Construction Cost Reviews Don t Spend Your Time Counting Petty Cash When Millions of Dollars are Going Out the Door for

1. Construction Cost Reviews?Don�t Spend Your Time Counting Petty Cash When Millions of Dollars are Going Out the Door for Construction Costs! Paul Donovan Director & Practice Leader- Construction Cost Services RSM McGladrey, Inc.

3. SAVE MONEY! Improve contractor�s care with billing; deter errors, and fraud Demonstrate good stewardship of funds to Donors Address Conflict of Interest concerns when Trustee is associated with the contractor. DISCLAIMER: RSM McGladrey, Inc. is not in the business of providing legal advice. The examples in this presentation are for illustrative purposes only. Please consult an attorney for legal advice. RSM McGladrey, Inc. performs consulting engagements and it does not perform audits or reviews in accordance with the audit standards promulgated by the AICPA for the United States. Why Review Construction Costs?

4. Roles and Responsibilities Owner Project/ Facility Managers Financial Management/ Internal Audit Architects Developer Contractor/ Construction Manager Subcontractors Suppliers Consultants Engineers Accountants (external consultants) Construction consultants Insurance Consultants Surety

5. Types of Contracts / Methods Fixed price or lump sum - contract Design/ bid/ build method - traditional Provides owner substantial control over design phase Owner retains architect / project managers to monitor progress Usually takes the longest time to construct the project AUDIT POTENTIAL- Generally can only audit change orders.

6. Types of Contracts / Methods (continued) Cost reimbursable/ cost plus contracts Guaranteed maximum price (GMP) � construction manager (CM) agrees to perform work at a guaranteed price for a fee. CM is at risk, CM may share in cost savings If non-GMP � CM reimbursed for allowable costs and a fee Provides owner substantial control over design phase Pre construction services � CM acts as advisor Construction phase � CM generally at risk Owner retains architect/ project managers to monitor progress Average time to construct the project AUDIT POTENTIAL- Generally can audit all costs unless excluded in contract

7. Types of Contracts / Methods (continued) Design/build method Owner contracts with one entity who provides all services including retaining architects, and engineers Single source of responsibility � team approach Best suited for non-complex projects Least control by owner over the design process Shortest time to construct the project AUDIT POTENTIAL- Generally can audit all costs unless excluded in contract

8. A.I.A. Contract Sections Contract documents Work of the contract Relationship of the parties Date of commencement and substantial completion Contract sum Changes in the work Costs to be reimbursed Costs not to be reimbursed

9. Article 8 - Costs Not to be Reimbursed 8.1 The Cost of the Work shall not include: 8.1.1 Salaries and other compensation of the Contractor�s personnel stationed at the Contractor�s principal offices other than the site office, except as specifically provided in Clauses 7.1.1.2 and 7.1.1.3 or as may be provided in Article 14 8.1.2 Expenses of the Contractor�s principal office and offices other than the site office

10. A.I.A. Contract Sections (continued) Discounts, rebates and refunds Subcontracts and other agreements Accounting payment Progress payments Final payment Miscellaneous provisions Termination or suspension Enumeration of the documents General conditions agreement - Article 7- changes in the work

11. Owner Controlled InsuranceProgram (OCIP) To Save on Insurance Costs in Labor Rates Consider Implementation of an Owner Controlled Insurance Program (OCIP) Owner provides insurance coverage to contractors and subcontractors including workers compensation, general liability and umbrella coverage Generally beneficial when owner has large multi-year construction program or one large project

12. Owner Controlled InsuranceProgram (OCIP) (continued) Advantage to owner Owner should be able to purchase insurance coverage at low rates due to volume and ultimately save substantial costs Disadvantages to owner Puts financial risk on owner � may purchase excess coverage policies to minimize risk Costs of program including administration and safety programs Generally the owner receives initial credits at beginning of the project (bid deduct) and then final credit based on payroll costs which may be incomplete or inaccurate, may require an audit Can create confusion for contractor and subcontractor (example, overtime wages)

13. Construction Cost Review Procedures Preconstruction: Review of contract language relevant to the review of the construction costs Review of budgets Review of contractor / subcontractor and equipment usage rates for incorporation into the contract

14. Construction Cost Review Procedures (continued) Construction phase: Review of contractor�s employees� labor rates Review of subcontractor�s employees� labor rates Review of equipment usage rates (owned vs. rented) Review of mark-ups for overhead and profit Review of applications for payment (requisitions) Review of general condition costs (example) Review of proposed change orders Review of overtime costs (example) Review of utilization of contingencies and allowances

15. Construction Cost Review Procedures (continued) Close-out phase: Calculation of adjustments Drafting report Meetings with contractor and owner

16. The Contractor shall keep full and detailed accounts and exercise such controls as may be necessary for proper financial management under this Contract; the accounting and control systems shall be satisfactory to the Owner. The Owner and the Owner�s accountants shall be afforded access to the Contractor�s records, books, correspondence, instructions, drawings, receipts, subcontracts, purchase orders, vouchers, memoranda and other data relating to this Contract, and the Contractor shall preserve these for a period of three years after final payment, or for such longer period as may be required by law.

17. Potential Audit Provisions Potential Audit Provisions to Consider for Incorporation in the Contract Agreement Specific reference to the owner�s right to audit the construction costs upon notice to the contractor Provisions to bind the subcontractors to the contract provisions and the audit provisions Contractor agrees to cooperate and make his facilities available for the audit Listing the types of documents that may be reviewed by the owner and his representatives Contractor agrees not to bill Owner for time devoted to audit. Contractor pays the audit fee if recoveries exceed a threshold amount

18. Potential Substantive Provisions to Consider for Incorporation in the Contract Agreement Cost of the Work will be based upon Actual Costs� Incorporating references to the statutory limitations on payroll taxes and owner�s approval of fringe benefits� Provisions to bind the subcontractors to the contract provisions and the audit provisions Provisions regarding the calculation of insurance costs Provisions defining the amount of mark-ups for subcontractors and sub-subcontractors Provisions defining what costs can be included in change orders and what costs are covered by the mark-up for overhead and profit of the change orders Potential SubstantiveProvisions

20. Overcharges to the Owner are often due to Excessive Labor Burden in Contractor�s employees� and Subcontractors� employees� Labor Rates: Statutory caps on payroll taxes are not adhered to: $14,000 limit for Massachusetts Unemployment Taxes in 2010. (Maximum amount depends on employer�s experience factor 12.27% in 2010) $7,000 for Federal Unemployment Taxes in 2010. (Maximum amount $56 per person - $7,000 x .008) $106,800 for Social Security Taxes in 2010. (Maximum amount is $6,621.60 per person - $106,800 x .062.) (There is no limit on Medicare taxes - .0145) Workers compensation costs are excessive Policy - Contractor/ Subcontractor has a favorable audited experience factor but does not reduce the workers compensation costs in the labor burden Self-Insured - Reserves (management�s estimate of liability) are too large based upon historical experience Overcharges

21. Major Reasons for Overcharges in Labor Burden (continued) Bonuses Charged to the Project Charging bonuses to project which should be paid from contractor�s overhead and profit Use of maximum contributions in 401(k) and other plans Often the contractor will use the maximum matching contribution although many employees have elected a smaller amount or are not enrolled in the plan at all

22. Inclusion of overhead costs unrelated to the Project Internal computer department costs (Example: $3.00 per hour) Accounting costs Maintenance and repairs Other Examples No reduction for portion of health insurance costs paid by employees Major Reasons for Overcharges in Labor Burden (continued)

33. Why Implement Financial Controls? Risk and likelihood of overcharges is great! Unallowable Costs (Contractually Excluded) Home and/or Regional Office Costs for CM Unsupported Costs (Not Adequately Documented) List Price vs. Trade Discounts (40%) on materials in C/Os Non-incurred �costs� (Hidden Profit Centers) Payroll Taxes, Employee Benefits, Insurances Sole Source Procurements Change Orders (Furnish and Install xxx for $_____) No breakout of Labor, Materials, Equipment

34. Before Award Project Team/Key Personnel: A range of rates for �Key Personnel� implies the project team isn�t final or committed If CM proposes billable rates (not subject to audit), please call before you sign!

35. Areas of Risk Construction Manager General Conditions Labor/Staffing Hours, Rates and $ per Proposal for �Key Personnel� Do these tie to the schedule? (Level of Effort, Duration) Hours and Rates per Requisition Does monthly detail match the proposal (Pre-audit and post-audit)? �To Date� adjustment based on audit results Overtime Charges for Salaried Personnel Add�l wages not paid, ? add�l taxes, insurance, fringes not incurred by CM, but billed as if incurred

36. Areas of Risk (continued) Smaller projects ? smaller, less administratively sophisticated contractors and subs No prior exposure to the audit process ? uncertainty & tension Financial instability ? consider labor and material payment and/or performance bonds on CM or specific sub(s)

37. Areas of Risk (continued) Construction Manager General Conditions Labor/Staffing Insurance: General Self-Insured? Captive/Affiliated Carrier? Need LOTS of historical and current backup! Please Call! Other Fringes (Pension, Profit Sharing, etc.) Eligibility Requirements per Employee (Company Policy) Capped by Contract or at Actual Cost? (Negotiate)

38. Areas of Risk (continued) Construction Manager General Requirements (time-driven costs) Copier/Computer rental charges > FMV Recent project: 10 Laptops @ $3,000/month for 18 months: ? Billings > FMV Wind-down of CM�s head count @ Substantial Completion: CM may not have a project to assign staff to, ? spend available $ in GMP budget

39. Areas of Risk (continued) Subcontractors No risk to Owner in base contract unless non-Lump Sum Request labor rate documentation @ Award Time for C/Os Allowance items: Allowance $ > Actual Costs, no credit for difference: Recent project: $62,000 overbilling recovered Change Orders Labor Rates: Payroll Taxes, Insurance, Apprentices, �Good Guy� and/or Sick/Vacation/Holiday Rates for FM, Overtime Rates for Base Contract Work, Small Tools and Expendables Insurance: Self-Insured for W/C and/or Liability? Materials: List Price vs. Trade Discount Price, No Sales Tax on in-place construction materials, Refundable Deposits Equipment: Match Operator hours to Hours Billed

40. Areas of Risk (continued) Change Orders (continued) Normal maintenance & repairs on owned equipment are OK, overhaul No! Match period of use to hourly billing rate (rentals) Markups not �tiered� or �piggybacked� (15% Max.) Base Contract work charged to T&M C/O Costs of corrective work Back charges not processed or credited Watch C/O transmittals for FP or LS language

41. Non-Financial, but Risk Triggers Design less than 100% complete at bid? Contingencies and cushions in both CMs� and Subs� bids Scope creep (Time and Money, Time = $) Delays in Completion

42. Risk Trigger Bidder�s Internal Questions: GC and Subs Are drawings, plans, and specs complete? Are drawings, plans, and specs clear & unambiguous? Can the work be done in the time allowed? Can all the work be physically performed? ---------------------------------------------------------- No = Contingency Funding ================================= One day per month for bad weather

43. Results/Corrective Actions Improved Contract Language Greater Sharing of Experiences and Information across Tubs �Lessons Learned� analyses Value Add Audit Process

44. Results/Corrective Actions (continued) For AY 2007, recoveries and avoidances totaled $1.2 Million on 15 projects For AY 2008, recoveries and avoidances totaled $1.9 Million on 21 projects For AY 2009, recoveries and avoidances totaled $1.5 Million on 12 projects Allston Science $1.8 Million through Oct. 2009 project to date Audit serves as a deterrent factor Contractors �Get with the Program�

45. Audit Anecdotes Site payroll processing fee: $20/EE/Month by Reg. Office Placement agency fee: $19,250 Holiday pay for Project Exec. & PM: $11,453 Vehicle Rate: $6.25 to $8.00 (28%) from Phase I to Phase II Same Contractor on two concurrent projects: (Audit Not Req�d) Hourly labor rate variances up to $20.92/Hr. Pickup truck rate variance of $3.00/Hr.

46. ? Questions ? THANK YOU!