Building Blocks Laying the foundation for success in major capital projects Issue 12, August 2013 Value-added findings in vendor audit By Patrick Wetherup, Major Capital Projects Advisory, Calgary Vendor audits usually focus on identifying opportunities for cash recoveries due to overpayments and/or noncompliant charges. However, a second type of finding, referred to in this article as “value-added” findings, instead provides long-term value by preventing overcharges before they occur. Two major areas for value-added opportunities are process improvements and contract language improvements. Process improvements During an audit, an opportunity for process improvement could be identified in the vendor’s or the company’s processes. Improving specific processes by implementing solid cost controls can reduce the risk of approving incorrect charges. For instance, a company’s timesheet approval process may require two levels of authority. However, timesheets are periodically signed off without proper review. It is consistently found that second-level approvers rely on the approvals at the field level without adequate control to assure that the field-level review is thoroughly completed. If the field-level approver has not properly reviewed a timesheet, this can lead to potential risks, including duplicate charges, incorrect billings, incorrect employee classes and/or incorrect hourly rates. A value-added vendor audit can help ensure that both levels of approval are carried out, reducing the likelihood of incorrect timesheets getting though the approvals process. Improving document control and creating a solid retention system also allows for better controls throughout projects. In most contracts, agreed-upon rate sheets are used to determine billing rates for labour, equipment and other project-related controls. Poor document control processes can lead to missing or altered documentation and increased risk of incorrect billing activities. By creating a central document repository system, companies can help ensure that applicable contract information is stored and available upon request. Contract language improvements Strengthening contract language limits risk exposure, reduces underlying cash leakage and increases opportunities for cost recoveries. For example, language around government burden should clearly state that any overcharges are repayable to the company, based on maximum statutory amounts. Such contract clauses should be brought to management’s attention in an effort to develop awareness and limit cash leakage. A second example would be the definitions of specific terms within the contract. When important terms are not specifically defined, they are left open to interpretation, which can allow the submission of charges for incorrect items. A value-added finding will recommend specifically defining these terms, as well as what is and what isn’t permitted, to limit interpretation in these areas and thus prevent incorrect charges. Benchmarking studies have noted that 3% of contract spend is thought to be in error, of which only 50% is typically recovered. Value-added findings represent long-term opportunities to prevent overcharges and reduce risk exposure. • Managing the complexity of major capital projects in today’s economy has never been more challenging. Capital projects increasingly comprise a significant percentage of company spend and require particular focus on budgets, schedules and execution. • Ernst & Young's Major Capital Project Advisory practice has successfully worked with leading businesses to support the safe, predictable and competitive delivery of a wide range of global capital megaprojects. For each focus area, our experienced program management professionals, who consist of architects, engineers, lawyers, economists, accountants and construction management professionals with major capital project industry experience, can tailor delivery enhancements to the unique circumstances facing your project portfolio. • Our work spans the lifecycle of a construction project from planning and design through to completion. We work with our clients to develop the methodology, systems and control tools to address project challenges head on and also to allow for the realization of new opportunities along the way. • Our service includes business case assessment, contracting strategy and implementation, organizational design — roles, responsibilities and work breakdown allocation, project controls, reporting and governance, qualitative and quantitative risk assessment, commercial optimization — tax, marketing, foreign exchange management, cost control, as well as community, public and indigenous affairs.
Transcript
Building Blocks Laying the foundation for success in major capital projects
Issue 12, August 2013
Value-added findings in vendor auditBy Patrick Wetherup, Major Capital Projects Advisory, Calgary
Vendor audits usually focus on identifying opportunities for cash recoveries due to overpayments and/or noncompliant charges. However, a second type of finding, referred to in this article as “value-added” findings, instead provides long-term value by preventing overcharges before they occur.
Two major areas for value-added opportunities are process improvements and contract language improvements.
Process improvementsDuring an audit, an opportunity for process improvement could be identified in the vendor’s or the company’s processes. Improving specific processes by implementing solid cost controls can reduce the risk of approving incorrect charges. For instance, a company’s timesheet approval process may require two levels of authority. However, timesheets are periodically signed off without proper review. It is consistently found that second-level approvers rely on the approvals at the field level without adequate control to assure that the field-level review is thoroughly completed. If the field-level approver has not properly reviewed a timesheet, this can lead to potential risks, including duplicate charges, incorrect billings, incorrect employee classes and/or incorrect hourly rates. A value-added vendor audit can help ensure that both levels of approval are carried out, reducing the likelihood of incorrect timesheets getting though the approvals process.
Improving document control and creating a solid retention system also allows for better controls throughout projects. In most contracts, agreed-upon rate sheets are used to determine billing rates for labour, equipment and other project-related controls. Poor document control processes can lead to missing or altered documentation and increased risk of incorrect billing activities. By creating a central document repository system, companies can help ensure that applicable contract information is stored and available upon request.
Contract language improvementsStrengthening contract language limits risk exposure, reduces underlying cash leakage and increases opportunities for cost recoveries.
For example, language around government burden should clearly state that any overcharges are repayable to the company, based on maximum statutory amounts. Such contract clauses should be brought to management’s attention in an effort to develop awareness and limit cash leakage.
A second example would be the definitions of specific terms within the contract. When important terms are not specifically defined, they are left open to interpretation, which can allow the submission of charges for incorrect items. A value-added finding will recommend specifically defining these terms, as well as what is and what isn’t permitted, to limit interpretation in these areas and thus prevent incorrect charges.
Benchmarking studies have noted that 3% of contract spend is thought to be in error, of which only 50% is typically recovered. Value-added findings represent long-term opportunities to prevent overcharges and reduce risk exposure.
• Managing the complexity of major capital projects in today’s economy has never been more challenging. Capital projects increasingly comprise a significant percentage of company spend and require particular focus on budgets, schedules and execution.
• Ernst & Young's Major Capital Project Advisory practice has successfully worked with leading businesses to support the safe, predictable and competitive delivery of a wide range of global capital megaprojects. For each focus area, our experienced program management professionals, who consist of architects, engineers, lawyers, economists, accountants and construction management professionals with major capital project industry experience, can tailor delivery enhancements to the unique circumstances facing your project portfolio.
• Our work spans the lifecycle of a construction project from planning and design through to completion. We work with our clients to develop the methodology, systems and control tools to address project challenges head on and also to allow for the realization of new opportunities along the way.
• Our service includes business case assessment, contracting strategy and implementation, organizational design — roles, responsibilities and work breakdown allocation, project controls, reporting and governance, qualitative and quantitative risk assessment, commercial optimization — tax, marketing, foreign exchange management, cost control, as well as community, public and indigenous affairs.
Key stakeholders in the Canadian mining industry — from Northern Quebec to British Columbia — have faced ongoing turmoil in recent years, highlighting the significance of clearly defining roles and responsibilities in mining projects to minimize operational risks.
Risks overviewHighly volatile commodity prices, archaic practices, increasing production costs and scarce qualified resources have resulted in greater scrutiny from investors. Major hurdles have also been identified on the operational front, including business functions operating in silos, increasing demand for streamlined processes and lack of capital to support current operations.
Leaders in the industry are actively looking for ways to mitigate risks by closely managing production costs and strengthening project controls. On many open pit mining projects, controls are scarce, operational continuity is neglected and uncertainty is high. In addition, most mining sites are located in remote, unattractive locations, creating ongoing labour sourcing and retention challenges. Significant cost reductions often result from bringing corrective changes to obsolete operational processes, cost control methods and major cost drivers. A recent EY survey showed that proactive contract management can prevent up to 50% of future cash leakage.1
Project planning key to risk managementOver the last year, several Canadian mining organizations have reassessed their relationships with their engineering, procurement and construction (EPC) contractors in order to redefine roles and responsibilities. A lack of clear roles and responsibilities had led them to major cost overruns, as well as missed milestones and resource constraints.
A proper planning phase is critical to a project’s success. In 2013, the Metal Bulletin estimated that capital cost overruns are currently 50% of all projects. Leading practices suggest that, prior to the commencement of a project, roles and responsibilities should be clearly defined among the execution team’s stakeholders. Levels of authority and issue remediation processes are key discussion points to prevent potential misrepresentations. The execution phase should be structured around major milestones. A thorough assessment of current key performance indicators (KPIs) would most likely lead to cross-functional synergies, resulting in the standardization of processes as well as more effective project controls. Ongoing KPIs and controls alleviate the need for extensive audits to resolve outstanding issues during the closing phase.
On mining sites, cost reductions are primarily achieved by improving operational efficiency and strengthening project controls. However, prior to focusing on improving onsite activities, the execution team should ensure that roles and responsibilities are properly disclosed to all stakeholders. In many instances, owners fail to provide clear direction to their third-party collaborators. Segregation of duties should also be clearly stated prior to the commencement of a project.
In summary, clear definitions of stakeholder roles and responsibilities can help prevent major operational risks on mining sites. As owners are looking into opportunities to build effective project governance systems, strong planning initiatives will strengthen an organization’s efforts toward accountability, responsibility and transparency.
1 EY, Vendor Audit Benchmarking Survey – vendor and contract risk, June 2013.
The need for project governance to manage riskBy Myriam Gafarou, Major Capital Projects Advisory, Calgary
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About EYEY is a global leader in assurance, tax, transaction and advisory services. The insights and quality services we deliver help build trust and confidence in the capital markets and in economies the world over. We develop outstanding leaders who team to deliver on our promises to all of our stakeholders. In so doing, we play a critical role in building a better working world for our people, for our clients and for our communities.
EY refers to the global organization and may refer to one or more of the member firms of Ernst & Young Global Limited, each of which is a separate legal entity. Ernst & Young Global Limited, a UK company limited by guarantee, does not provide services to clients.
About EY’s Risk Advisory ServicesEffective risk management isn’t just about protecting your business – it’s also about making it better. We do this by helping you understand your business risks and developing plans for you to address them. The quality of our service starts with our 14,000 risk professionals. We harness their diverse perspectives and experience by bringing together a seasoned multidisciplinary team to work with you. We use both proven, integrated global methodologies and fresh perspectives in our work. And we work to give you the benefit of our broad sector experience, our deep subject-matter knowledge and the latest insights from our work worldwide. It’s how we make a difference.
For more information about our organization, please visit ey.com.
This publication contains information in summary form, current as of the date of publication, and is intended for general guidance only. It should not be regarded as comprehensive or a substitute for professional advice. Before taking any particular course of action, contact Ernst & Young or another professional advisor to discuss these matters in the context of your particular circumstances. We accept no responsibility for any loss or damage occasioned by your reliance on information contained in this publication.
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