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Wednesday , 30 July 2014
Accounting firm: widespread fraud in construction business

Accounting firm: widespread fraud in construction business

There’s widespread, even rampant, fraud in the construction industry. Hearing these words causes about as much shock as hearing that pop stars have a tendency to abuse drugs and alcohol. The average response is likely to be: no kidding. We tend to think in stereotypes, after all. But what you may not have considered is the fact that often the construction company is itself the victim of fraud, not the perpetrator. It’s a very complex, multi-layered business, with plenty of opportunity for deceit at every level.

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White paper on fraud in the construction industry says that the use of “undocumented cash” in transactions is one reason for the widespread fraud.

The forensic accounting firm of Nagel and Associates wrote about construction fraud last June and concluded by stating that “greed continues to be one of the primary drivers of fraud. As long as this remains the case, fraud . . . will continue to be perpetrated.”

Again, does the presence of greed as the prime motivational factor in fraudulent activity surprise anyone?

It’s important to remember, however, that failure and catastrophe do not define the fraud-friendly environment. Successful projects and profitable relationships are just as susceptible to fraud as unsuccessful projects.

Grant Thornton White Paper on fraud in the construction industry

Vigilance key to fraud prevention

A new white paper from the Toronto forensic accounting firm Grant Thornton notes that  greed, and therefore fraud, is likely to be with us for some time, so the best we can do is try to prevent it. To that end the paper lays out some of the particulars of the construction industry that make it peculiarly vulnerable to fraudsters in the first place. The usual perpetrators, “up and down the supply chain,” are “employees, property managers, general contractors, employees of joint venture partners, subcontractors, suppliers, and consultants.”

This list, and no doubt other categories could be added, points out the really complex nature of the construction business. Any project, even the building of a single house, involves numerous parties, each with its own opportunities for “padding” and otherwise defrauding. A large project—and currently there are more than a hundred high-rise buildings under construction in Toronto, with hundreds more in the pipeline—will require the input of hundreds of workers from potentially dozens of different companies.

A look at a “schedule of values,” the form used in the construction industry to outline work done and materials used in a given period, reveals the incredible number of suppliers, tasks and services required to put up a large building. A typical schedule of values could have upwards of 150 items: project management; water lines; rebar; structural steel material; foundation waterproofing; carpentry; insulation; painting; roof hatches; signs; boiler materials; gas piping; water heater; fire alarm install; light fixtures, to name just a few. Carrying out all of this work are general contractors, sub-contractors and even sub-sub-contractors. Many of them look at a large construction project as a giant cash cow, making them a fraud waiting to happen.

Add to all of these opportunities for fraud the various motives that arise, including: economic pressures that many firms face—there’s always the risk that the client, or a supplier, will go bankrupt, for instance. Also, construction firms tend to lack “proper monitoring/oversight and a transparent paper trail,” which at once invites fraudulent activity and makes it nearly impossible to trace. Then there’s the use of “large amounts of undocumented cash.” Need more be said about that? And the widespread practice of estimating contracts based on costs facilitates substituting cheaper materials or labour without changing those estimated costs.

How can any one honest individual maintain absolute oversight when so many workers (potential fraudsters) have so many reasons to be dishonest?

Whether the construction company is the perpetrator or the victim, the fraudulent techniques seem to be the same:

  • falsifying payment applications, where a project manager or accountant siphons funds from the project to pay him/herself via a dummy company
  • billing for work that was not done
  • bid rigging/price fixing, where companies collude in the bidding process
  • substituting lower-grade materials
  • stealing equipment, tools and materials
  • making false representations on a wide range of subjects including insurance, environmental compliance, test results and use of undocumented workers

Here are the “red flags” they identify as signs that you need to take a closer look at who is being paid for doing what on your construction project.

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Read the Grant Thornton White Paper here.

About Nicole Ryan Editor

I am Nicole Ryan, a contributing editor at Condo.ca—Canada's Condominium Magazine.

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