Divisions of Work
Divisions of work typically follow CSI standard format
Division examples are:
Site work
Electrical
Mechanical
> Each line item budget is an estimate by the prime contractor or bid amount
by the subcontractors

16

Sample Schedule of Values

17

Polling question #3

Which
c o
of tthe
e following
o o
g is
s
not a hard construction
cost?

A. Concrete and masonryy work


B. Landscaping
C. Floor and wall coverings
D Construction management fee
D.
E. Equipment rental charges

Please respond using the radio buttons in the WebEx screen to the right.
18

Understanding Construction Costs

Cost Types
> Soft
S ft costs
t are the
th indirect
i di t costs
t associated
i t d with
ith the
th construction
t ti project
j t
such as:

General conditions
Construction
C
t ti managementt ffee
Insurance and bonding
> Hard costs are the direct costs for constructing the facility.
CSI divisions
di i i
2-16
2 16

Materials, supplies and equipment


Subcontractor costs
Self-performed construction costs

19

Understanding Construction Costs

Hard costs are usually supported by third


party
t iinvoices,
i
time
ti
sheets,
h t and
d receiving
i i
tickets.
Soft costs are more subject to interpretation
and require a more thorough analysis to
quantify allowable and non-allowable costs.

20

Understanding Construction Costs Soft Costs

General Conditions is the contractors


recovery off project
j t managementt costs.
t
It should
h ld nott be
b a di
directt recovery off th
the
contractors corporate overhead costs.

21

Understanding Construction Costs Soft Costs

What kind of costs should not be allowed as a


generall conditions
diti
expense:
> Project management software
> Software trainingg
> Small tools
> Company owner/principal labor and burden expense
> Site clean up
> Insurance and deductibles
> Bonding
> Executive transportation
> Overtime costs for exempt employees

22

Understanding Construction Costs Soft Costs

What kind of costs should not be allowed as a


general conditions expense: (cont)
> Bonuses
> Outside professional services
> Rework resulting from incomplete or unacceptable work product
> Anything with its own line item in the budget

23
23

Understanding Construction Costs Soft Costs

Generally accepted general conditions costs:


> Project
P j t manager, assistant
i t t and
d superintendent
i t d t llabor
b costs
t
(project management personnel)

> Vehicle costs for project management personnel


> Job
J b ttrailer,
il utilities
tiliti and
d jjob
b ttrailer
il ffurniture
it
((nott tto exceed
d purchase
h
cost)
t)
> Per diems and project management travel costs

24

Understanding Construction Costs Soft costs

Construction management fee is the agreed


upon overhead
h d and
d profit
fit paid
id tto th
the
contractor.
It is usually based on a percentage of the total
contractors
contractor
s cost of the project
project. Not the
Owners cost of the project.

25

Understanding Construction Costs Hard Costs

Hard costs usually include:


> Direct
Di t llabor
b
> Direct materials
> Construction equipment
> Facility equipment (boilers, air exchangers, air conditioners, etc)

26

Understanding Construction Costs Hard Costs

Hard costs usually exclude:


> Construction
C
t ti managementt ffee on change
h
orders
d
> Embedded profit margin in labor rates
> Equipment rate mark up over the fee
> Contingency budget
> Owner allowances
> Anyy costs alreadyy ppaid for in General Conditions

27

Understanding Construction Costs


Change Orders

Change orders are Owner authorized


modifications to:
> Scope
> Schedule
> Project budget

Change orders occur for these primary reasons:


> Revised
R i d estimate
ti t
> Change in plans or specifications
> Compliance with building codes
> Change in building conditions
> Resource constraints
> Owner requests
> Poor communication and planning
28

Project Financial Controls

Construction Risk Pools


> Subcontractor
S b
t t bid
bids
> Schedule of value
> Pay application
> Job cost
> Change orders
> Contingency
g
y

29

Project Financial Controls

Schedule of Values
> Verify
V if arithmetic
ith ti
> Identify subcontractor contracting methods
> Confirm line item budgets

30

Project Financial Controls

Pay Application
> Verify
V if arithmetic
ith ti
> Reconcile supporting documentation
> Obtain lien waivers
> Verify billing rates
> Compare observed progress with reported progress

31

Sample Pay Application

32

Project Financial Controls

Job Cost
> Compare
C
actual
t l costs
t iincurred
d
with reported costs

> Verify no exempt employees are


charging overtime

> Verify labor burden contain only


cost

> Compare equipment usage with


operator hours

> Compare material purchases


with job site receipts

> Compare material


purchases with plans and
specifications

> Verify labor rates


> Verify equipment rates
> Confirm direct labor costs
with payroll journal

> Verify direct labor hours


with time sheets

> Verify equipment hours with


equipment logs

> Identify non-allowable


g
charges

33

Labor Burden Analysis

Contractor Labor Rate Calculation


Contractor Name: Electric

Occupation: Electrician

Rate Applicability Period: June 2009

Straight Time

B
Base
W
Wage ($ P
Per H
Hour))

Overtime

Occupation: Forerman
Double Time

Straight Time

Overtime

Double Time

38
38.52
52

57
57.78
78

77
77.04
04

$ 42
42.37
37

$ 63
63.56
56

$ 84
84.74
74

Subtotal Taxable Wages & Benefits $

38.52

57.78

77.04

$ 42.37

$ 63.56

$ 84.74

Pension

12.80

19.20

25.60

$ 12.80

$ 19.20

$ 25.60

Health & Welfare

9.39

14.09

18.78

9.39

$ 14.09

$ 18.78

NEBF (3%)

1
1.16
16

1
1.73
73

2
2.31
31

1
1.27
27

1
1.91
91

JATC (2%)

0.77

1.16

1.54

0.85

1.27

1.69

LMCC

0.13

0.13

0.13

0.13

0.13

0.13

Taxable Benefits

Union Benefits

2
2.54
54

NLMCC

0.01

0.01

0.01

0.01

0.01

0.01

Safety

0.03

0.03

0.03

0.03

0.03

0.03
0.04

Substance Testing

0.04

0.04

0.04

0.04

0.04

AMF (.5%)

0.19

0.29

0.39

0.21

0.32

0.42

NECA Service Charge


g ((.5%))

0.19

0.29

0.39

0.21

0.32

0.42

Total Union Benefits $

24.71

36.96

49.21

$ 24.94

$ 37.31

$ 49.67

Subtotal Base Rate + Fringes $

63.23

94.74

126.25

$ 67.31

$ 100.86

$ 134.41

Insurance
Workers Compensation (1%)

0.39

0.58

0.77

0.42

0.64

0.85

Liability Insurance (.5%)

0.19

0.29

0.39

0.21

0.32

0.42

0.23

0.23

Payroll Taxes:
State Unemployment (3.9% of $12,300)

Fed Unemployment (6.2% of $7,000)

0.21

0.21

0.56

0.84

1.12

0.61

2.95

4.42

5.89

3.24

4.86

6.48

Total Tax & Insurance $

4.52

6.12

8.17

4.93

6.74

8.98

0.92

Medicare (1.45%)
F.I.C.A. (7.65%)

1.23

Cost Per Hour

67.75

$ 100.87

134.42

$ 72.24

$ 107.60

$ 143.40

Contract Hourly Rate

100.00

$ 150.00

200.00

$ 100.00

$ 150.00

$ 200.00

Premium (Discount)

32.25

65.58

$ 27.76

$ 42.40

$ 56.60

49.13

34

Project Financial Controls

Change Orders
> Confirm
C fi authorizations
th i ti
> Review C/O log for duplicates
> Confirm C/O is not in budgeted scope
> Verify change order pricing
> Reconcile change order with actual cost incurred

35

Change Order Analysis Template

SubcontractorChangeOrderPricingProposalSummarySheet

Subcontractorand
SubcontractScopeof
Work:

Change
Proposal
Description/
Scopeof
Work:

ChangeOrderProposalNumber:

ChangeOrderPricingSummary:

SubcontractorSelfPerformedWork:
Materials(includingapplicablesales/usetax)
LaborandLaborBurden
Equipment(withpurchasecostgreaterthan$750)
Subtotals

Markup
PercentageFee:
Costbeforemarkup Maximum=15%

Subtotals

$1,050.00
$1,022.44

$157.50
$153.37

$1,207.50
$1,175.80

$2,072.44

$310.87

$2,383.30

Markup
PercentageFee:
Costbeforemarkup Maximum=5%

Total

2
3
4

$
$
$

$
$
$

$
$
$

ChangeOrderProposalWorkperformedbySubSubcontractors(Enternamesofsub
subcontractorsandthesubsubcontractorscopeofwork)

5
Subtotals

Total
TotalChangeOrder SubcontractorFees
ProposalCost
IncludedinChange
beforeMarkup
Order
TotalProposedChangeOrderCosts
Totals

$2,072.44

$310.87

$2,383.30

SubcontractorChangeOrderPricingCertification:
Icertifytothebestofmyknowledgeandbeliefthatthischangeorderhasbeenpricedinaccordancewiththecontractprovisions
foundinExhibit"A" entitled"PricingofConstructionContractChangeOrdersbySubcontractors"
and that the pricing information included in the change order is subject to further review in accordance with 4 1 4 2 and 4 3 of
andthatthepricinginformationincludedinthechangeorderissubjecttofurtherreviewinaccordancewith4.1,4.2and4.3of
Exhibit"A".
Subcontract
orSignature:

Date:

36

Project Financial Controls

Contingency Budget
> Reconcile
R
il O
Owners
contingency
ti
with
ith authorized
th i d uses
> Credit Owners contingency with scope reductions, material substitutions
and value engineering savings

> Confirm
C fi contractors
t t contingency
ti
with
ith O
Owners
contingency
ti

37

Leading indicators of control problems

Excuses
> Cant
C t fifind
dad
documentt
> Competing deadlines
> Limited resources and staff turnover
> Dont remember why
> I didnt know we needed to do that

38

Leading indicator of control problems

Repetitive Errors
> Incorrect
I
t billi
billing rates
t
> Arithmetic errors
> Verbal change orders without written authorization
> Late or missing documentation

39

Leading indicator of control problems

Project Trends
> Missed
Mi
d milestone
il t
d
dates
t
> Job cost is consistently under-billed
> Change orders for code compliance
> Failed inspections
> Consolidated change orders
> Use of Owners contingency
g
y faster than Contractors contingency
g
y

40

Leading indicator of control problems

Project Trends
> Project
P j t costs
t increasing
i
i disproportionally
di
ti
ll tto jjob
b progress
> Lump sum change orders
> Large no bid change orders
> Subcontractors are unpaid
> Change order requests dated near financial milestones

41

Leading indicator of control problems

Project Trends
> Frequent
F
t changes
h
in
i project
j t personnell
> Slow response to questions and information requests

42

Polling question #4

A. Project teams construction


Estimating
E
ti ti time
ti
for
f
monitoring controls is
dependent on:

controls experience

B. Size and complexity of the


construction project

C Quality of the project financial


C.
controls

D. All of the above

Please respond using the radio buttons in the WebEx screen to the right.
43

How to budget and pay for the


construction controls

Rules of thumb to follow


M it i h
Monitoring
hours equall .001%
001% times
ti
the
th construction
t
ti
cost.
t

> For instance, a $50 million project should have 500 financial control hours
> This assumes an experienced team, moderate construction schedule and
an average building

44

How to budget and pay for the


construction controls

Rules of thumb to follow (cont.)


The costt off the
Th
th project
j t financial
fi
i l controls
t l iis a reall construction
t
ti
cost like project management, engineering services and
construction materials.
Options to pay for the construction controls:

> Capitalize
p
the cost with other construction costs
> Charge back to facilities management
> Special budget resource request to fund the
> construction audit as a special project
> Part of annual internal audit budget

45

Construction controls program

Financial controls program


> Preparation
P
ti off control
t l schedules
h d l
> Reconcile project expenditures
> Direct labor analysis
> Labor burden analysis
> Change order analysis and pricing analysis
> Subcontract analysis
y
> Material purchases
> Verification of contracted scope
> Equipment rental analysis
> Bonds and insurance analysis
> Quality assurance and quality control

46

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
circumstances
i
t
off any individual
i di id l or entity.
tit IIn specific
ifi circumstances,
i
t
th
the services
i
off a professional
f
i
l
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 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.

47

Baker Tilly Webinar Series

Coming up in the Understanding Construction


Contract Controls and Construction Audit Best
Practices Webinar Series:
Post-Construction Auditing and Fraud Detection
Wednesday, November 9, 2011
12:00 p.m. Central
Register at bakertilly.com/construction-audit-webinar

48

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

49

Questions?

Any Questions?
Please feel free to ask questions in the screen to your right.
We will answer as many questions as time permits.

50

Contact information

To receive CPE credit for todays presentation, you must complete the
survey following the webinar.
webinar CPE certificates will be mailed to you in
about three weeks.
Thank you for participating today!

T
Tony
Ollmann
Oll

E ik Schuchardt
Erik
S h h dt

CCA, Director

CPA, Manager

608 240 2618


tony.ollmann@bakertilly.com

608 240 2439


erik.schuchardt@bakertilly.com

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