Divider
Divider

Steven Hazel
Steven Hazel
 

CPAs Gamble on Vegas Accounting Fraud

How a standard litigation assignment, used in tandem with forensic accounting, uncovered fraudulent practices in a construction engagement.

September 28, 2009
by Steven Hazel, CPA, ABV

Forensic accountants are often retained to support special investigations related to a broad range of subjects. A number of skills and techniques are required to investigate and reconstruct facts, which are especially helpful in litigation assignments. In previous articles, I focused on the use of forensics in business valuation, but these same forensic skills and techniques apply to litigation engagements as well.

The following case study illustrates how a standard litigation assignment, used in tandem with forensic accounting, uncovered fraudulent practices in a construction engagement.

Case Study

RGL Forensics was engaged to perform a cost audit of a large resort under construction in Las Vegas. The project consisted of a large hotel and casino, including a spa, fitness center and convention facilities. When we were hired by the resort owner’s attorney, the project was substantially over budget. We were brought in to provide the owner with a clear financial picture of how and where the money was going.

As part of the engagement, RGL requested the standard construction cost overrun contractual and financial documentation. We began with a review of the construction contract between the owner and the general contractor. In these matters, the construction contract may be on a gross maximum price (GMP) or cost-plus basis, sometimes referred to as a time-and-materials (T&M) job. This particular case had a GMP construction contract, in which the general contractor was responsible for all the work to be completed, but assigned various tasks to subcontractors for completion of the work. Each individual subcontractor (Sub) had a contract with the general contractor (GC). The Sub’s work could be on a GMP or T&M basis, but it could differ from one subcontractor to another.

In addition to the construction contract itself, the second most important document we review in these matters is the general contractor cost report that details all costs for the specific construction project. A cost report is similar to a general ledger, but compiles job costs and does not include asset, liability, equity, revenue and expense categories. Costs are normally categorized by area of work, such as structural, plumbing and HVAC (Heating, Ventilating and Air Conditioning), with each subcontractor invoice listed separately by date, amount, purpose, etc. In addition to the general contractor’s cost report, each subcontractor maintains their own cost report with the same type of detail in order to summarize their costs.

After reviewing these contracts, we analyzed the actual costs expended and compared them with budgets prepared prior to the start of the project, including “updates” to the budgets completed as the project progressed. While construction project cost overruns may occur for a variety of reasons, including acceleration, disruption, defects, etc., scheduling issues are typically the predominant factor driving up costs. One of my favorite sayings is: “What else is there but costs and schedule, if we can keep those in line, there is no problem.” This is particularly true in construction scenarios.

Our next task was to complete a schedule of all the GC billings or pay applications (Pay Apps), for the project. We also summarized the GC change orders, which are standard even in a GMP environment, as changes in the scope of the project, betterments during the construction and other unanticipated issues occur. Included in the schedule was an analysis of each subcontractor, comparing their original scope of work and anticipated cost. While several subcontractors were flagged for additional analysis, one subcontractor stood out above the rest. He was responsible for fireproofing and his original budget was approximately $1 million. The subcontract was a GMP contract, but multiple change orders had been submitted and approved that increased his cost to almost $3.5 million — more than three times his original budget!

With red flags raised, we consulted with the attorney and requested additional documents from this subcontractor. Because the change orders he had submitted included T&M charges, we requested to review employee timesheets for documentation in regard to the number of billed labor hours. 

We had our work cut out for us when multiple boxes of timesheets as well as volumes of electronic information arrived at the attorney’s office. After extensive review, we were able to prove that a good portion of the timesheets were false. Some timesheets related to the subcontractor’s other jobs, while in some cases the job name was literally “whited out” and changed. Other timesheets had been submitted twice and still others even had names of fictitious employees. In several cases, timesheets did not have the required signatures of employee and supervisor and it was evident that hours on particular timesheets had been manipulated.  Armed with this evidence, we quantified an estimate of the overstatement of the direct labor. Not only did the construction project owner get his cost audit, but he also discovered he had a fraudulent subcontractor on hand. This unexpected development enabled him to bring a case against the subcontractor and the attorney eventually settled the matter to the owner’s benefit.

Conclusion

As part of this standard litigation engagement, RGL Forensics could have accepted historical financial information available without further investigation. However, a forensic accountant’s job is to investigate and analyze all available financial information to determine its accuracy and completeness.

Rate this article 5 (excellent) to 1 (poor). Send your responses here.

Steven J. Hazel, CPA, ABV, CFF, ASA, CVA, CMC, is a partner in the Denver office of RGL Forensics.