MANAGEMENT OF CONSTRUCTION
PROJECTS
WHO IS
VERIFYING/MONITORING CONSTRUCTION PROJECT COSTS?
1.0 INTRODUCTION
1.1 It is a common practice in the corporate sector that the Board of Directors [‘BOD’] generally does not personally monitor the costs of Construction Projects [‘Projects’]. This responsibility is generally assigned to the Chief Executive Officer/Managing Director who in turn will normally assign it to the various Divisional Directors, Site Professionals or other Senior Managers as appropriate. The ‘BOD’ may also presume that this monitoring function will be undertaken by the members of the Audit Committee [‘AC’] who in turn will depend on the Internal Auditor [‘IA’] and/or the External Auditor [‘Auditor’].
1.2 It has been observed during my service as an ‘Auditor’/‘IA’ in the Government and Corporate sector that the members of the ‘BOD’ rarely have expertise or experience that may be relevant to the construction industry. The ‘IA’ and other members in the Internal Audit Department [‘IAD’] also are generally finance audit oriented though with some knowledge and expertise relevant to the construction projects that they may audit. The scope of audit by the statutory ‘Auditor’ is limited to those requirements that are prescribed by the respective Statutory Regulatory Authorities.
1.3 Thus it can be assumed that none of the three entities [‘BOD’, ‘AC’/’IA’ or ‘Auditor’] who should be monitoring the ‘Projects’ actually undertake effective monitoring of the implementation and the associated costs. Thus the wasteful costs, possible frauds and corruption and cases of mismanagement go undetected or unreported. In cases where such cases are detected and/or reported action is seldom taken against those responsible for the direct/indirect financial and other losses suffered by the company or the taxpayers.
2.0 Actual Cases
2.1 In some rare cases the ‘Projects’ that may have resulted in large losses due to mismanagement or suspected fraud/corruption the projects are exposed in the media. The Reports issued by the Auditors General in most countries provide regularly cases of mismanagement and suspected frauds/corruption in public sector ‘Projects’. Similar cases of possible mismanagement or fraud/corruption in the corporate sector are also reported in the media especially in countries that have laws pertaining to freedom of information. However it is a rare case where effective deterrent action is taken against those responsible even when it is proved beyond doubt, whether in the developed, developing or under-developed countries.
[A] Port Klang Free Zone Construction Project
2.2 The most recent case that has been widely publicized in the Malaysian media refers to the Port Klang Free Zone [‘PKFZ’] project where the original cost has been reported to have escalated from RM4.5 billion to over RM7.5 billion with possibility of it rising further to RM12.5 billion. The ‘PKFZ’ project has already been the subjected to two special reports the first of which was prepared by one of the leading accounting firms and the second by a special team lead by one of Malaysia’s leading lawyers and other experts. In addition the ‘Project’ is being investigated by the Public Accounts Committee [‘PAC’] appointed by the Malaysian Parliament.
2.3 The ‘PAC’ has been reported [in the Star dated 14.8.09] to have expressed the view that ‘massive cost over-runs could have been avoided if the Port Klang Authority Board Members [‘PKA’] had adopted a hands-on approach during the development phase and had currently concluded that the hands-on approach [monitoring on the part of the ‘BOD’] was not there. It was further stated that the ‘BOD’ had not gone to the ground to find out what was happening and had allowed the ‘PKFZ’ management to carry on without checks and balances and thus the ‘PKAs’ ‘BOD’ had largely failed in its duty to oversee ‘PKFZ’s construction. The ‘PAC’ concluded that as all the information was coming from one source, not multiple sources if someone says it’s white all the way, everything is white and thus from the ‘BOD’s angle everything looked very good from the early part of the project. The ‘PKA’ had placed too much trust on decisions made by the ‘PKFZ’ Directors/Senior Management and many decisions had been made without the full knowledge of the ‘PKA’ who were senior civil servants who were nominees of the Government but failed to attend the ‘BOD’ meetings. These members did not question in-depth many of the matters that had, among others, financial implications on the ‘Project’ [Star dated 20.8.09 refers].
2.4 Subsequent media reports [The Star dated 27.8.09] have reported the ‘PKA’ revealing of possible conspiracy among several parties in connection with the ‘PKFZ’ scandal that included main contractor, Sr. management and technical professionals. Also revealed was unsubstantiated claims amounted to about RM1.5bil that included Procurement, extra payments for works included in original scope of works, undone works, over measurement of works, non-contribution of statutory fees, consultancy fees, etc.
2.5 Presently the ‘PKFZ’ project is under investigation for possible mismanagement and fraud/corruption by the Authorities including in-depth investigations by the Malaysia’s Anti-Corruption Commission and the Police Authorities.
2.6 The contents of the two special reports and other disclosures as published in the media has indicated the involvement of politicians and civil servants from the inception of the ‘Project’ beginning with the award process and costing of the ‘Project’ including subsequent massive over-runs. It may be too early to identify those to be held responsible or to speculate the action to be or be taken against them. However if the past is anything to go by then it is probable that the case files of the ‘PKFZ’ project will also probably be
buried as is usually done worldwide when people with power and influence are deemed to be involved. It is also possible that those involved may come out of this whole episode as richer and more powerful as has just happened to the icons of western financial institutions that placed the world’s financial systems and economies of many countries in mess. In the meantime all have provided interesting reading and entertainment for the general public and appears to have eroded confidence in the honesty, integrity, ethics, morals and trust worthiness of the political system, the corporate leaders and the professionals who are entrusted with management of public funds.
[B] Professional Fees Computation of a Private Technical Consultancy Consortium
2.7 A Property Development Construction Company [‘Client’] appointed a Private Technical Consultancy Consortium [‘Consultants’] to provide services that included Architectural, Engineers [C&S/M&E] and Quantity Surveying services for a Mixed Development Property Township Project [‘Project’]. The leading professional was an Architect who possessed a doctorate and state title. The terms and conditions of appointment were as prescribed by the relevant Regulatory Authorities [‘Boards’] except the basis of computation of professional fees.
2.8 The professional fee was specified as to be computed on Cost of Works [‘CoW] but consolidated to be 10% of ‘CoW’. Professional Fees payments would be invoiced after every ten percent of works were certified completed and approved within sixty days of approval of the invoices by the ‘Board’. The payment for the approved invoices would be settled electronically by crediting the approved claim sum to the bank account of the appointed ‘Contractor’ within thirty days of approval by the ‘Board’.
Project Cost
2.9 The total cost of the ‘Project’ was estimated at RM400.00 million [USD120.0 million]. The detailed breakdown of the RM400.00 million was composed of the following components where the estimated cost of each of the components was as detailed below.
COMPONENTS COST [RMMillion]
[a] Cost of Land 40
[b] Conversion Fee 20
[From Agricultural to Commercial/Industrial/Residential]
[c] Land Clearance 20
[d] Piling Works 30
[e] Sub-Structure Works [Parking for High Rise Buildings] 20
[f] Superstructure Works [Commercial/Residential] 150
[g] Infrastructure 30
[h] Technical Professional Services Fees & Reimbursable] 45
[i] Approval Fees Payable to Local Authorities & Utilities Cos.15
[j] Contingencies 30
TOTAL ESTIMATED PROJECT COST 400
Management Team
2.10 The ‘Client’ established a Special Committee [.Committee’] to monitor the financial management of the ‘Project’. The ‘Committee’ composed of technical, legal and other professionals with expertise relevant to the various components of the ‘Project’. In addition a flow chart for the checking and verification of invoices submitted by the ‘Consultants’ for their professional fees. The approved and prescribed flow chart was as follows:
[a] Invoice receive and record by the ‘Committee’;
[b] Claims invoices forwarded to the Technical Professionals in the ‘Committee’;
[For checking computation and to be in compliance with specifications and technical aspects and as per terms and conditions approved by the ‘Boards’]
[c] Technical Professionals approved invoices forwarded to the Legal Professional;
[For verifying the legality of the claims]
[d] Legally verified claims to be forwarded to the ‘Committee’ for approval and then submission to the Finance Director for budgetary approval;
[e] Budgetary approved claims forward to the Chief Accountant to prepare payment voucher and check;
[f] Chief Accountant approved amount forwarded to the Chief Accounts Clerk for preparation of check;
[g] Prepared check forwarded to relevant check signatories;
[Chief Accountant-Finance Director-Chief Executive Officer/Managing Director-BOD member as prescribed by the ‘BOD’]
[h] Prepared check dispatch to the ‘Consultants’.
Audit of Claims
2.11 The implementation of construction works of the ‘Project’ progressed as per agreed Period of Completion and the schedule attached thereto. The ‘Consultants’ submitted invoices for their claims to the ‘Client’ as and when the completion mile stones were reached progressively to the ‘Client’. The claims were examined, verified and approved by the various designated professionals as prescribed in the appointed special ‘Committee’ and checks issued for the approved claims. The amount paid was the same as the amount stated in the invoiced claims submitted by the ‘Consultants’ without any changes.
2.12 The ‘AC’ was directed by the ‘BOD’ to subject the Professional Fees component of the ‘Project’ to a comprehensive audit. The in-house ‘IA’ informed the ‘AC’ that it did not have the expertise to conduct the special audit and sought ‘BOD’ approval to appoint an external Auditor with the relevant expertise. The proposal was accepted and the recommended ‘Auditor’ appointed to the ‘IAD’ for a period of three months. The scope of duties of the appointed ‘Auditor’ was included to lead and train a team that would include existing ‘IAD’ staff members to enable them to acquire knowledge and enhance their expertise in this specialized field.
2.13 At the time of appointment of the new ‘Auditor’ the ‘Project’ had been certified as fifty per cent completed and correspondingly Professional Fees [‘Fees’] amounting to fifty percent had been certified and paid. Scrutiny of the ‘Fees’ computation showed that the ‘Fees’ had been computed based on ‘Project’ cost of RM400.00 million. Thus the ‘Fees’ claimed at the rate of ten percent of the ‘Project’ cost and fifty per cent of the ‘CoW’ as certified was computed as RM20.00 million and had been certified and settled.
2.14 The ‘Auditor’ scrutinized the Terms and Conditions of the Appointment Agreement showed that the ‘Fees’ was to be computed as ten per cent of the ‘CoW’ and not the cost of ‘Project’ as detailed in paragraph 2.7 above. The ‘Auditor’ was of the view that the computation of the ‘Fees’ should be based only on components that could be defined and as being included in the ‘CoW’. Thus the components that should be included in ‘CoW’ would be only the following:
COMPONENTS COST [RMMillion]
[a] Land Clearance 20
[b] Piling Works 30
[c] Sub-Structure Works [Parking for High Rise Buildings] 20
[d] Superstructure Works [Commercial/Residential] 150
[e] Infrastructure Works 30
TOTAL ‘COST OF WORKS’ 250
2.15 Thus based on the Total Cost of Works of RM250.00 million the total ‘Fees’ should be RM25.00 million being ten per cent of ‘CoW’ of RM250.00 million and not RM40.00 million based the cost of the ‘Project’ of RM400.00 million. Further as the ‘Works’ as certified completed was only fifty per cent the total ‘Fees’ payable would be only RM12.5 million resulting in an over payment of RM7.5 million as RM20.00 million had already been paid. The appointed ‘Auditor’ submitted his report together with justification and supporting documents to the ‘AC’ who then forwarded it to the ‘BOD’.
2.16 The appointed ‘Auditor’ held a meeting with the ‘BOD’ where the ‘Committee’ members together with the Finance and Accounting professionals were invited to comment on the findings of the ‘Auditor’. All agreed with the findings of the ‘Auditor’.
2.17 The ‘Auditor’ was requested to ascertain the causes that led to the wrong computation that resulted in the over-computation and over-payment of the ‘Fees’. He requested each of the members of the ‘Committee’ to describe in detail the basis on which the submitted claims ware verified and approved. The responses were as follows:
[a] Technical Professionals in the ‘Committee’ – We accepted the claims without any actual examination as we had full trust, confidence, integrity and honesty of the ‘Consultants’ and had assumed that the claims were properly computed. The basis of this assumption was that the claims had been prepared and certified as correct by the leading Architect who had a doctorate, possessed over thirty years of experience, was a respected leader in the profession and honored by the country. Based on this assumption the claims were approved and forwarded them to the Legal Professional;
[b] The Legal Professional cleared the invoices based on the assumption that computations had been examined and approved by the Technical Professionals;
[c] The chairman of the ‘Committee’ gave its approval without any examination as the claims had been cleared by the Technical Professionals and the Legal Professional;
[d] The Finance Director did not do any checking except to confirm that the claims were within the approved budget. His basis for approval was that the claims had been examined and approved by the Technical and Legal Professionals. He further stated that his scope of responsibilities did not include examination of the computation of the ‘Fees’ and also admitted that he did not possess the relevant expertise to examine the computation of the ‘Fees’ claims;
[e] The Chief Accountant prepared the voucher based on the approval by the Finance Director. The Chief Accountant also further stated that his scope of responsibilities did not include examination of the computation of the ‘Fees’ and also admitted that he did not possess the relevant expertise to examine the computation of the claims.
[f] The Chief Accounts Clerk prepared the check and forwarded it to the relevant signatories and then forwarded it to the ‘Consultants’ after updating the relevant records.
2.18 The lead ‘Consultants’ agreed to the ‘Auditor’s computation and admitted that there had been an over payment He further admitted that he personally did not prepare the claim invoices nor examine the ‘Fee’ computations as it was normally prepared by his Financial Clerk who had been doing this function for over twenty years and thus had assumed that the computations were done correctly. The ‘Client’ agreed to the ‘Consultants’ request that the overpaid amount be treated as an advance against final amount of ‘Fee’ due and payable as computed on completion of all works in the ‘Project’. In addition ‘Consultants’ would pay interest on the overpaid amount that would be computed based on the Base Lending Rate approved by the Central Bank of the country.
3.0 Conclusion
3.1 The above cases clearly illustrate weaknesses that exist in the construction industry:
[a] The ‘Client’ and the members of the ‘BOD’ and ‘AC’ and in-house Technical, Legal, Financial, Accounting and ‘IA’ professionals normally do not possess sufficient knowledge and expertise relevant to the various specialized aspects of the ‘Projects’.
[b] The in-house professionals generally show little interest in equipping themselves with the special knowledge and expertise that is relevant to the construction industry. It is perceived by them that there are few prospects for career advancement. This perception was supported during the past recessions when it was observed that many construction industries cut costs through either down sizing their ‘IAD’s through retrenchment or outsourcing the ‘IA’ function;
[c] Another reason could be the lack of support by the ‘Client’ for those who may be interested in acquiring/enhancing knowledge and expertise relevant to the various aspects of management, monitoring or audit of ‘Projects’ through the provision of reading materials or attendance in in-house/public training seminars where available. This view is based on personal experience of the writer during visits to construction industries and feedback from participants of in-house/public training seminars;
3.2 This article has used only two cases to illustrate the weaknesses as these cases received media coverage. There were many more such cases though of smaller monetary amounts that the writer had observed during his 37 years of experience of audit of ‘Projects’. The over-claims observed during audit were recovered when these were discovered where the ‘Projects’ were still under implementation or the final payments had not been paid to the appointed ‘Consultants’. However in cases where the over-payments were discovered after completion of the ‘Projects’ and full payments had been paid the ‘Clients’ preferred not to pursue the recovery action if the Technical Consultants were not willing to refund the computed over payments. The rationale of not taking any action was stated that any legal action will damage the reputation of the ‘Client’ and the legal action could be time consuming and the costs may not be recovered. Another contributory factor was the poor documentation to justify legal action.
3.3 The best action is for the ‘Clients’ and contractors to ensure that all payments are justifiable to prevent any possible over payments. This is only possible if the Managements, ‘BODs’, ‘AC’ members, the various professionals including the members of the ‘IAD’ involved in any aspect of responsibility of ‘Projects’ planning, management and implementation were to acquire knowledge/expertise/enhance that is relevant to their scope of responsibly/duties. Another important aspect is continued monitoring the financial and physical construction aspects of the ‘Projects’.
Monitoring & Verification Functions are Essential Components of
Quality Management of Construction Projects
[This Needs Knowledge, Expertise & Interest to Avoid Blind Trust]
GSK/Sept.09
Please provide feedback on this article below
The opinions, beliefs and viewpoints expressed by the various authors and forum participants on this web site do not necessarily reflect the opinions, beliefs and viewpoints of AuditNet®