State Auditor’s Office Change Order Pricing Practices Performance Audit of Eight Local Governments Puyallup City Council February 7, 2012 Chris Cortines, Principal Auditor for Local Government Performance Audits 1

Why we did the audit Local governments in Washington spend billions of dollars on construction projects every year. Change orders are often needed to respond to unforeseen conditions, which increase the cost of the original contract by changing the amount or type of work to be delivered. 2

Why we did the audit To identify leading practices local governments can use to help reduce the cost of change orders. 3

Sources used to identify leading practices Construction subject matter experts Construction and procurement manuals published by various government agencies including the U.S. Federal Transit Administration and the Washington State Departments of General Administration and Transportation Articles published by the Association for the Advancement of Cost Engineering, the Delaware Associated Builders and Contractors Partnership Committee, Municipal Research Services Center of Washington, and the National Institute of Building Sciences. 4

Leading practices identified 5 Establish terms in the original contract how change order pricing will be handled. Establish in advance the basis for pricing the work performed under a change order. Contractually require contractors to submit detailed change order proposals when the work to be performed will not be based on unit prices. Specify the level of monitoring expected by A&E firms charged with overseeing change order pricing.

Leading overhead practices 6 Manage and review construction and A&E change order costs. Obtain written change orders for all additional work or materials beyond the scope or price of the original contract. Accept unit pricing for change orders only when it’s appropriate. Perform detailed reviews of contract change order costs proposed by contractors. Spot-check the scrutiny provided by A&E.

Benchmarks used in the audit Unit prices. Using unit prices from the original bid, or from other recent bids, to price change orders can be appropriate if: Market prices have not significantly changed The location, timing, nature, or conditions of the change work are similar to the work in the original contract 7

Benchmarks used in the audit Construction labor costs. Because they are tied to market conditions, many government agencies tie construction labor costs to the prevailing wage rate. The General Conditions for Washington State Facilities Construction limits labor rates on change orders to those submitted on the Statement of Intent to Pay Prevailing Wages or higher amounts if approved by General Administration. 8

Benchmarks used in the audit Increases in A&E firms’ labor rates can be tied to the original contract plus a predetermined escalation rate, such as the Consumer Price Index or the Producer Price Index. Materials prices typically are limited to vendor quotes, the contractors’ cost, or the original contract price. 9

Benchmarks used in the audit Equipment rental rates. The Rental Rate Blue Book is a common industry guide for determining reimbursement rates for heavy equipment use. 10

Benchmarks used in the audit Common change order markup rates for profit and overhead: 29 percent for labor 15 percent for materials and equipment. 5 percent for prime contractors’ oversight of work performed by subcontractors. 11

Benefits of pre-established pricing Local governments are less likely to overpay. Change order negotiations can focus on the quantities of materials and labor hours. 12

Recognitions Overall, Puyallup used most of the leading practices we identified. It was the only local government that contractually required the construction contractor to submit proposed change orders with detailed costs and pricing. One of the few municipalities whose construction contract limited the pricing of materials on all change orders. Hired outside experts to help ensure change orders were sufficiently detailed and fairly priced. Paid a reasonable overhead rate for its construction management firm. 13

Opportunities Establishing limits on labor rates, materials pricing, and markups in the original contract for change orders. Contract specified a 32 percent markup on labor and a six percent markup on subcontractor costs. These rates were slightly higher than more typical rates. Contract allowed the contractor to charge its actual labor costs. City officials thought they were obligated to pay the labor rates shown on the contractor’s certified payroll reports, which sometimes exceeded the prevailing wage rates. 14

Opportunities Specifying the level of scrutiny the City expected the A&E firm to provide over change order prices, and conducting periodic spot-checks of the firm’s work. Contracts for the City’s A&E and construction management firms did not specify the level of pricing scrutiny the City expected. 15

Opportunities Comparing change order costs against vendor quotes, invoices, original contract prices, contractual caps or limits, benchmarks, or typical rates. The A&E and construction management firms did not always obtain itemized change orders, although they were required by the City’s contract with the GCCM. As a result, the City had no way of knowing whether it received good pricing for materials, labor, and equipment. 16

Opportunities Other observations The City also paid markups for performance bonds that ranged up to 2 percent of direct costs, even though the contract obligated the contractor to pay them. The City paid those charges without verifying the contractor obtained the additional bonding. 17

Opportunities 18

Open Discussion/Questions and Answers Questions and answers 19

State Auditor’s Office Contacts State Auditor Brian Sonntag, CGFM (360) Larisa Benson, Director of Performance Audit (360) Chuck Pfeil, Director of Audit (360) Chris Cortines, Principal Performance Auditor for Local Governments (360)