Do You Need a Construction Overrun Investigation? by Joel Glick, CPA/CFF, CFE, CGMA
Posted on August 17, 2022
While construction cranes continue to dot the skylines of cities across the world, the construction industry is facing a challenging time. Soaring demand for projects are being hampered by rising costs of construction materials, delivery delays due to supply chain disruptions and a shortage of skilled laborers.
In this environment, real estate developers, building owners and construction contractors must keep a keen eye on both their initial budgeted costs and the actual expenses that can accrue throughout a project’s development. Inaccurate estimations prior to the commencement of work can lead to an avalanche of change orders that can lead to significant scheduling delays and cost overruns. In some cases, one or more parties may file legal claims against the others to recover the costs above the contracted prices. However, before allowing overruns to escalate to this point, project owners should consider the benefits of engaging construction consultants/engineers and forensic accountants to conduct a construction overrun investigation.
This type of investigation involves examining the underlying project records along with the accounting records to identify and quantify the source(s) of higher-than-expected costs and its impact on the total project budget. These studies may further assist in improving communication and relationships between owners and contractors, and, in extreme cases, help to demonstrate a causal link between a party’s action or inaction, and a loss, which is required to recover damages in legal proceedings.
Sources of Construction Overruns
The reasons why a construction project can exceed estimated budgets and result in a considerable number of change orders are vast. Examples of the most common causes include:
- Design and scope changes
- Field conditions
- Fluctuations, especially increases, in the costs of labor, materials and equipment
- Poor workmanship
- Poor record-keeping
- Product defects
- Labor productivity
- Unexpected costs
- Inaccurate budgeting and/or method of cost estimation
- Code revisions
- Intentional fraud and corruption
When project costs exceed the estimated budget, it is usually the result of a combination of the above factors, especially in a construction project with so many moving parts. Identifying the cause is not always simple and sometimes there are competing causes. However, when performing a construction overrun investigation, professionals can conduct a complex process of assessing the underlying documentation involved in a project, identifying, and separating the potential sources of an overrun and prioritizing them by degree of causation.
Quantifying Cost Overruns
Whereas a qualitative analysis of cost overruns helps to identify how and why they occurred, a quantitative analysis of cost overruns aims to assign a dollar value to them. The process of quantification can be likened to finding a needle in a haystack, as it often requires exhaustive reviews of voluminous amounts of project records stored both digitally and in hard copies. Diligence and attention to detail are key and require the skill of experienced forensic accountants working together with construction engineers to identify the underlying causes of cost overruns and apply sound financial strategies to quantify claims and determine if excessive costs are appropriate and justified.
For example, a developer may claim that cost overruns resulted from excessively high expenses incurred for a crane operator. Demonstrating such a claim requires not only going back and reviewing the number of hours the crane was in use and the related charges for labor, but also comparing those assumptions against the facts relating to the time of the year and weather conditions during use. If the crane were used during the fall or the winter months when daylight hours are limited, it would be unreasonable for a project to incur excessive costs for labor to operate it beyond daylight hours. Costs may also be considered unreasonable if weather conditions on the dates the crane was purported to have been in operation were so severe that use would have been hindered.
Similarly, a developer may set out to make minor renovations to an existing property at a modest budget. However, as work progresses, the developer may decide to expand the scope of the project, make substantial renovations, and even reposition the property for a different use. Realistically, the developer will expect an increase in the initial project budget. However, not all subsequent cost overruns and schedule delays will be a result of the developer’s commitment to do more work. A cost overrun investigation that reviews schedules and accounting records will point to how the budget changed over time, identify where increased costs were justified and where they were inappropriate and allocate a dollar value for each.
Construction overrun investigations are complex and time-intensive endeavors. However, the benefits they provide to property developers, real estate owners, operators and contractors can go a long way to identify budget traps, improve scrutiny of change orders and improve cost efficiencies into the future.
About the Author: Joel Glick, CPA/CFF, CFE, CGMA, is a director in the Forensic and Advisory Services practice with Berkowitz Pollack Brant, where he serves as a litigation consultant and expert in forensic accounting matters relating to bankruptcy and receivership, economic damages and forensic investigations. He can be reached at the CPA firm’s Miami office at (305) 379-7000 or via email at firstname.lastname@example.org.