“RED FLAGS” for Construction Payment Application Reviews Henry L “RED FLAGS” for Construction Payment Application Reviews Henry L. Woods, Jr., MBA, CRIS, CCA, CCP Stephen Strohman, MBA, CPA, CCA, CCP September 10, 2019 © 2019 All Rights Reserved Brown Smith Wallace LLP

Henry Woods, Jr. Stephen Strohman CCA, CCP, CRIS, MBA CCA, CCP, CPA, MBA Experience Cost control, safety management, risk management, project management and oversight, and project administration Industries Construction, Health Care, Higher Education, Transportation, Casinos, Sports Facilities, Military Housing, Industrial, Manufacturing Contact Information (314) 983-1266 hwoods@bswllc.com Experience Cost control and risk management, construction and internal audit, contract compliance, vendor qualification Industries Higher Education, Health Care, Retail, Veteran Housing, Municipal Sewer Districts Contact Information (314) 983-1373 sstrohman@bswllc.com

Learning Objectives Help Owners Understand Their Payment Applications Clarify Specific Audit Elements of a Payment Application Identify Things To Look For in a Payment Application  Understand What Audit Findings Tell You Example(s) of Cost Recovery Audit © 2019 All Rights Reserved Brown Smith Wallace LLP 3

Payment Application Example © 2019 All Rights Reserved Brown Smith Wallace LLP 4

Specific Elements of a Payment Application

Payment Application Elements Materials Rentals Insurance Other Labor © 2019 All Rights Reserved Brown Smith Wallace LLP 6

Labor

Labor Trade Labor, Labor Rates and Labor Hours Staff Labor Holidays Overtime Approvals Bonuses and Promotions © 2019 All Rights Reserved Brown Smith Wallace LLP 8

Labor – The Red Flags Labor rates that include overhead and profit. Certain levels of hourly employees (e.g., general foreman) billing consistent overtime hours on a daily or routine basis. Staff employees: charging for vacations and holidays that have a vacation or holiday component within their billing rate. For projects where an established rate for hourly employees is not used, i.e., base plus burden invoiced based on the contractor’s actual charges, no decrease in the rate invoiced as SUI, FUI and FICA maximums are met. Where a Contractor is engaged on several projects for the Owner, hours could be duplicated among the projects. Small tools, trucks and communication devices included as an adder. Changes to staff and trade rates not authorized by the contract or the project manager. © 2019 All Rights Reserved Brown Smith Wallace LLP 9

Labor Rates Example Need higher quality image. © 2019 All Rights Reserved Brown Smith Wallace LLP 10

Materials

Materials – Items up for review New or Old supplier / vendor invoices; Supplier / Vendor invoices that apply to another project; Sales tax; Purchased equipment/ vehicle not tracked; Duplicate charges (job materials, labor-force, subcontracts, per diem); Discounts Warehouse/contractor-supplied/purchased equipment/tools charged to the project Purchased equipment/ vehicle not tracked for ultimate possession of the owner © 2019 All Rights Reserved Brown Smith Wallace LLP 12

Materials Red Flags to watch for: Substituted materials process and approval Correct material used on the project © 2019 All Rights Reserved Brown Smith Wallace LLP 13

Materials – The Red Flags Supplier/Vendor Invoices for the Project (i.e.- Concrete tickets/Electrical/Mechanical/etc.). Invoices or receipts submitted in more than one payment application, workforce payroll overlapping or submitted twice rental periods, overlapping in payment applications, and etc. Sales tax collected by a contractor on exempt items and not refunded to the owner. Stored materials for the project (cost being paid out). Generally materials (cost greater than $500 or $1000 that owner should retained). Discounts (should accrue to the owner and not be retained by the contractor.) Warehouse or Contractor-supplied materials and equipment (excluding rentals) can be issued to the project and returned to the contractor without crediting the project. Invoices or receipts submitted in more than one payment application, workforce payroll overlapping or submitted twice rental periods, overlapping in payment applications, and etc. Generally materials with a cost greater than $500 that are retained by the contractor at the conclusion of the project rather than released to the owner. © 2019 All Rights Reserved Brown Smith Wallace LLP 14

Materials- Example Invoices / Packing List

Rentals

Rentals Review purchases of equipment where a similar or exact item is also rented. Test for rotating equipment when a rental cost limit is met. © 2019 All Rights Reserved Brown Smith Wallace LLP 17

Rentals Contractor-Owned Rentals: Third Party Rentals: Reasonable rental rates consistent with prevailing rates in the market Usage or term coincides with field records Values at levels that do not exceed the true value of the items Test the mathematics Third Party Rentals: Independence of the third-party vendor Lease-purchase agreements between the CM and the rental firm © 2019 All Rights Reserved Brown Smith Wallace LLP 18

Rentals – The Red Flags No limit on the total rents charged to the project. Generally this should be limited to 75% of the value of the item. Test for rotating equipment when a rental cost limit is met. Purchases of equipment where a similar or exact item is also rented. Charged in both a unit cost and billed separately. Overlapping rental periods. © 2019 All Rights Reserved Brown Smith Wallace LLP 19

Rental Example © 2019 All Rights Reserved Brown Smith Wallace LLP 20

Insurance

Insurance Verify compliance to the terms and conditions of the contract. General liability insurance should not be computed on fee or on itself. Verify that the subcontractors subject to SDI, if SDI is used on the project, are clearly identified. Ensure CDI/SDI is actually purchased. Check for duplication of coverage in wage rates, SDI, workmen’s compensation insurance, general liability insurance, OCIP or CCIP, and builder’s risk coverage. Test and confirm insurance and bond coverage meets requirements of the contract. © 2019 All Rights Reserved Brown Smith Wallace LLP 22

Insurance (Items) Owner Controlled Insurance Program(OCIP)/Contractor Controlled Insurance Program(CCIP)/Contractor or Subcontractor Default Insurance (CDI/SDI)- Verify which contractors and subcontractors are enrolled, if they have coverage, and how its being tracked Verify or test which class of work is excluded Assess or test for excluded classes of workers and work on the project Claims or Loss Run Data reviewed and EMR rating should be reviewed Punch list and warranty work coverage © 2019 All Rights Reserved Brown Smith Wallace LLP 23

Insurance – The Red Flags Verify and calculate how the insurance is billed Agreement of tracking who is covered under the insurance program CDI/SDI charged but might be purchased or purchased at a lesser amount an owner is charged Workman Compensation in the charged waged rates and paid to third party as part of CCIP’s or ROCCIP © 2019 All Rights Reserved Brown Smith Wallace LLP 24

Other Red Flags

Other Red Flags Schedule of values Lien waivers Excessive charges for meals, travel, per diem, subsistence Allocations (IT, accounting systems, home office expenditures, overhead, etc.) Quality assurance and quality control Cost performance, schedule performance and earned value Schedule of Values – Mathematical errors that accelerate costs or ignore credits. Percent billed that exceeds the percent completed. This accelerates cash flow plus adds financial risk to the project. Excessive Charges – Charges for meals, travel, per diem, subsistence – per diem and subsistence that exceeds customary levels. Meal reimbursement that should not be considered a project-related reimbursable expense. Mileage or gas charges that should not be applied. Allocations (IT, Accounting Systems, Home Office, Overhead, Etc.) – billing home office expenditures as project-related. Charging person-based allocations to all individuals irrespective of their use of the allocated attribute. © 2019 All Rights Reserved Brown Smith Wallace LLP 26

Schedule of Values Example © 2019 All Rights Reserved Brown Smith Wallace LLP 27

Payment Application – Close-Out Items Substantial Completion Warranty Paperwork and Starting Dates clarified Building Turnover- Access/ Keys/ Safety/ Move-in Training for the Staff- O & M and Equipment Operations Drawings & File Transfer Punchlist Completion and Finish Various other items © 2019 All Rights Reserved Brown Smith Wallace LLP 28

Summary of Payment Application Recovery or Refund Example Possible Recovery for a Large Construction Project- Project Size $ 75,500,500.00 Project Savings $ 4,500,000.00 Direct Audit Savings $ 949,690.00 Audit Savings Basis Backcharges $ 18,260.00 Duplicate Invoices $ 260,280.00 Fee & Insurance Calculations $ 65,820.00 Wrong Invoices Charged to Project $ 46,740.00 General Conditions (including some items accounting systems charges, office furniture, training, etc. $ 130,180.00 Unapproved legal fees in General Conditions $ 28,750.00 Incorrect or Inappicable Labor Hours $ 267,160.00 Overpayment to Subcontractors $ 26,760.00 Overcharges on Rentals $ 57,680.00 Overcharges on Vehicle Expenses $ 48,060.00 Total Hard Dollar Credited Refunded= © 2019 All Rights Reserved Brown Smith Wallace LLP 29

Questions?