Handbook for Technical Auditors of the Construction Industry

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Construction Industry is huge and is growing practically in every country in the world. The Industry as a whole not only survives under economic difficulties, but also grows so fast it would be difficult to predict the volume of increase in the future. A recent newspaper report suggested that China intends to shift 100 million village people to towns within the next decade. One wonders the amount of construction output that is required for such an exercise as we are speaking a population which is approximately four times the population of a country like Saudi Arabia or Sudan. This kind of hurried construction in such a massive scale shall be a playground for smart Contractors.

Like in any other industry, where human beings are involved, there are lots of irregularities, frauds etc. are taking place, worldwide on a regular basis. As the construction output increases so does the loss in the construction industry. Estimates vary from country to country. We shall now consider the loss in an advanced country like the United Kingdom. A recent Chartered Institute of Building (CIOB) study in UK found that 49% of the respondents believe corruption is common in construction and that 50% believe companies are not doing enough to prevent corruption. The office of Fair Trading and the Office of National Statistics in one of its largest ever Competition Act investigations found widespread evidence of bid rigging on procurement projects in the UK. This investigation uncovered issues such as so-called ‘breakfast-clubs’ (a form of illegal cartel where contractors meet up to decide who will win the latest contract) this relates to behavior of contractors in early years. But in a 2012 survey of procurement professionals for The National Fraud Office’s Annual Fraud Indicator (AFI), 40% of respondents said that spend on construction is at greater risk from procurement fraud. Another survey by the CIOB published in 2013 found 20% of respondents still thought the practice of cover pricing was not corrupt. This gives an indication that there are a big proportion of individuals out there willing to engage in this kind of activity. The Chartered Institute of Loss Adjusters produced a report in 2011 stating that fraud in construction in the UK was rife, estimating at 10%. AFI reported losses to private construction companies resulting from fraud in 2012 at US $ 4.5 Billion. A 2009 CIOB report on crime in the construction industry found that a third of companies had experienced fraud. When asked who was most likely to commit fraud, the top responses were contract staff and trade staff. There is debate about whether fraud is greater in boom times or in a crisis. In boom times, frauds may be less likely to be detected. However; a crisis such as the recent economic downturn can lead to greater pressure on individuals who wish to maintain their status or corporate fermonce, so, turn to fraud or corruption to reach results.

Any way as the downturn led to increased focus on costs and more scrutiny more fraud has come to light. Perhaps this led to Transparency International’s Global corruption barometer 2013 showing 65% of respondents considering that levels of Corruption has increased in the UK over the last two years. The serious Fraud Office and city of London Police Economic Crime Department are specialized units who get involved in more Complex and larger cases. Professional advisors can conduct investigations themselves and then hand over a prepared case to police to consider asking the Crown Prosecution Service to launch a prosecution.

The UK government has tightened up the technology area fraud and is also learning its lessons. It is moving towards centralized procurement procedures and frequently uses e-auctions. Some twenty or so different types of frauds were investigated in relation to the Millennium Dome construction project in the early 2000, but there was only one known case related to the 2012 Olympics, due to the heightened fraud risk assessments undertaken. The type of corrective actions taken by the UK government cannot be compared with other countries, particularly the developing or the BRICS countries, in addition these countries are going to spend heavily on construction in the foreseeable future, therefore the Frauds in those countries can be much higher.

Grant Thornton International, a global advisory firm, recently issued a report on fraud in the construction industry in Australia, Canada, India, the U.S., and the U.K. The statistics are sobering to the construction cost professionals to say the least:

3.4% of all fraud cases reported over a two-year period were in construction

The median average loss was US$300,000

Fraud impacts 10% of the industry’s total revenues in the U.K.

Applying these data points to global construction and its projected growth suggests that fraud and corruption could account for US$860 billion today and $1.5 trillion by 2025.

Grant Thornton adds an accelerating factor: As the global economy recovers, activity across the construction industry will increase. This will bring more opportunities for fraud. So the reasonable chances are that the frauds in the construction industry worldwide shall be near to US $ 2 Trillion by 2025.

These figures are now superseded by the recent findings by Transparency International for their Initiative for the Construction Sector known as Cost. The values are frightening to say the least for an ordinary man let alone a Construction Cost Professional. Transparency International estimates the loss owing to frauds or corruption of one form or the other on Government funded construction as upwards of US $ 4 Trillion per year. Up to around a third of all construction values.

To put this in real context, the loss owing to construction frauds in Govt. funded construction today is US $ 7.61 million per minute, US $ 1.50/= per head per day for the entire world population, (including babies, children and adults) and increasing as the construction output increases. This amount does not include the loss owing to construction disasters both manmade and natural. It can be safely assumed that if 20% of this amount can be salvaged then Poverty can be wiped out from the face of this earth.

There is another loss to Clients, particularly governments. Normally, a project’s Defects Liability Period is one year, so in theory the Contractor is not liable for any corrective work after the Defects Liability period. There were several cases where after couple of years defects become more apparent and correcting same require substantial money to the government and there is no way that the same can be recovered from the contractor. The governments find it difficult to increase the maintenance budgets of existing as new ones have to be built and which takes preference, thus making the constructed facilities to deteriorate further. There are many reasons for such failures, the main reason being under quality or factory rejected materials were used. I can still remember, during our school days, we used to buy shirts from a factory which used to sell factory rejects every month. This factory used to produce top quality shirts for international market by expert tailors and even a small mistake can cause the rejection. These rejected shirts were very cheap about 15% of the actual cost and can be used as it is or with some very minor corrections. Similarly some factory rejects can be used for a few years without any difficulty but cannot be used for say 20 years which is the guaranteed period given by the company for its products. This kind of usages shall certainly come to light in Technical auditing owing to the specialized skill of the auditor, but may not in financial auditing.

In certain countries the contractor has to give Decennial liability for some period after completion usually about 10 years and the contractor is responsible for the project until such time. So much so, that in some countries, Decennial liability is both Contractual and Legal requirement, this necessitates an Insurance cover from the Contractor for decennial period. In countries where Decennial liability is not a requirement, which is the case in most countries in the world, the cost of repair after the Defect Liability period can be substantial and so far no one has estimated and none of the above estimates regarding losses owing to frauds include this. If and when Technical Auditing made mandatory, the Technical Auditors owing to their Engineering skills shall be in a much better position to detect the possibility of such cases and highlight same in their recommendations to make corrections in the future.

Like in medicine, prevention is better than cure. The disease has been diagnosed thanks to the Accounting Institutions and is real and growing fast. The first action is to control and then to cure systematically over a period of time.

The interesting part of the Construction Fraud detection is, it is mostly if not totally done by the Accounting Institutions and not by the Professional Institutions which are associated with the costing of the construction industry, which by definition have to give best value for money spent. The construction industry as a whole and Clients in particular should appreciate and thank the Accounting Institutions for high lighting the construction frauds for years. The sad fact is the Risk element in the Accountant auditing exercise has not been highlighted. This Risk increases as the construction becomes more and more complex. The Risk causing the Lawsuits in State Construction Project Audit in China is a big problem. Extensive Researches have been done as it is very difficult to implement audit findings owing to this risk and it was found that improvements were required in audit model control, carrying out the audits and quality of the audit staff. The cat is now out of the bag. This risk element of enforcement of audit findings explains that the loss is estimated to be 10%, in UK, so it is reasonable to assume as 15% in other countries, but the gain in the form of savings generated owing to double auditing (internal & external) by Accountants in Government departments has not reached even 0.10%, let alone suggestions for improvements in the future. The other aspect of Financial Auditors in the construction industry is that they unnecessarily and without logic trying to apply some financial application and exert leverage to the extent that construction professionals are forced to do things which are not contractual. One clear example is trying to limit the Contractors’ Interim payments in relation to progress, or high material prices without knowing that at the end of the day, Interim payments, materials at site shall be zero. They always insist on the worst case scenario of Contractor becoming bankrupt during the execution of the project. The nett effect is Contractors suffer financially, thus the project is likely to be delayed and this is the start of non-trust relationship between the Contractor and Employer. This goes without saying that the cost of auditing itself is a loss. It is interesting to note the practical experience of Technical Auditing companies in the United States. This has to be looked in the context of Technical Auditing of construction conducted by specialized companies with their own methods and standards, where it is proved by their proud reports that the Client never loses in the event of Technical Auditing. The ratio (cost Vs. Savings generated owing to Technical auditing) is another factor to be considered, some even suggesting as much as 1:10 on certain projects. I’ll leave it to the reader to imagine the amount of savings that can possibly be generated in an environment where accredited Engineer Auditing is the norm with internationally accepted standards for construction auditing, given the fact that the loss has reached upwards of US $ 4 Trillion per year.

Enough is enough. This is not the time for finger pointing, prestige or global leverage and the time has come for Professional Institutions which are involved in the costing side of the construction industry to lead from the front as technically they are most suited for this kind of activities specially in the present environment, where the construction is much more complex and much more competitive, thus more open for frauds and other irregularities.

The problem is, there is no Professional Association/University level course work /Standards/regulation of the profession for construction project auditing. Owing to the absence of the above, Accountancy firms have firmly inserted themselves into regulatory and statutory requirement of audit. However, Accountants do well enough in auditing for fiscal irregularities when it comes to numbers which do not in themselves require knowledge of construction. Thus, the construction auditing is also performed by Accountants to Accounting standards for over a century and they maintain that firm global leverage on the subject of auditing. In the process have high financial vested interests. There is an urgent necessity to initiate internationally acceptable Construction Auditing Standards, a Post-graduate course of study for Technical Auditors, a union for such auditors, a system of accreditation and at least one Engineer Deputy Auditor General in countries, where the overall Government expenditure on construction is in excess of 10% of the budget.

Action in the form of suitable Technical Auditing standards along with proper training is now required that too on an urgent basis from the construction professionals who are involved in Costing. If this is not done, then the public at large may be forced to suspect that the Construction cost professionals wanted it that way (Frauds are part of construction) thus affecting the integrity of the profession as a whole. As a start, all government funded projects should be subject to Technical auditing or Performance auditing by trained Engineering professionals, with clear protocol and standards. Further, as suggested all govt. Projects to be Re-measure type to eliminate the Contractor risks. As it is traditional for the Governments to award the project to the lowest tender, a mandatory check by inserting the Quantities of Statement at Completion instead of tender to see whether the awarded tender is still the lowest. If it is not, then the whole exercise of value for money is lost and an explanation has to be called for from the consultant, who has prepared the tender documentation and the Government should have provision to claim damages from the Consultant as professional negligence. At present, it is common practice in the world that all Government funded projects under go double auditing (internal & external) with an Auditor General with wide powers and an army of Accountant Auditors. The situation regarding frauds and irregularities are unfortunately is the same, in fact increasing. The waste in government funded projects cannot be tolerated in any country as there should be transparency and mandatory check and balance for public expenditure. So there is no wonder that the litigation in the Construction industry can only be comparable to that of Extra-marital cases. This situation and the existing legal systems were found to be inappropriate for construction owing to its technicality has created various forms of construction dispute resolution methods commonly known as Alternate Dispute Resolutions, All these are of recent origin and still evolving, and can be considered as post-mortem exercises after the event has taken place.

There is an urgent if not an immediate need to separate the construction auditing from other Auditing exercise. This is a specialized field which has to be done by Engineers with suitable training and accreditation. Auditing has been and continues to be a specialized field reserved solely for Accountants worldwide, over a century. Construction then was simple structures and Accountants were able to audit like any other. Over the years construction has evolved and is now much more complex owing to size, uniqueness, complexity and the fact that projects are structured through various phases and contractual links that disperse accountability among many separate agents. The irregularities, frauds etc. in such an environment cannot be handled by Accounting Institutions. This may be the reason as to why frauds in construction are continuing to increase. There may be a school of thought that what the Accountants doing is unethical as a Professional is not expected to do a job in which he/she is not competent of. A system cannot survive depending on whistleblowers.

The usual argument put forward by Accounting Institution is Auditing is their field and if and when specialized expertise is required, they will use such expertise to fulfill their obligations. The usual example is the appointment of Doctors in the Army as their expertise is required. These Doctors are given very high ranks owing to their non-fighting skills. These Doctor Officers can’t hold a gun properly, let alone command a battalion, which is the requirement for their grade of office. The case here is completely different. The Engineer accredited Technical Auditors can do the fighting (Auditing), that too much better than their Accountant counter parts due to their construction know how, skills and relevant experience.

The sad fact is there are lot of construction failures, both during and after construction which had resulted in many deaths and injuries in addition to loss of money. Statistics released in 1984 by the National Safety Council in the United States reported over 2,200 deaths for the construction industry for that year, and 220,000 disabling injuries, the largest total for the eight major industries surveyed. Over $1.6 billion is lost annually in the U.S. due to construction accidents .Forty-nine percent of false work collapse happens during concrete placing. Untimely removal of false work is the second most significant event related to concrete failure. Investigations prove that many accidents causing thousands of dollars’ worth of damage could have been prevented if only a few hundred dollars had been spent on diagonal bracing for the formwork structure. If the loss is such in the United States, where it can be safely assumed being an advanced country with sufficient codes of practice, I’ll leave to the readers to speculate the magnitude of losses in other countries.

The sad element regarding corruption and other improper behavior in construction is that it can be deadly as well as costly. A recent study by the US based International Anti-Corruption Resource Center (IACRC) regarding the probable effect on the death tolls from earthquakes, particularly those resulting from the collapse of buildings, noted that poor building practices can turn even moderate earthquakes into major disasters. The authors concluded that 83% of all deaths from building collapses in earthquakes over the past 30 years occurred in countries perceived to have abnormally high levels of corruption. Such deaths have been increasing despite advances in the ability to construct earthquake-resistant buildings. As an example of the difference properly constructed buildings can make, the authors contrasted the 2010 earthquake in Haiti, which killed many thousands, with a quake of similar intensity in New Zealand which did not result in fatalities. It is true that some countries cannot afford such high costs. However it was found that massive amounts of aid have been poured into under developed regions by governments, development banks, and NGOs, but too much of which has been siphoned off before reaching its intended beneficiaries. In these cases it is not the problem of money as a project budget can be sufficient to fund earthquake-resistant school buildings-but the looting of project funds to finance corruption schemes. With the use of substandard materials or omitting some key materials partly or entirely-such as those needed to withstand the pressure and stress of an earthquake, the conspirators can appear to complete a project while secretly diverting vital funds to themselves and the corrupt officials whose acquiescence make the scheme possible. In an earthquake the building shall collapse killing innocent people. This situation is rather unfortunate as people are stealing money at the risk of others’ lives.

There is every possibility that most if not all of these disasters could have been avoided, lives and money saved, if Technical Auditing by trained Engineers had been the norm in construction as most of the mistakes were found to be easily identifiable for Engineers.

World Bank like any other leading lending Institution has recognized that financial management as an integral part of the construction process and thus has a mandatory Auditing provision in their contracts. The saddest part is construction auditing for World Bank and other such Institutions is still being performed by Accountants to Accounting standards. One fails to understand why this Construction Cost Engineering Professionals are not getting involved in an organized manner for construction auditing.

THE MONITOR dated 16.10 2010 reported a news item Foreign Engineers Probe Roads Mess in Uganda. A whistleblower had written a 13–page dossier to the World Bank highlighting poor management of contracts, influence peddling and inflation of construction costs by Uganda National Roads Authority among others as the reason why the country’s roads were in a deplorable state. In trying to establish how much has actually been spent on the road sector, the Auditor General’s office, has hired the services of six Engineers from Tanzania to investigate allegations of shoddy road works and procurement related graft by the UNRA. According to the Deputy Auditor General, this team of Engineers shall be on top of financial auditors in order to improve the output in Engineering audit. The Deputy Auditor General further said that they were targeting to audit more than 50 roads, going in-depth into even those they had earlier audited and they had asked the World Bank to second to the Auditor General, a procurement expert to assist in the UNRA procurement audit and dispatched staff to Japan to train in public works audit. After all, this kind of activities is not new to construction as China investigated more than 21,000

Construction cases in 2009 and it was found 15.2% of the frauds occurring during the bidding process involving corruption, interfering with the bidding process, insider trading and cheating.

The fact remains that owing to frauds and the uncertainty of the cost, time, the final product meeting the intended purpose, confidence level of the construction industry, meaning at the end of the day the owner shall get the value for money, is to say the least is low. This is highlighted by the reluctance of the international investors to get involved in construction in a big way in spite of its potential. Even the present volatility of the international investment climate such as, here to safe heavens of sovereign bonds are longer safe, turbulence in the share markets, gold the traditional rescuer in times of financial crisis has lost its shine, reaching its peak and losing as much as 15% in a short period and staying in decline, a situation probably never in the history, have not tempted them.

Therefore, Technical Auditing of construction projects has to be separated with its own body with relevant standards pertaining to the industry. These to be updated on a regular basis.

Professionals who are involved in the construction industry have a professional responsibility to give the necessary confidence the industry needs. They should see that at the end of the day, the