What is construction fraud: Identify likely fraud schemes and develop internal controls to reduce risk.
One particular statistic keeps many construction business owners and executives up at night: a typical case of fraud within the construction industry has a median loss of $245,000.
This is based on the 2014 Report to the Nations issued by the Association of Certified Fraud Examiners (ACFE) on occupational or internal fraud.
The report further indicated that the construction industry’s median loss is approximately $90,000 higher than the average fraud loss across all industries. It is critical for construction companies to diligently examine possible windows within their organization that would allow such fraud schemes to happen.
Types of Construction Fraud
A company should identify the likely fraud schemes they face and understand how to mitigate them. Listed below are many schemes frequently used to defraud construction companies.
Billing schemes —The ACFE report indicates that billing schemes account for 35 percent of the fraudulent activity within construction companies. These schemes can be payments to fictitious vendors, overpayment to vendors and purchase of personal items with various company funds.
Theft—Construction is particularly susceptible to theft of materials due to the location of jobs and the difficulty of tracking materials and equipment. Jobsites can be located in remote areas and subject to less supervision. Additionally, materials on jobsites are hard to track during the construction process. Items like lumber, concrete, copper pipe, wire, and cable can create an easy opportunity for thieves if proper controls are not in place.
Misuse of company equipment — Misuse of company equipment can also become an issue if there is a lack of controls present.
Bid rigging and corruption —Con-tractors are subject to the risk of bid rigging and other forms of corruption. In the ACFE study, nearly 47 percent of the fraud cases examined had an element of corruption. Whether it be bribery, kickbacks or quid pro quo situations, the bid process can be riddled with opportunities for this type of fraud.
The Importance of Internal Controls
A company must design a control structure that will reduce the opportunity for fraud and increase the chances that fraud will be detected. The foundation of a strong internal control environment is proper segregation of duties. For example, the person in charge of setting up vendors should not also be the person approving vendor payments or reconciling bank statements. Moreover, the payroll clerk should not be the same person who disburses paychecks. Proper segregation of duties like this should apply to all areas of business and can be employed effectively at little to no cost.
The following are simple, effective internal controls leaders can implement:
- Check all estimates for the accuracy of calculations, labor rates and correspondence with drawings.
- Compare job-cost estimates with actual costs. Require approvals for cost adjustments or transfers of costs.
- Require that all material estimates above a specified amount include quotes from two or more vendors.
- Make purchases only with pre-numbered purchase orders and match them to both receiving reports and invoices before payment is made.
- Check invoices against estimates to ensure proper discounts and pricing.
- Always refer to specific job numbers, phase codes or work order numbers in on-site communications.
- Obtain ink or electronic signatures on change orders before work begins, and revise contract values accordingly.
- Allocate equipment usage to contracts weekly and record maintenance expenses in the ledger as they occur.
- Review all billings for timeliness, accuracy and conformity with contract terms and correct customer information.
- Reconcile contract billings with general ledgers monthly and calculate under billings and overbillings.
- Prepare and review financial statements monthly and reconcile them to supporting ledgers, bank statements, and loan schedules.
Know the Signs
The profile of a fraudster can be as important to know as the typical fraud schemes employed themselves. Per the ACFE, a repeat offender typically does not perpetrate fraud. In fact, only 5 percent of fraudsters had been previously convicted of a fraud-related offense before committing the crimes examined in the ACFE study. This shows that while background checks are useful in screening out some bad applicants, they might not be effective in predicting fraudulent behavior.
Most fraudsters have been employed for more than one year before committing fraud, so understanding risk factors and warning signs of fraud are more likely to identify fraud than pre-employment screening. Fraudsters might display some warning signs, such as living beyond their means or having unusually close associations with vendors or customers. Train and inform leadership to recognize these warning signs.
Protect Your Company’s Reputation
Ultimately, there is another benefit to having a strong corporate culture focus-ed on ethical behavior: your company’s reputation. Whether it is the presentation of financial statements, interactions with suppliers or the day-to-day actions of employees, companies should operate under a code of ethics that builds their reputation in the community.
How eSUB Can Help
eSUB is a cloud-based project management platform built especially for subcontractors. It seamlessly integrates with leading construction software systems so you can easily switch from your current RFI process to a cloud-based system to upgrade RFI process.
eSUB organizes all of your project information in one place, allows for smooth collaboration, and streamlines communication through its intuitive interface. It also works on your mobile, so you can track projects on the go—no matter where or when—and stay up-to-date.
About the Author
Ken Van Bree, CPA, is a partner in charge of the Construction Services Group at RubinBrown.