Guaranteed maximum price (GMP) construction contracts are audited more often due to the nature of the reimbursable costs. And the contractors on these projects often have questions when the client notifies them that their project may be audited.
Does the client mistrust the contractor? Is the client looking for something specific? Is this just a way to beat up the final costs? Don’t forget to add in the perception of the unforgiving auditor who ransacks the mounds of paperwork searching for any shred of evidence or mistake. These questions and ideas lead many contractors to have a cynical attitude toward an audit.
But consider another point of view. The client, who is spending millions of dollars to have something built, wants to ensure that the project is being built correctly and efficiently and that the money is being spent carefully. In addition to the bank loan, there may be layers of investors, funding sources and stockholders that all have various fiduciary requirements as part of the fiscal responsibility of their money. Think about how many news reports there are on the misuse of funds.
There is a growing need from many organizations to have assurance that they are being diligent stewards of the money they are spending or lending. Audits are not necessarily a reflection of concerns with project performance. An increasing number of contractors are welcoming construction audits in order to support their position on projects and to prove that they have acted responsibly within the bounds of the contract.
Despite the common misperception, an auditor’s main role is not to find mistakes to make you look bad or to penalize you. In fact, a construction auditor’s primary function is to provide a systematic and independent examination of data, records, operations and performances to verify the final contractually allowable costs. A neutral audit can serve to help the owner confidently discuss the care and diligence put into the managing of the funds.
The main steps of a construction audit are the same as the steps that should be taken to financially close out a project. There are contractors who perform their own audits as part of their project controls process. These are much more streamlined, given that it is being done internally. The quality of a firm’s project controls often has a direct correlation to the magnitude of findings, if any.
1. Why Is the Project Being Audited?
When contractually allowable, the invocation of an audit clause is a reasonable and responsible action that may be taken to ensure accurate total billing. Beyond the financial aspects, many organizations will audit construction projects to help plan for future projects by understanding the differences between their budgets and final costs.
Audits can be used for internal compliance verification, as well as a review of how the terms of the construction contract were executed in comparison to the stakeholder’s expectations.
It is common for an audit to be requested simply to verify the final project value. Many organizations are not accustomed to spending large amounts of capital on construction. Audits with small or insignificant findings can be just as meaningful as audits that uncover large mistakes. Minimal findings can strengthen the relationship between the owner and contractor by showing that the process was working as planned.
2. Where Are the Errors?
The pay application represents a finite point in time with a cumulative view of the project to date. Many auditors will look at the data in different ways to validate that the total of all the payment applications matches the totals of all the supportable cost documentation. It is also important to understand that some costs are not reconcilable until the end of the project.
Some examples of these types of costs include bonds, insurances and certain types of allowances. It is entirely possible that the sum of the pay applications exactly matches the total value of the project. While this may be the internal requirement for some construction companies, it does not make it universally true.
The auditor cannot assume that all data is contained within the pay application until they have performed their diligence. The results can validate the accuracy of the pay application process.
3. Will the Auditor Be Fair to Both Parties?
It is in the auditor’s best interest to present an unbiased report of audit findings. Most construction audits are a verification of what has been presented by the contractor as valid and verified costs. If the contractor believes that there are valid unsubmitted costs, then they should present these in billings, change orders or some type of communication with the owner.
Contractors who are unsure of their own numbers can also engage an auditor (internal or external) to perform a similar task. In the end, it helps the contractor to be as forthcoming with their data and documentation as possible. Even in an adversarial situation, cooperation demonstrates the intention to comply with the contract.
The easiest way to understand the auditor’s intent is to ask yourself what you would want from someone else if it were your money. Some owners and contractors will jointly hire auditors so both parties are equally represented. There are owners who seek, and some audit firms that sell “recovery audits” based on contingency fees.
Certain states and federal entities, like the Securities and Exchange Commission, have discouraged contingency-based fees for financial auditing with the premise that it can distort the objectivity of the auditor. A good auditor should have the professional integrity to provide the same service regardless of their fee structure.
4. How Does the Audit Benefit the Contractor?
A construction audit can also have benefits for a contractor. An audit can help to strengthen the trust from the project owner. Working through findings and being open to correct mistakes demonstrates the willingness to be part of the overall capital improvement team. This increased trust and cooperation helps to build a long-term relationship, which can potentially lead to more work. Furthermore, it can build a reputation of integrity that can open additional doors of opportunity.
Audits can provide confidence in the contractor’s fiscal stewardship of the project funds. The results can confirm good project control practices or be a catalyst for a contractor to improve their controls. Good cost and document controls does take additional time during a project. But it ultimately saves time in the long run by helping a construction firm be prepared for audits, claims or disputes with owners as well as subcontractors and vendors.
Nearly every GMP contract has audit rights for the project owner. There are advantages when a contractor is both accepting and supportive. It enforces the relationship of trust and confidence between the contractor and owner. The ultimate result is better internal controls and industry reputation.