Combating Construction Fraud:Contractors Toolkit forAvoiding the Unplanned and Excessive Cost of FraudWednesday, November 5, 2008 Todd Taggart, CPA Grant Thornton LLP (612) 677-5193 Todd. Taggart@gt.com Jim Schmid, CPA, CFE Grant Thornton LLP (248) 233-6910 Jim.Schmid@gt.com Carol Esselink, CPA, CFE Grant Thornton LLP (248) 213-4267 Carol.Esselink@gt.com
Agenda • Critical legal pressures • What is the cost of fraud • What is fraud • Who commits fraud • The fraud triangle • Types of fraud • Key elements of fraud prevention program • Ethics program • Internal controls • Financial statement fraud • What to do when there is an accusation of fraud
Critical Legal Pressures • Sarbanes Oxley • Foreign Corrupt Practices Act • False Claims Act (and copycats) • Federal Labor Standards Act
What is the cost of fraud? • Six percent of revenue • $330,000 per occurrence • Risk of losing legitimate claims • Loss of ability to pre-qualify for bid invitations • Loss of borrowing and/or bonding capacity
What is Fraud? • A Representation • About a Material Point • Which is False • And Intentionally or Recklessly so • Which is Believed • And Acted Upon by the Victim • To the Victim's Damage
What is Fraud? (continued) Fraud is: Fraud is not: • Intentional • Trick or deceive someone out of their assets • Theft • A crime • Taken by physical force • A mistake or error • Victimless • Insignificant because no one got hurt • Acceptable or justifiable Source:Albrecht, Albrecht & Albrecht. Fraud Examination. Mason, OH: Thompson, 2006.
Who Commits Fraud? • Accounting department employees • Executive/Upper management • Sales • Other
Who Commits Fraud? (continued) Fraud Perpetrators Other Property Offenders College Students Source:Albrecht, Albrecht & Albrecht. Fraud Examination. Mason, OH: Thompson, 2006.
Perceived Pressure Rationalization Perceived Opportunity The Fraud Triangle
Types of Fraud • Asset Misappropriation • Financial Statement Fraud • Corruption
Asset Misappropriation • Check tampering • Payroll fraud • Skimming • Billing schemes • Missing Assets
Asset MisappropriationCheck Tampering • Forms • Forged maker • Forged endorsement and altered payee • “Tacking on” additional information • Prevention/Detection • Separate accounts for each project • Separation of duties • Preparation and review bank reconciliations • Deposits and check preparation • Check preparation and check signing • Disbursements should tie to invoices or other back-up • Disbursement authorization limits and signature controls • Track and reconcile voided checks and unpaid invoices
Asset Misappropriation (continued)Payroll Fraud • Forms • Ghost employee and falsely modified pay rates • Falsified hours • Prevention/Detection • Segregate Duties • Master file maintenance and approval • Payroll preparation and payroll disbursement • Payroll disbursement • Payroll bank reconciliations • Periodically Review • Employee lists to payroll lists • Timecards and accompanying supervisor signature • Payroll system changes and journal entries
Asset Misappropriation (continued)Skimming • Forms • Unauthorized or unrecorded sales • Phony discounts and refunds • Receipt manipulation • Prevention/Detection • Perform random receipt audits • Require approval for discounts, returns and voided transactions • Regular tracking and spot checking of labor and equipment • A/R confirmations • Random testing of scope and price of subcontractor C/O's
Asset Misappropriation (continued)Billing Schemes • Forms • Shell Companies • Submission of false invoices or expense reports • Personal purchases and diverted purchases • Prevention/Detection • Review invoices with no ship-to address (will call) • Check vendors and employees with the same address • Watch for invoices from vendors with PO boxes • Monitor A/R patterns in write-offs, documentation and approvals • Match invoice, PO and receiving confirmation • Out of sequence purchase orders • Perform vendor confirmations
Asset Misappropriation (continued)Missing Assets Forms Missing material Missing equipment Prevention/Detection Separation of purchasing and receiving Receiving controls and documentation Compare usage with requirements Surveillance Equipment tagging and location recordkeeping Unscheduled audits
Types of Fraud (continued)Financial Statement Fraud • Revenue recognition • Concealing liabilities
Financial Statement FraudRevenue Recognition • Project percent complete • Excessive or unusual journal entries • Note contract modifications with no apparent economic purpose • Monitor claims and change orders • Monitor high risk contracts • Monitor revenue in advance of billings
Financial Statement FraudConcealing Liabilities (or inflating asset values) • Movement of material from one project to another • Inconsistencies in labor or other costs when comparing different projects • Improper asset valuations or measurements • Disputes with project owners or subcontractors • Subcontractor claims • Excessive subcontractor change orders • Manipulation of the Schedule of Values • Unrealistic burden rates
Corruption • Institutional over-billing or advance-billing schemes • Conflicts of interest • Bribery • Illegal gratuities • Extortion
Key Elements in Fraud Prevention Program • Attitude from above • Ethics program • Hot line • Internal controls • Internal audit • Surprise audits • Fraud training • Conduct background checks on all new hires
Ethics ProgramFeatures - General • Suitable to the size of the company • Facilitate timely discovery and disclosure of improper conduct • Ensure corrective measures are promptly instituted and carried out
Ethics ProgramFeatures – Contract Specific • In writing • Issued within 30 days of the contract award • Furnished to each employee engaged in performance of the contract • That the contractor "promote" compliance with its code of business ethics and conduct
Internal ControlsFeatures • Contract administration and a contract compliance director • Routine supplier confirmations • Electronic system back-up • Proper control of check generation and bank statements • Pre-qualify bidders (subcontractors and suppliers) • Matching of invoices and receiving documents • Clearly defined field procedures and compliance audits • PO and WO control (approval and coding to work) • Payroll system additions, modifications and testing
What to do when there is an accusation of fraud? • Call your attorney • Secure the documents • Secure the electronic files • Notify your Board Audit Committee • Critical Legal Pressures • Sarbanes Oxley
Biographies James T. Schmid, CPA, CFE National Director of Construction Forensics – Grant Thornton LLP National Director of Construction Forensics – Grant Thornton LLP Jim Schmid is a Director in the firm's Economic Advisory Services specializing in providing economic and damage analysis as an expert witness and litigation support consultant. He also provides fraud investigation services for property and financial statement fraud and has passed the AICPA’s Advanced Business Valuation exam. Jim’s background includes both industrial engineering and accounting/finance. His approach to evaluating damages utilizes both of these disciplines. He has acted as technical reviewer for the popular college accounting textbook, Accounting Principles and has authored chapters for four books on construction: • “Pricing the Loss” • “Project Management Forms” • “Post Failure Accounting Systems and Methods of Pricing Damages” • “Payment Delay Claims” Jim began his career as an industrial engineer with a large tier-one automotive industry supplier. As an industrial engineer, Jim performed product line and part cost studies, conducted time and motion studies and optimization of production routing. He has been a director with Coopers & Lybrand in San Francisco, owner of a California-based construction management firm and was vice president of a large Michigan-based automobile supplier of interior trim, seating and airbags. Jim earned a Bachelor's degree in Engineering from Oakland University and an MBA from the University of Michigan. Jim is a licensed Certified Public Accountant in Michigan and Illinois, and is a member of the American Institute of Certified Public Accountants and the Michigan Association of Certified Public Accountants. He is also a Certified Fraud Examiner and a member of the Association of Fraud Examiners.
Biographies Carol S. Esselink, CPA, CFE Manager, Economic Advisory Services Carol Esselink is a Manager in Grant Thornton’s Economic Advisory Services (EAS) group located in Southfield, Michigan. She has significant construction forensic experience managing both construction claim calculations and fraud investigations. Carol is a CPA and CFE and has in-depth experience in both audit and litigation support. Sample Construction Claims and Fraud Investigations Luxury Condominiums Analyze the costs incurred to construct approximately 300 luxury condominiums in a major metropolitan area Identify and investigate suspected fraudulent activities Hotel Construction Analyze the costs incurred to construct a major chain hotel Analyze the contractor’s compliance with key provisions of the contract National Retail Chain Analyze the owner’s construction management approach and procedures Investigate whether the contractors have complied with the cost control provisions of their contracts Develop recommendations for improved owner construction management controls Commercial Office Building Analyze cost overruns incurred during construction of the international headquarters for a multi-billion world class foundation Allocate cost overruns between contractor-caused and owner-caused overruns Prior to joining Grant Thornton’s EAS group, Carol worked in Grant Thornton’s assurance practice. She was responsible for supervising audits for clients in the construction, manufacturing and financial services industries. She also was a supervisor for several critical litigation support engagements, including CPA malpractice, construction breach of contract and financial restatement engagements. Carol began her career in the Litigation Support practice at Ernst and Young. She spent 12 years at Ernst & Young and Equity Partners, Ltd. (a boutique litigation firm) as an associate involved in developing detailed financial models for use as trial exhibits in patent and trademark infringement, breach of contract, professional malpractice, condemnation and other litigation cases. Carol earned a Bachelor’s degree and Masters in Accountancy from Walsh College. Carol is a member of the American Institute of Certified Public Accountants, the Michigan Association of Certified Public Accountants, and the Association of Certified Fraud Examiners.
Todd Taggart Todd Taggart, CPA Tax Partner Todd is Grant Thornton’s National Construction Practice Leader. He has over 25 years of experience serving a wide variety of construction contractors and suppliers to the construction industry. Todd is heavily involved in construction industry trade associations; he sits on the Executive Committee of the Construction Financial Management Association and is actively involved in many of their committees. He also is a member of the Association of General Contractors Tax and Fiscal Affairs Committee. In addition, he is a member of the American Institute of Certified Public Accountants and the Minnesota Society of CPAs. Todd frequently writes and speaks on topics of interest to the construction industry. Todd received the Debra Hahn Memorial Award in May, 2004 from the Construction Financial Management Association for his leadership in that organization.
QUESTIONS? Todd Taggart, CPA Grant Thornton LLP (612) 677-5193 Todd.Taggart@gt.com Kevin Basso Computer Guidance Corporation (480) 444-7028 www.computerguidance.com Kbasso@computerguidance.com Jim Schmid, CPA, CFE Grant Thornton LLP (248) 233-6910 Jim.Schmid@gt.com Carol Esselink, CPA, CFE Grant Thornton LLP (248) 213-4267 Carol.Esselink@gt.com