1. Construction Auditing Risks and Capital Project Recovery
Strategies for 2015 and Beyond
Presented by:
Ashok Tundare
Practice Leader – Construction Audit Services

2.  Outcomes of this presentation
 What is a Construction Audit?
 Construction statistics
 Why is it important to internal auditors?
 Variations of Construction Audits
 Types of construction contracts and associated risks to your organization
 What to look for during an audit
 High-risk areas and common issues
 Examples and case studies
Agenda

3. Outcomes of this Presentation
 What a Construction Audit is and the variations of a
Construction Audit
 Why a Construction Audit is important to your organization
 Determination if a construction project at your organization
is a candidate for an audit
 The various scopes of a construction review
 Key high-risk areas to audit during a review

4. What is a Construction Audit?
Audit is defined as an all-encompassing
scope of the construction process from
solicitation of bids to final payment.
Not just looking for cost recoveries or overbillings, but
also provide process improvement recommendations for
the project management team

5. Therefore, a Construction Audit…
i. Is not just a cost recovery review but cost
prevention
ii. Should involve auditors prior to contract execution
iii. Should act as intermediary between owner and
General Contractor (GC)
iv. Should assist with disputes and litigation

6. The history of the Indian construction industry
dates back to period from early 1950 to mid 60’s
which witnessed the government playing an
active role in the development of these services
and most of construction activities during this
period were carried out by state owned
enterprises and supported by government
departments. In the first five-year plan,
construction of civil works was allotted nearly 50
per cent of the total capital outlay.
History of the Indian Construction
Industry

7.  The first professional consultancy company, National
Industrial Development Corporation (NIDC), was set up
in the public sector in 1954.
 Subsequently, many architectural, design engineering
and construction companies were set up in the public
sector such as • Indian Railways Construction Limited
(IRCON) • National Buildings Construction Corporation
(NBCC) • Rail India Transportation and Engineering
Services (RITES) • Engineers India Limited (EIL), etc. In
the private sector, companies such as following were
incorporated: • M. N. Dastur and Co. • Hindustan
Construction Company (HCC) • Ansals.
History of the Indian Construction Industry

8.  In the late 1960s government started encouraging
foreign collaborations in these services.
 The Guidelines for Foreign Collaboration, first issued in
1968, stated that local consultant would be the prime
contractor in such collaboration.
 The objective of such an imposition was to develop local
design capabilities parallel with the inflow of imported
technology and skills. This measure encouraged
international construction and consultancy organisations
to set up joint ventures and register their presence in
India.
History of the Indian Construction Industry

9.  The importance of this sector in India need not be
overemphasized. In India, construction has accounted
for around 40 per cent of the development investment
during the past 50 years.
 Around 16 per cent of the nation's working population
depends on construction for its livelihood. The Indian
construction industry comprises 200 firms in the
corporate sector. In addition to these firms, there are
about 1,20,000 Class A contractors registered with
various government construction bodies. There are
thousands of small contractors, which work as sub-
contractors of prime or other contractors.
History of the Indian Construction Industry

11.  It contributes more than 5 per cent to the nation's GDP
and 78 per cent to the gross capital formation.
Total capital expenditure of state and central govt. will be
touching 8,021 billion in 2011-12 from 1,436 billion
(1999-2000).The share of the Indian construction sector
in total gross capital formation (GCF) came down from
60 per cent in 1970-71 to 34 per cent in 1990-91.
Thereafter, it increased to 48 per cent in 1993-94 and
stood at 44 per cent in 1999-2000. In the 21 st century,
there has been an increase in the share of the
construction sector in GDP and capital formation.GDP
from Construction at factor cost (at current prices)
increased to 1,745.71 billion (12.02% of the total GDP )
in 2004-05 from 1,162.38 billion (10.39% of the total
GDP) in 2000-01.

12. Construction Statistics
The forecast?
o Non-residential and residential construction
are moving in opposite directions.
o Over a 12-month period, non-residential
slumped down % while residential rose .%.
o Pipeline of projects in various stages is very
dense
o Time will tell
o Industry is the first the fall and last to recover

13. Why is it Important to Internal
Auditors?
What does it mean to us and why are these audits
necessary?
– Risks to your organization can be significant
o Loss of capital funds
o Fraud
o Impact to operations
o Impact to strategic objectives
o Lack of management/committee trust for future
expenditures
o Litigation

14. Who is responsible for ensuring
the accuracy of construction costs?
1. N/A
2. Project management
3. Owners rep
4. IA
5. No one
6. Do not know
7. 3rd party service provider

15. Why is it Important to Internal Auditors?
What does it mean to us and why are
these audits necessary?
 “In some organizations, cost recoveries from
contract audits exceed the entire annual
budget for the internal audit department, . . .”
 Typical recoveries are 1 to 3% of total project
cost

16. Common rebuttal:
“We hire a construction management firm to
monitor and manage the project.”
 Risk still exists even with outsourcing the project management
function
 May not have the owner’s best interest in mind
 Possible collusion between GC and CM
 Priorities such as schedule could take precedence over cost
 Scope and contract changes between GC and PM could occur
without proper oversight
 Owner and/or auditors still need to stay involved throughout the
process!

17. Common rebuttal:
“We have worked with the same GC and no issues or
cost overruns have occurred in the past.”
 Just because a project is on budget or was completed under
budget does not mean all costs were appropriate
 Was the original budget a sound figure?
 Sound bidding and budget policies and procedures are needed
 Aggressive GC savings established
 Incentive to come in under budget
 Scope completed as planned
 Scopes of work eliminated to maintain budget
 Substitution of materials
 Utilize materials of lesser value and quality to limit cost

18. Common rebuttal:
“GCs that work on our jobs have never been convicted
of fraud.”
 Generally overcharges or unallowable costs are not due to
fraudulent activity
 Regardless of contract – “This is how it has always been
done.”
 Lack of resources by owner and/or GC
 Lack of communication between owner and GC/architect
 Excessive change orders/scope changes
 Mathematical errors
 Abundance of paperwork

19. High-Risk Areas and Common
Issues
 Change orders
 General conditions (allowable vs. unallowable cost)
 Equipment rental costs
 Labor and labor burden
 Subcontractor payments
 Bid process
 Subcontractor contracts

20. High-Risk Areas and Common Issues
Change
Orders
High risk
Owner’s contract must include detailed requirements for
estimating/pricing and the ultimate billings of costs
Strong procedures and processes must be in place
Markup percentages vary by level of contractor
Adequate support often not provided
Review of labor rates, if not agreed upon in advance, is
time consuming

21. High-Risk Areas and Common Issues
General
Conditions
High risk
Owner’s contract must include detailed requirements on
what is considered allowable and unallowable
Too many supervisors on site
Excessive entertainment and travel
Sales tax on exempt projects
Rebates or cash discounts not passed to owner
Excessive relocation, moving, transportation, and
communication costs

22.  Equipment & Rental Costs
 High risk
 Owner’s contract and plans must include detailed requirements as to
what equipment is expected to be used on the job
 Contract should indicate what equipment is anticipated to be rented
through the GC
 Contract needs to specify what is allowed
 Use industry benchmark data
 Charges in excess of total value
 - AED Green Book for example

23.  Labor & Labor Burden
 Labor burden percent used is often incorrect
 Labor burden often includes non-reimbursable items:
 - Bonuses
 - Parties
 - Education
 Unemployment tax still charged after maximum reached
 Ease on owner and auditors if rates, including labor burden,
are agreed upon for all crafts before work starts
 If not, contracts must define what is allowable in labor
burden build ups

24. Subcontractor
Payments
Back charges not passed through
Markups calculated incorrectly
Duplicate COs
Errors in payment application

25. Bid
Process
Need sound internal policies, procedures,
and processes
Adequate bid schedule
General Contractor/Project Managers
competing for packages of work
Design documents completed

26. Subcontractor Contracts
Critical for contracts with a Guaranteed Maximum
Price (GMP)
Variances (under-runs) accrue to the owner
Risks
Buyouts are not reviewed/managed by owner
The GC transfers the variance to its self-performed
budgeted line items
High-Risk Areas and Common Issues

27. Summary
Procurement of capital construction assets
involves high risk activities and
complicated execution processes.
Construction Audits and Cost Segregation
Studies are not an expense – they are
necessary for sound, effective cost
management that reduces total project
costs.

28. Construction Audits are an essential
internal control process to maximize
capital program effectiveness.
Auditor involvement in the beginning
provides a tone of oversight and often
results in limited cost overruns or
overcharges/billing errors.
Summary

29. Ending Notes
Internal Audit Standards Board

30. www.themegallery.com