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FINANCE FOR NON-FINANCIAL EXECUTIVES IN CONSTRUCTION INDUSTRY

[Role in financial aspects in management of construction projects]

by Gursharan Singh

1.0 INTRODUCTION

1.1 The definition of ‘Non-Financial Executive’ in the construction industry would generally include the various technical and other professionals associated with the implementation of any aspect of construction projects. The technical professionals would include architects, engineers, quantity surveyors, land surveyors, landscape architects, interior decorators, etc. The ‘Other Professionals’ would include project managers, lawyers, financiers [banks] & financial Advisors and insurers. They could be part of the in-house management or the need could be outsourced by appointment of private consultants. In addition, there are also professionals who provide specialized expertise in specific fields at micro level.

1.2 The general perception of the role of non-financial executives has been that of being responsible for technical aspects pertaining to the respective construction projects. The financial aspects of construction projects are generally deemed to be the responsibility of the accountants and those with financial expertise. Thus the financial implications arising from the technical aspects pertaining to the project may not be given its due importance by the non-financial executives for reasons of possible lack of expertise and/or the view that it is not within their scope of responsibility and that relevant financial professionals have been appointed. Similarly, the financial/accounting executives may not give the due importance to the financial implications that may arise from the various technical aspects for the same reasons as that provided by the technical professionals i.e. they do not possess the relevant expertise and/or is not within their scope and that relevant technical professionals have been appointed.

1.3 From the foregoing it would appear that there may exist a void in the management, procedures, processes and internal controls in the management of construction projects. The owners of the projects may not be aware of the adverse financial implications in the implementation of the project. In the event of it being discovered subsequently it may either be covered with collusion of the involved parties or justified with the explanation that it is one of the ‘unforeseen/unknowns risks’ that normally exist in the construction industry with the owners having very limited remedies if any..

1.4 The objective of this article is to fill this void by providing some suggestions and guidelines to make the owners and their management team members who are mainly ‘non-financial executives’ to be aware of the financial implications of some of the more important and relevant aspects in the construction projects.

2.0 NON-FINANCIAL EXECUTIVES

[Technical Consultants]

2.1 The technical professionals involved and some of the more important aspects that have financial implications that are relevant to their scope of duties and of which they should be aware of are provided in the foregoing paragraphs. Some of the aspects are common to more than one type of non-financial executives and should be considered to be important by each and all. This is because some of the aspects cannot be separated to be applicable to any particular professional. The aspects listed below are not in any degree of importance or sequence.

2.2 It is the owner’s prerogative to either have in-house technical expertise or to procure the required expertise by the appointment of private professional as is deemed appropriate. There are standard agreement formats that have been approved and prescribed by the respective regulatory authorities [Boards of architects, engineers, quantity surveyors and land surveyors] and are for mandatory compliance by all relevant registered technical professionals. Their employers are similarly required to comply with the prescribed agreement formats. However, these agreement formats contain terms & conditions that are for common usage. They need to be modified suitably for specific type projects such as property development as these projects have multiple-type buildings and infrastructure.

2.3 It is the general practice for owners to take the words of the non-financial professionals [technical consultants] at ‘face value’ and not to request/seek any clarifications on the terms & conditions that are incorporated in the approved agreement formats. Possible reasons include the assumption that the professionals are persons are experts, of integrity and bound by the Code of Ethics of their professions, absence of interest by the owners and/or their perception that any request for clarification may be deemed to indicate their own ignorance that they may not be inclined to expose or fraud opportunities in which the parties may be involved. It may be remembered that almost all the frauds that have been reported worldwide in the local and foreign media were alleged to have been committed over long periods by ‘professionals with Codes of Ethics and integrity’ and with collusion of the involved parties. The victims and those entrusted with the responsibility to protect the owner’s interest including the regulatory authorities, generally showed no interest resulting in no-recovery of losses from these frauds.

2.4 The best course is ‘prevention’ and this is only possible if the owners are aware, vigilant and ask the right questions before appointment and signing on the dotted lines in any agreement and also have continuous monitoring. Owners should never accept any terms & conditions without first understanding their legal/financial implications

2.5 It is equally important for the non-financial executives to provide upfront to their employers all the relevant information of possible legal/financial implications of the terms & conditions of these appointments and provides, where possible, recommendations in respect of the projects without being requested. Any intentional silence and/or withholding of relevant information that may subsequently create adverse financial/legal implication to the owners may be deemed to be misleading and thus could be presumed to be unethical, unprofessional and/or fraudulent. It may also lead to legal action against these non-financial executive for recovery of losses.

2.6 The remuneration of the in-house technical professionals is prescribed in their terms of employment and does not vary with the scope of their services, type of project or the project cost. Thus it is important that comprehensive and relevant procedures and internal controls with continuous monitoring exist to ensure that the projects are implemented bearing in mind their cost-efficiency and cost-effectiveness. These will minimize the fraud opportunities that may exist or be created due to conflict of interest.

2.7 The appointed technical professionals are in a position where conflict of interest exists. They have many opportunities to abuse their position for self enrichment. This is due to several aspects as their remuneration is based on many aspects. These include terms & conditions and scope of their appointment, cost/type/category of project, their role as advisor in evaluation & selection of contractors/suppliers/contracts and subsequent certifiers of all payments and changes to any aspect of the construction process and project as all of these have financial implications.

3.0 PROPERTY DEVELOPMENT PROJECTS

NON-FINANCIAL ‘TECHNICAL CONSULTANTS’

3.1 Property development projects generally consist substantially of buildings of various types and sizes with infrastructure facilities being a support segment of the overall project. Thus the main non-financial executive assigned for the overall responsibility for the project would be the architect who is then the lead consultant in all building construction projects. He advises the owner on the selection of other consultants [engineers – civil & structure and mechanical & electrical], quantity surveyor, land surveyor, landscape architect and interior decoration]. The architect is designated as the ‘superintending officer’ representing the owner and all other appointed consultants required to report to him. It should be the responsibility of the architect to provide the financial implications of the various terms & conditions of appointment of all the other consultants and this should include his own

3.2 The ‘consulting engineer’ [civil & structure] is generally the lead consultant representing the owner for ‘infrastructure’ projects such as highways, bridges, railways, etc and possibly for projects that are constructed on other implementation systems such as ‘turnkey’, ‘design & build’ or ‘build, operate & transfer’. The comments provided in the following paragraphs would also be substantially applicable in respect of infrastructure projects but in this article the emphasis will be on non-financial executives involved in the implementation of property development projects. It is important that the owners and their financial advisors are aware of these to optimize the benefits. Some of the more important aspects that have financial implications are listed below:

[a] Scope of Appointment

The ‘scope of appointment’ should be based on ‘scope of services’ that is compatible to the ‘needs’ of the project. The ‘needs’ of the project should be itemized as it would facilitate monitoring and better control. The legal/financial implications of appointment for partial or specialized scope of services should be explained in detail. The financial implications of any ‘wants’ that the owner wishes to be included in the project should similarly be explained. [3/8]

[b] Cost of Works

The components to be included in the ‘cost of works’ should be detailed in the approved agreement formats and should be individually quantified and justified as they form the basis of ‘cost of works’ that will be used for computation of professional fees. Owners should study these in detail and understand them with clarifications being sought from the technical consultants/legal advisors where necessary. It will also enable the owner to include realistic costs in the project budget and ascertain the economic viability of the project. As in the case of ‘scope of appointment that should based on ‘need’ based, it is important that components that do not need any expertise or could be implemented with ‘in-house’ expertise/resources, should be omitted/deleted or agreed not to be included in the ‘cost of works’ quantum for purposes of computation of remuneration that would be payable to the consultants.

[c] Category of Works

The buildings could consist of works of various categories i.e. for the very complex to medium complexity to of simple complexity. The professional fees scale rate is highest for projects that are deemed to be very complex, lower rate for projects of medium complexity and lowest for those of simple complexity. Broad examples of the categorization/classification of the more common type of projects are generally provided in the standardized approved agreement formats. It must be remembered that these are broad guidelines and just examples that should be understood by the owners. The category/class should be agreed before the appointment is finalized. It may be noted that a contract for painting of a building was categorized as ‘very complex’ as advised by a consultant resulting in the professional fees being paid at the highest rate even though the painting works did not need any expertise from any of the consultants.

[d] Computation of Professional Fees and Reimbursables

The relevant authorities in Malaysia have approved prescribed rates of professional fees that are chargeable. These rates are on a sliding scale and based on the category [or class] of the components included in a project. Similarly the sliding scale also applies to the individual components of the works. The professional fees can be based on several methods such as percentage of cost of the project/individual components that is either fixed or sliding scale, the cost of project/works be variable or predetermined with/without minimum/maximum limits, duration of services and rates chargeable on man-months [time basis], combination or be negotiated. Property development projects are generally of mixed type as they contain different types of buildings and infrastructural facilities the cost of which can vary from a few thousand to tens of millions ringgit [Malaysian currency: Ringgit 3.80 = One USD] for each type. The buildings and infrastructure facilities can also vary from simple to complex and of mega size. Remuneration of the private technical consultants varies with the scope of their appointment, the type of project and the project cost. Consequently, it is important that these aspects be scrutinized due to the existence of possibilities of conflict of interest and/or vested interest that exist in any short term appointment. Thus it is important that the Owners ensure that the ‘Computation Method to be Used is Fair and Just’ to all parties. It is for this reason that greater emphasis should be given to the various methods of remuneration computation. [4/8]

Management should exercise its rights and control & scrutinize in advance by making all claims the type and extent of claims to be subject to prior approval and ensure that the each claim is fair, reasonable, justifiable, and supported by documentary evidence. Further the computation Method of professional fees for mixed property development projects should also be understood and agreed in advance with advice from the relevant authorities if in doubt.

3.3 All the above variances have direct effect on the quantum of remuneration that is payable to the non-financial executives involved in any aspect of the construction projects. Property development projects are mostly implemented by major property development companies by implementations of every project through the establishment of individually incorporated subsidiary companies. Thus there may not be effective controls and absence of effective monitoring of the various aspects of implementation. Thus cost-efficiency may not be a priority. All these provide many opportunities for fraud to all parties involved in whatever capacity in the implementation of property development projects.

4.0 OTHER NON-TECHNICAL PROFESSIONALS

[Project Management Consultants, Legal, Finance [Banks], Insurers]

4.1 The services of other professionals that have financial implications to the cost of construction projects include project managers, legal practitioners, financiers and insurance companies. Brief notes are provided below.

[a] PROJECT MANAGEMENT CONSULTANTS

They provide expertise in managing the construction projects from inception to post-completion stage or as per scope of appointment. However, presently there is no official regulatory authority to prescribe their scope of services, remuneration or responsibility. They are self regulatory. Thus the owners of projects may not possess any sufficient knowledge/guidelines to be able to negotiate for an equitable remuneration package or evaluate their performance at the end of the day. The recently reported failures of several mega infrastructure/building construction projects that were assigned to the PMCs has amply illustrated the weaknesses in the system of appointing or monitoring the performance of the PMCs. While there have been some success stories, the many failures have overshadowed them. It is evident that this ‘profession’ needs to be fine-tuned before it can be recommended for wide usage. Owners will have to be cautious in the appointment of PMCs.

[b] LEGAL PRACTITIONERS

The expertise of the legal professionals is essential and mandatory for any agreement and construction contracts are not exempted. However, the terms & conditions in respect of construction contracts are varied in scope and type. Thus it is important that the terms & conditions are relevant to the type & scope of contract and the locality of construction. It is extremely difficult for any construction company or property developer to have standardized terms & conditions. Further the numbers of professionals with the relevant legal expertise are very limited and this discipline appears to be not a favorite with the legal profession.

[c] FINANCIAL ADVISORS

The financing resources [banks/finance companies] are in a monopolistic position. This is due to the very small number of approved financial institutions, the possible strict enforcement by their association and that the lending rates/conditions are within the limits imposed by the regulatory authority [Central Banks]. Thus, the construction industry, especially the property developers, may not have many alternatives regarding the fee & Expenses that may be claimed or any other aspects of the finances/financial expertise that may be procured by the owners of property development projects or others involved in the construction industry.

[d] INSURERS

It is mandatory for all construction projects to be covered by relevant insurance policies that will be prescribed. It is important that the non-financial executives ensure that the insurance policies taken protect the interest of the owners and all those at risk and are adequate to the needs of the project, the risks and not over/under insured. This is important as there is financial implication involved on the scope and quantum of coverage. Like the financial institutions, the insurance industry is also regulated by the relevant authorities.

4.2 Thus, as the legal profession, financial institutions and the insurance companies are all regulated and have strong centralized ‘associations’. This gives the perception of the existence of a monopolistic situation and a ‘sellers’ market’. Consequently, the construction industry may not have many alternatives regarding remuneration or any other charges that may be imposed by the providers of these services that are mandatory to be procured. Nevertheless, Owners should make relevant/irrelevant enquiries from these ‘other professionals’ and subject them to controls similar to those applied for other procurements of goods/services. It is better to have some controls than not to have any at all or have blind trust in their integrity’/‘ethics’.

5.0 IN-HOUSE EXPERTISE

5.1 The aspects mentioned in paragraphs 3.0 and 4.0 above do not apply where in-house expert technical and non-technical professionals are employed. Their scope of services and remuneration [and perks] packages would have been detailed in their letters of appointment.

6.0 CONTRACT/AGREEMENT FORMATS

6.1 Presently, the Pertubuhan Arkitek Malaysia [Malaysian Architects Association] has two types of standardized terms & conditions for building projects [with quantities and without quantities]. Similarly, the Construction Industry Development Board has standardized terms & conditions for contracts for common usage. Large organizations such as the Public Works Department, Drainage & Irrigation Department, Malayan Railways and Local Authorities, also have their own Standardized contract terms & conditions for their own specialized requirements.

6.2 Private sector clients have generally adapted for use these existing terms & conditions format. However, it is important that selected standardized terms & conditions are modified and amended to make them relevant to the needs of the project for which it is to be used. The expertise of the legal advisors/technical consultants will be needed to make the appropriate amendments. Here again it is the responsibility and obligation of the non-financial executives to advice the owners on the legal/financial implications under the amended terms & conditions before adoption.

7.0 ROLE OF FINANCIAL EXECUTIVES

FINANCIAL/ACCOUNTING PROFESSIONALS

7.1 The role of the financial/accounting executives is generally perceived to be limited i.e. to account keeping. This is due to their hands-off approach on the other aspects of construction projects implementation. This perception is due to their opinion that the various aspects of construction projects are the responsibilities of the relevant experts involved in the management, planning, designing, implementing, supervising, monitoring, etc. of the Project. The other relevant non-financial executives [technical and other professionals such as architects, Engineers, quantity surveyors, land surveyors, landscape architects, interior designers/decorators, Lawyers, project managers, insurers, internal/external auditors, etc.] are responsible for their specific fields of expertise. This view of the financial executives may be outmoded in present times when they should be playing a pro active and participatory role by providing their expertise to the non-financial executives for mutual benefit and for the benefit of the owners/project.

7.2 The financial executives are generally part of the team that is involved from the very beginning and inception of any Project. They advise on the sources of funds that will finance the construction of the project and its economic viability. The role of the financial/accounting professionals should thus not be relegated to that of examining the financial transactions and record keeping only. They should play a pro-active role from inception to the final handover of the project to the rightful owners. They could be instrumental in reducing/minimizing the overall costs/losses of any construction project

ROLE OF MANAGEMENT

7.3 Management of construction companies generally consists of executives with both fields of expertise i.e. financial and non-financial. It is the responsibility of every management to provide support and avenues for these executives to co-operate and work together. Owners can thus better monitor and control the financial [and physical] progress of the projects being implemented. Appropriate preventive measures to reduce costs and delays [that also cost money] to some extent can be taken in the early stages. This will benefit the owners in creating another control in minimizing, if not preventing overpayments, wrong payments and fraudulent payments. Management will thus be in a better position to obtain the optimum results.

8.0 RECOMMENDATIONS

8.1 There should be continuous consultation, co-operation and co-ordination among all the involved non-financial and financial executives for optimum cost-effectiveness and cost-efficiency in the implementation of any project. The completion within the agreed completion period, approved budget, as per prescribed specifications and to the satisfaction of the ultimate user, will signify a success for all. The reputation and goodwill gained would ensure additional projects for the future. Thus the non-financial executives can also contribute significantly to the success of the construction companies that should then translate into higher and continuous financial rewards to all.

9.0 CONCLUSION

9.1 It is important and long overdue for the non-financial executives co-operate with the financial executives and the management. All should support each other to play a more proactive and comprehensive role and add value to their respective services by being involved in the many aspects of construction [including property development] projects. They should not be over dependent on others but equip themselves with knowledge about the varied aspects in construction projects and their implications. This would assist in upgrading the quality of their duties and add value to their contribution to success besides enhancing career prospects.

9.2 Both the non-financial and financial executives should remember that they each possess expertise in their respective professions while being aware that they may not possess in-depth knowledge about each others professional expertise. Thus it is not in the interest of both types of executives to have blind trust but they should be aware of the many adverse possibilities. Both should be able to ask some commonsense questions from each other and seek advice. Thus when both are alert and knowledgeable, the possibility of overclaims, overpayments or fraudulent claims and payments will be prevented or minimized.

BEWARE, BE AWARE, AVOID BLIND TRUST & BE INVOLVED AND PROFITABLE

GSK/Dec04

GURSHARAN SINGH C.M.I.I.A.

[Trainer - Audit Officer]

116 Jln. Hujan Manik, O.U.G. Jalan Kelang 58200 Kuala Lumpur, Malaysia

[Tel. No. [O] No. 603-62570812 [H] 79824492 E-mail: gsk38@hotmail.com]

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