After a New York-based real estate developer formed a joint venture with a local construction firm to rehabilitate a historic building, the construction manager quickly began exceeding the budget of the project. While some overages were justifiable – due to unexpected issues that arose on the project – the developer began to grow suspicious as the budget ballooned.

Concern only grew when the construction manager indicated he had $2 million in unbilled change orders that still needed to be processed. He then began to negotiate with the developer to apply for historic tax credits, but instead of sending the tax credits to the joint venture, he would retain the credits and not submit the change orders, simply adding it to the final value of the agreement.

“Obviously, this raised red flags with our client,” said Tom Niles, partner at Springline Advisory, a leading accounting and business consulting firm. “They engaged us to audit the project and to figure out if these $2 million in unbilled change orders were legitimate or not.”

The Springline team was also asked to investigate liens filed by subcontractors, as well as look at the underlying details and documentation to better understand the finances of the project.

Audit process reveals myriad issues

Springline had done work for the real estate developer in the past, primarily on the tax side, and the client was already aware of the firm’s forensic audit capabilities. The strong relationship built over the years made the selection process simple, Niles said.

“They didn’t even look at anybody else,” he said. “They basically called us and told us what they wanted, and we provided them with a scope of work.”

The Springline team began evaluating the project’s financial structure, which was based on percentage-of-completion billing: The lending bank appointed a representative to assess the monthly progress and approve a percentage that could be billed for that month.

While the construction manager was forthcoming with information throughout the audit process, Niles said much of the data wasn’t available electronically, requiring several site visits by Springline team members to review hard copies of documents.

“It was a tedious and sometimes mind-numbing process to work through,” Niles said.

After gathering accounting details for the subcontractors, the team began reconciling all expenses and discovered what the construction manager was being paid didn’t match what was being spent on subcontractor labor and materials.

“Things should match up pretty closely, even in a percentage-of-completion project like this,” Niles said. “But what was being billed really wasn’t corresponding to what was being billed externally or what they were receiving from the partners on the project.”

As subcontractors began finishing their portion of the project, the construction manager was running out of money.

“It had been front-loaded, and nobody was really sure where all of the funding had gone,” Niles said.

The team further scrutinized the $2 million in change orders and found issues with both the documentation and timing of the orders — even discovering that many of the requests had already been incorporated into prior bills.

“Many of the changes to the scope of the work were additive to the project,” Niles said. “But the areas they were being allocated to were actually under budget. They figured through the percentage-of-completion model they could just report their completion for different project areas. Basically, the total value of the project should have been at least $2 million lower than what they had reported.”

The team was also able to prove the construction manager had received money in excess of what he had been paying out to subcontractors, which was the reason for the lien filed against him.

Communication, expertise lead to successful engagement

Despite digging through financial data from nearly 30 subcontractors, the Springline team was able to quickly identify the root causes of the attempted fraud.

“Being able to eliminate all the noise and determine the weakness was the high point of the engagement,” Niles said. “Despite a complex process, it ended up being something as simple as reviewing the budgeted amounts and realizing where the problem was.”

Communication was a key reason for the successful audit, Niles said, along with the team’s ability to articulate the complexities of the audit.

“We were diligent in our communications with them about our progress and the barriers we were facing,” he said. “Plus, being able to explain the issues we uncovered and how it impacted them – and what was really happening with the project – made all the difference.”

Once completed, Niles said the construction audit led to an even larger engagement with the same client.

“This project really highlighted our ability to take an unusual and complex situation and work through it to deliver valuable results to our client,” he said.

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*Springline Advisory, LLC, is not a licensed CPA firm. Its affiliate entities, which are also not licensed CPA firms, provide tax, advisory, and other non-attest services to clients.  Springline Advisory, LLC and its affiliates operate in alternative practice structures with independent licensed CPA firms in accordance with the AICPA Code of Professional Conduct and applicable laws, regulations, and professional standards. Those independent CPA firms provide attest services to their clients. Audit and assurance services are provided by EFPR Group, CPAs, PLLC and EFPR Group Florida, CPAs, PLLC.