1

ASSESSING CONSTRUCTION AUDIT RISKAUDIT RISK: THE ROLE OF INTERNAL AUDIT AND THE EXTERNALAND THE EXTERNAL CONSULTANTROBERT S. BRIGHTPRESIDENTTALSON SOLUTIONS LLC

AHIA 31st Annual Conference – August 26-29, 2012 – Philadelphia PAwww.ahia.org

Agendag

Why the Audit?2

Why the Audit?Controls for Capital Program Contract TypesContract TypesThe ContractConstruction Audit StrategyConstruction Audit StrategyAudit Red Flags and Cost RecoveryB t P tiBest PracticesCo-Sourcing

Why the Audit?y

Lack of construction oversight3

gUnfamiliar with construction industry practicesNon-compliance to contracts / processesp pFailure to reconcile project financial reportingInadequate cost estimates / contingencyReporting lacks critical informationExcessive budget and / or schedule changesPotential for cost recoveryTransparency is critical

Controls for Capital Programsp g4

Project Scope Quality ManagementProject Scope ManagementDesign Management

Quality Management SystemDocument Controles g a age e

Project ScheduleChange Management

Document ControlInvoice ProcessingProject ReportingChange Management Project Reporting

“Defined Completion / Close-out Processes”Defined Completion / Close out Processes

Contract Typesyp5

Type CharacteristicsType Characteristics

• Closed bookLump Sum / Fixed Price • Known costs upfront

• Monitor deliverables / changeschanges

Guaranteed Maximum Price• Open book

D fi d “ t l” tGuaranteed Maximum Price (GMP)

• Defined “actual” costs• Cost reconciliations

The Contract

Key Contract Provisions6

yScope of Work / Performance, SpecificationsDefinitions - Technical and Financial (e g “CostDefinitions - Technical and Financial (e.g., Costof Work”)Payment Terms / Subcontractor Paymenty ySchedule of Work / DeliverablesIdentification of Signature AuthoritiesgChange Order / Contingency ManagementProgress Reporting / Dispute ClausesProgress Reporting / Dispute Clauses

Construction Audit Strategygy7

Timing – “Depends” on ObjectivesTiming – Depends on ObjectivesConstruction - Early for Full ComplianceFinancial - Contract Close-outLump Sum - Key Milestones / Deliverables

TEAM Together Everyone Achieves MoreTEAM – Together Everyone Achieves MoreOwner….Auditor....Experts….Contractor….Management

Essential DocumentsExecuted Contract w/ Exhibits Subcontracts / Change OrdersSubcontracts / Change OrdersUpdated Project Logs/ Reports / Schedules

Audit Red Flagsg8

Continuous updating of budget / schedule

Lack of project understanding

Significant changes due to errors / missing data

Data inconsistency

Non-compliance to project change proceduresCash Flow vs. Project Time

Contingency draw-down not analyzed

Continuous project forecast $$$ creep$

Plan

Missing “Milestone” dates

Capex expenditure rate too slow / fast Time

Actual

Cost Recoveryy9

Change orders not resolvedChange orders not resolved

Lack of defined reimbursable cost…Cost of the Work

Accrued costs vs actual cost / Lack of reconciliationAccrued costs vs. actual cost / Lack of reconciliation

Excessive open issues: design, quality, safety, changes

Premium / overtime charges at incorrect ratesPremium / overtime charges at incorrect rates

Contractor unwillingness to produce reports

Bonuses training and unallowable expenses in hourly ratesBonuses, training and unallowable expenses in hourly rates

Best Practices10

Know your Objectivesy jKnow the Contract…Read the ContractInvolve Key Players / Expertsy y pConvert Observations to RisksIntegrate Cost / ScheduleIntegrate Cost / Schedule“Play the Hunch” --- Peel the OnionDon’t IgnoreDon t Ignore

Audit follow-up

Co-Sourcingg

Know client priorities11

Know client prioritiesUnderstand appetite for expert servicesShare knowledge / teachShare knowledge / teachIdentify critical issues / “What is important?”I fl t d i i kInfluencer, not a decision-makerBe transparent

contact: rbright@talsonsolutions.com

INTERNAL AUDIT DEPARTMENT PERSPECTIVEDAVID SMALLDIRECTOR OF INTERNAL AUDITDIRECTOR OF INTERNAL AUDITTHE CHILDREN’S HOSPITAL OF PHILADELPHIAOF PHILADELPHIA

AHIA 31st Annual Conference – August 26-29, 2012 – Philadelphia PAwww.ahia.org

Facilities Backgroundg

Manages new construction and renovations at main d ff it l ti

13

campus and off-site locations.The Department staff includes experienced engineers, architects, and support personnel., pp pWorks with external construction managers, architects, and other consultants to complete projects.M lti l t j t ith i ifi t fi i lMultiple concurrent projects with significant financial exposure.Recently completed the construction of an eight-story y p g yresearch facility. An eight-story ambulatory care center is in progress.

Internal Audit Backgroundg

The Internal Audit Department is comprised of eight dit ith IT l d fi k l d

14

auditors with IT, revenue cycle, and finance knowledge.The current department structure was reestablished four years ago (July 2008).Historically, audits of facilities construction projects were performed by an external audit firm; only large construction projects were covered.p jThe prior year Audit Plan included a first time co-sourced internal audit of a hospital floor conversion construction project. p jGoing forward, co-sourced audits of both large and smaller-scale construction projects are planned.

Areas of Audit Focus

Contract Evaluation – Key financial provisions are 15

y pdefined. General Conditions – Costs are supported and labor burden rates are accurately appliedburden rates are accurately applied.Change Orders – Subcontractor labor and material costs are reasonable and supported. Markups are accurately pp p yapplied.Allowances – Applicable charges are tracked and unused amounts are returnedunused amounts are returned.Other Cost Recovery Opportunities – Buy-out savings and other cost reconciliations.

Other Audit Risk Considerations

Type of contractual arrangement16

Type of contractual arrangement.Budget development and monitoring.C titi biddi d l tiCompetitive bidding and selection process.Insurance program. Sales tax and other taxes.

Program Implementationg p

Develop a Construction Strategy.17

p gyObtain management and Audit Committee endorsement.Determine staffing method (internal versus external), considering resource constraints and expertise requirementsand expertise requirements.Select and engage external consultants and determine fundingdetermine funding.Determine roles and responsibilities for all involved stakeholders.involved stakeholders.

Key Items for Successy

Defined Objectives18

Defined ObjectivesAdd ValuePartnership with StakeholdersProper Timing of ActivitiesProper Timing of ActivitiesTransparency

QUESTIONS19

Save the Date: August 25‐28 2013August 25 28, 2013

32nd Annual Conference 

Chi ILChicago, IL

August 29, 2012 20