United States

How a construction audit reduces risks for gaming construction projects


Fall 2012

While construction has largely halted in Las Vegas due to the economic slowdown, many other gaming properties, especially for Native American properties, are still expanding. Construction is among the most complicated projects gaming properties can undertake. It usually involves a unique design that is subject to an aggressive schedule. Therefore, effective management of all three components of a construction project—schedule, cost and quality—is vital during the expansion of a gaming property. A construction audit should be undertaken by the owner to ensure the three components of the construction project are well-managed and that controls are in place to prevent or mitigate the risk of fraud, waste and abuse.

The construction auditor's role
Typically, the owner of a property may hire three distinct parties to complete the project – an architect engineer, a project manager and a general contractor. While the architect engineer will usually assist in reviewing payment applications and should assist in reviewing change orders for entitlement, it is the project manager's responsibility to review and approve payment applications and change orders. The construction auditor adds an objective set of eyes well-versed in construction practices and focuses exclusively on protecting the owner's interests. Given the dollars involved in most construction projects and the 2-to-5 percent savings construction auditors historically generate, a construction auditor is a wise investment. Engaging a construction auditor can address issues such as risks in construction costs, schedule and quality. It can also assist in protecting against fraud, waste and abuse.

Cost risks
The McGladrey construction audit team maintains benchmark data on various construction costs categories. As economic conditions have tightened, we have noticed several areas increasingly subject to overcharges, namely:

  • Labor
  • Insurance
  • Self-performed work
  • Billings in excess of cost

Labor cost
Compared to all other areas of billing, labor is most likely to see overcharges. Historically, labor overcharges result from one of three issues:

  • Labor rates applied to the incorrect labor classification
  • Fringe benefit costs overstated
  • Charges made for labor classifications that are not allowed per the contract

Because most contractors are struggling to find work in the current economy, they do not often have enough projects to keep their current workforce busy. This has resulted in a new labor risk for owners – overstaffing. We are seeing contractors assigning more staff than usual to projects and billing their time to the project owners. Owners should examine the staffing levels in construction proposals against historical levels for similar projects to prevent overstaffing.

Insurance cost
Insurance is complicated and has changed considerably in recent years. The advent of subguard insurance and contractor-controlled insurance programs (CCIP) has changed the landscape of insurance coverage on construction projects. Previously, insurance costs represented about 2 percent of potential contractor overcharges. Now, it represents 25 percent of the potential overcharges.

The increase is due to several issues. First, because current insurance programs are relatively new, the costs are reviewed but not validated. In the case of subguard insurance, the contractor may invoice the project 1 percent of subcontract costs, which costs may be supported by payments to the bonding company. However, the contractor may be entitled to a credit at the end of the project that could reduce its subguard costs by 25 percent. The owner may not be aware of or may fail to examine these credits and, thus, may inappropriately compensate the contractor for the pre-credit insurance cost.

Self-performed work cost
Current economic conditions also have encouraged contractors to increase the amount of self-performed work. Self-performed work is labor that a general contractor would normally delegate to a trade subcontractor that the general contractor decides to perform itself. By increasing self-performed work, general contractors can keep their people and equipment more fully leveraged.

Self-performed work can raise a variety of construction audit issues. First, the general contractor may be awarding work to themselves without any competitive bidding process, resulting in the owner paying higher costs than it would have had the work been bid appropriately. Second, the owner may end up being billed twice for self-performed work -- once under billings for general conditions, and again under billings for self-performed work. Third, general conditions may be capped at a not -to-exceed amount. In some cases where costs are going to exceed the general conditions threshold, contractors will transfer general condition costs to the self-performed work category.

Billings in excess of cost
For cost-reimbursable contracts, the contractor is required to invoice the lesser of actual cost incurred or the percent complete. Often, the contractor would bill the client for more than the cost incurred. Members of the McGladrey construction audit team have noticed, that while contractors may invoice in excess of cost incurred during the construction, they are more likely to reconcile the cost incurred to the amount invoiced at the end of the project because owners are being more diligent about validating the contractors' actual costs.

Schedule risks
Every construction project has a schedule. For casinos, the schedule can be particularly important. For example, the owner may well be heavily promoting the grand opening of a hotel and casino and may have a full house of guests with reservations for the opening date.

The agreement with the contractor should include liquidated damages so that the contractor will owe a certain amount per day if the property is not completed on schedule. Without effective management, however, the owner may lose the ability to collect these damages even if the completion date is missed. For example, the owner could approve change orders that do not specify an impact on the schedule.

Owners can also face schedule related risks even in cases where a project is completed on time. During one construction audit engagement, we identified significant overtime charges that the general contractor had billed to the owner so that the contractor could meet the scheduled completion date and collect a substantial bonus. Under the contract, the owner did not owe these overtime costs.

Quality risks
Construction audit team members have seen an improvement of quality in construction projects over the past few years. However, validating the quality and material included in construction project is still important, especially on stipulated sum projects. Construction auditors can assist the owner by validating that material used meets contract specifications, either through physical inspections or by verifying the material on the receiving documents. We have had numerous occasions where we have assisted the client in identifying issues related to workmanship that have resulted in amounts refunded to the owner. This could include, but is not limited to, cinder block, ply board and air conditioning.

Fraud, waste and abuse risks
Many members of our construction audit team are Certified Fraud Examiners. We have experience in identifying unusual transactions or control weaknesses that can lead to fraud, waste and abuse. Irregularities can occur within the owner's operation during the procurement process, where in-house parties award contracts, change orders, or have other purchases that are indications of irregularities. From the contractor's standpoint, most of the irregularities involve related parties. In these instances the owner is not advised that the party providing services is related to the contractor.

Construction audits provide added value to the owner by:

  • Identifying overbillings from contractors and suppliers
  • Improving the key processes
  • Identifying or preventing potential irregularities

Construction audits can prove especially valuable in the gaming industry because of the fast-track schedules and the complexity of the projects and will help the owner meet their construction goals while still controlling their costs and risks.

In This Issue

Title 31: Risk assessment - Part II

How a construction audit reduces risks for gaming construction projects

Technology trends for 2012

New auditee resource center