construction industry update - spring/summer 2015

Copyright © 2015, Sikich. All Rights Reserved. www.sikich.com

Avoiding the 5 Most Common Types of Fraud in Your Construction CompanyBy Mary O’Connor, ASA, CFE; Partner, Sikich

Have you ever noticed how our culture seems to be fascinated with crime and policing? For generations, we have watched actors portray white collar detectives and criminals in media like Wall Street, Catch Me If You Can and White Collar. Perhaps part of what makes these shows and movies so entertaining is the fact that many are based on true stories.

Although many of these stories associate fraud with large enterprises, research shows it is extremely difficult to predict the organizations that can fall victim to fraudulent acts. As the leader of a construction company, it’s important to know that, regardless of the size and scope of your organization, there is always potential of facing fraud.

When looking at the numbers, the construction industry is far less susceptible to fraud schemes compared to industries such as banking and government. In fact, the Association of Certified Fraud Examiners’ (ACFE) 2014 Report to Nations noted that only 3.1 percent of all fraud cases occur within the construction industry, a decrease of 0.3 percent from the ACFE’s prior report. Also declining is the median loss construction companies take from these fraud incidents. But while the numbers are in fact improving, the median loss of $245,000 per incident is still overwhelmingly high.

Most often driven by financial and economic pressures, fraud within the construction industry can be committed by employees, subcontractors, suppliers or anyone else involved in your projects. Because of this, construction business owners and their management teams must understand the most common types of fraud to which construction companies fall victim.

1. Corruption: Making up nearly half of all construction fraud incidents, corruption is particularly prevalent in contract-heavy industries. When contracts are high in value or long in project length, corruption is often easier to conceal, making this an appealing opportunity for fraudsters.

2. Billing: The second-largest type of fraud in construction companies, billing fraud can mean a number of different things. Subcontractors can bill for underperformed or unperformed work, or invoice your company for inflated or non-allowable materials.

3. Check Tampering: This type of fraud accounts for more than a quarter of all construction fraud. When an employee engages in check tampering, he or she is simply altering or forging a check associated with the organization’s bank account. This type of fraud can often be avoided by entrusting more than one individual with accounting responsibilities.

4. Expense Reimbursements: Since employees and subcontractors are often responsible for purchasing materials and later expensing those materials, padded expense reports are common. In fact, they make up 27.9 percent of all construction fraud incidents. Learn more about creating accountable reimbursement plans at http://bit.ly/reimburse-plan.

In This Issue

Avoiding Fraud ....................... 1

Effectively Managing Cash Flow .................................. 2

Employing Independent Contractors .............................. 3

New Revenue Recognition Standard .................................... 4

Research Tax Credit ............. 5

Succession Planning .............. 6

Construction UpdateThought Leadership Experts

Spring/Summer 2015

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5. Non-Cash: The fifth most common type of construction fraud lies in stealing non-cash assets for personal use, including materials, equipment and tools. Keep an eye out for employees or subcontractors who purchase any of these, but have them shipped to an unfamiliar address.

This list is not necessarily an all-encompassing list of fraud that can occur within construction companies, which is why it’s crucial to have your key leaders understand identifying, handling and protecting against fraud. Learn more about our fraud services at sikich.com/dispute-advisory.

Mary can be reached at [email protected] or 312.648.6652.

Avoiding Fraud, continued...

Construction Update – Spring/Summer 2015

Copyright © 2015, Sikich. All Rights Reserved. www.sikich.comCopyright © 2015, Sikich. All Rights Reserved. www.sikich.com

With the increased backlogs of many contractors, it’s as important now as it’s ever been before to plan for and manage your cash flow. More contractors go out of business due to a lack of cash as opposed to backlog or profit. Cash can fuel your growth—lack of it will hinder your ability to grow and take on work.

Largest Effects on Cash Flow

The largest impact on your cash flow is a result of contract negotiations and understanding the owner or general contractor you’re working with prior to bidding. Is the owner or general creditworthy, do they pay on time and do they often have chargebacks? Jobs usually require significant upfront costs. Negotiating the contract to reflect such and negotiating payment terms can help your cash flow. Develop a relationship with the owner and the person responsible for payables to have an open line of communication regarding payments.

� Negotiate Retainage: A 5 to 10 percent retainage may be higher than the overall gross profit on a job, and collecting that on the back-end of a job can be a drain on your cash flow. Try negotiating your retainage percentage downward to reduce the impact on your cash flow or negotiate a phase-out of the retainage over the life of the project.

� Change Orders: Change order language should be part of any of your contracts and is an important factor to ensuring you get paid. Be sure to identify change orders early on in the process and discuss them promptly. Obtain a signed change order as soon possible to help ensure payment for work you’re performing.

� Overbillings: The ability to frontload your schedule of values and be responsibly aggressive in overbilling can significantly improve your cash flow. Any overbilling on a project greater than the anticipated gross profit (referred to as job borrow) should be in the bank. Issue your billings timely including for stored materials, when applicable. There is no good excuse for an underbilling.

� Punch List and Contract Close-Out: Don’t let retention kill your cash flow. Create your own punch list every few hundred man hours to speed up the contract close-out and hope to avoid the old adage of the last 10 percent of the contract taking 20 percent of the time. Strive for a quick close-out of a project

that should also keep the customer happy and lead to quicker collection of your money.

� Budgeting: A good starting point for a budget should be anticipated revenue, which can be estimated using the volume of work you’re bidding on multiplied by your average win percentage, factoring in your current backlog and factoring out any work that may not be completed until future periods. You should also factor in the market and aligning your budget with your business’ strategic goals. For cost considerations, factor in your average gross margin, direct cost trends, labor burden, administrative overhead and sales and marketing expenses. Consider any changes you plan on making in your business including adding staff, purchasing new equipment, pay raises, health insurance costs, etc.

Cash flow should be forecasted and monitored at the project level. For specific projects, anticipate the timing of job expenditures and cash inflows from billings in order to determine whether your company can take on additional work or will need additional financing to be able to take on additional work. You should know how much work you will do each month, how much you are allowed to bill for, when you will collect your retention, whether it will be necessary to use your line of credit and when you can pay it down. If you don’t understand your cash flow timing, you won’t know if you can take on additional work responsibly. Individual project cash flow forecasts can be compiled for building a cash flow budget. Also, consider capital budgets and general and administrative budgets.

� Other Strains on Cash Flow: An additional strain on cash flow can include ignoring or not paying close attention to the aging of receivables. Furthermore, high fixed costs for equipment can hinder your company. Consider leasing or renting equipment if you don’t plan on fully utilizing the equipment during the year.

Effectively managing cash flow can make or break the success of your construction company. By taking the steps outlined above, you will more likely have the ability to leverage opportunities for growth. To learn more about our expertise in helping construction companies manage cash flow, visit sikich.com/accounting-audit-tax.

Casey can be reached at [email protected] or 262.754.9400.

Effectively Managing Cash Flow to Fuel GrowthBy Casey Malek, CPA, CCIFP; Senior Manager, Sikich


In addition to hiring traditional employees, organizations can meet their staffing needs through a variety of alternative arrangements. One more popular option, particularly in the construction industry, is hiring individuals as independent contractors.

Perhaps the most basic question about the employment relationship is whether a worker is, in fact, an employee or independent contractor. As with so many employment law issues, the answer is, “It depends.” In this case, it depends who is asking: the U.S. Internal Revenue Service (IRS), the U.S. Department of Labor (DOL), a workers’ compensation hearing officer and so on. Even courts have admitted that the distinction is not always clear.

Employee status triggers employer obligations under various federal and state laws that do not apply to independent contractors, and the responsibility for classifying a worker correctly falls squarely on the employer. Accordingly, organizations must understand the practical and legal differences between employees and independent contractors.

The Staffing Decision: Employees or Independent Contractors?

Construction companies cannot use independent contractors indiscriminately to avoid the tax, equal employment opportunity and other legal requirements applicable to employees. Organizations face significant risks when they improperly classify a worker as an independent contractor when, under all the circumstances, that worker should be treated as an employee.

Accordingly, an employer should consider a variety of factors—none of them in isolation—in deciding whether to meet a staffing need by means of independent contractors versus employees. Weighing the requirements of the job in combination with other factors will enable the employer to judge whether an independent contractor will both meet the employer’s staffing needs and withstand legal scrutiny.

Factors to consider include:

� Duration� Exclusivity � Control � Independent judgment� Specialized knowledge,

training or experience� Importance of marketing� Exigent circumstances� Business essentials� Employees doing

the same job

� Industry standard � Controlling administrative

overhead� Legal ramifications

of misclassification� Tax consequences� Workers’ compensation� Unemployment

compensation� Wage and hour liability� Vicarious liability

How to Classify Properly

Classifying a worker as an independent contractor should always be an informed and bona fide business decision, not an opportunity to avoid the employer’s obligations to employees. Independent contractor arrangements have drawn increasing scrutiny and significance with the proliferation of workplace laws covering employees and the growth of the contingent workforce. Misclassification of an individual as an independent contractor can give rise to a variety of liabilities.

Tests for Independent Contractor Status

No legal test applies in every situation when deciding to classify a worker as an independent contractor. For example, the IRS and DOL use different, although similar, analytical frameworks. In fact, the multiplicity of tests defining independent contractor status applied across federal and state laws makes it possible for a worker to be classified as an independent contractor “under one law, but as an employee under another.” The specifics related to these test can be located by visiting the specific agency’s website.

Effective Practices

Construction companies can take a number of proactive steps to ensure they effectively use independent contractors within the bounds of the law:

� Involve HR upfront in making a decision whether to meet a staffing need through independent contractors or employees and in making sure the arrangement qualifies as a bona fide independent contractor relationship.

� Use written independent contractor agreements containing language that helps establish the bona fides of the classification as an independent contractor.

� Adopt a formal policy concerning the use of independent contractors.

Employing Independent ContractorsBy Joy J. Duce, SPHR; Senior Managing Director, Sikich

continued...


� Use a checklist to make sure all details regarding management of independent contractors are being handled.

� Do not treat independent contractors like regular employees, but do ensure they understand and adhere to the organization’s policies and procedures.

No bright-line test exists to determine when a worker should be classified as an employee rather than as an independent contractor. However, a wealth of information is readily available

to help organizations make the necessary case-by-case determinations. Once the decision has been made to meet a staffing need through independent contractors, organizations can take a number of practical steps to manage independent contractors effectively.

Learn more about how Sikich can help with the intricacies of employing independent contractors by visiting us at sikich.com/hr.

Joy can be reached at [email protected] or 262.754.9400.

It has been approximately one year since the Financial Accounting Standards Board (FASB) issued its sweeping change to the recording of revenue for U.S. Generally Accepted Accounting Standards (USGAAP) from the rule-based model broken down by industry to the one comprehensive principal based model covering substantially all industries.

Effective Date of New Standard Postponed

Many implementation issues still need to be addressed, and for that reason, both the FASB and its international counterpart, the IASB, have proposals to postpone the effective date of the new standard for one year for both public and nonpublic entities. We believe the proposals will be adopted as early as June 2015. The new effective dates, which we believe will be enacted, moves the effective date for public companies to periods beginning after December 15, 2017 and for nonpublic companies to periods beginning after December 15, 2018.

Financial Reporting Standards for Contractors: Changes are Coming

While this deferral will benefit everyone from an implementation standpoint, we are encouraging all of our clients and friends to use this time wisely to prepare their businesses for a smooth transition. For our construction clients, there was an initial fear that the long-time honored percentage of completion method of accounting was going to be scrapped; it was not, but new complexities are added to the revenue recognition process. Some of these complexities include:

� Is revenue recognized when the performance obligation is completed or as the performance is being completed?

� Is there more than one performance obligation in a contract which needs to be accounted for separately?

� What additional footnote disclosures will need to be included? (Yes, expect as least some enhancements to current disclosures.)

� When and at what value do you recognize revenue or costs for:

• Unpriced change orders?

• Contract awards and bonuses?

• Contract penalties and claims?

• Uninstalled materials and fulfillment costs?

• Capitalization of incremental costs to obtain a contract?

Some areas may require little if any changes such as the method for recognition of losses on construction contracts.

Impact on Income Tax Reporting

There will also be tax implications, as these changes will certainly increase the number and amount of differences between financial statement and tax income. Already there are a number of differences between financial statement and income tax reporting, and the addition of the aforementioned complexities along with others will certainly add to the reportable differences.

Other Operating and Financial Impacts to Consider

Contractor financial statements are often confusing to infrequent users, and the new standards will potentially add additional challenges to the users of contractor’s financial statements. Many financial institutions have substantial challenges in the understanding of the accounting principles used in the industry. This will lead to a need to review traditional banking financial covenants, debt repayment requirements based on various formulas that may be impacted by the changes, and employee performance incentives based on net income, contract gross profit and revenue.

Transition Period Reporting

Because of the complexities of revenue recognition, contractors should consider all of the options available in the preparation of their financial statements. As part of the transition to the

New Revenue Recognition Standard Update By Bart Adams, CPA, CGMA; Partner, Sikich

Employing Independent Contractors, continued...

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Construction Update – Spring/Summer 2015


new standard, every year presented will need to be reviewed for required changes to the reported revenue and expense items and balance sheet items. This change will also impact the beginning balance sheet for the one-, two- or three-year periods presented. For many of our clients, a possible alternative includes a single-year presentation, as that would eliminate looking back and making reporting adjustments to more than the beginning balance sheet items for the current year to be reported.

While you may feel some relief with the potential to postpone the adoption of these new GAAP standards, we encourage

you to review the changes that will impact you and, with your team, develop your business’s plan of action to meet these new effective dates.

Read more about the new revenue recognition standard in our white paper, Strategizing for Global Financial Changes: 8 Steps You Can Take Now to Prepare for the New Revenue Recognition Standard, at sikich.com/strategizing-for-global-financial-changes.

Bart can be reached at [email protected] or 262.754.9400.

In today’s competitive construction industry, businesses are constantly striving to improve and develop new ways to succeed. Firms look for ways to gain market share and create a niche; if not, they could soon be on the outside looking in. Congress decided to reward these efforts in the form of the research and development tax credit (“R&D credit”). Awareness of this credit may reduce a taxpayer’s overall income tax liability, and thus trim the cost of overall research expenditures.

Historically, taxpayers have found the R&D credit difficult to use and calculate. In recent years, however, new tax laws and IRS regulations have broadened the availability of R&D credits by expanding the expenses allowed in computing the credit and simplifying the calculation of the credit (Please note: The R & D credit temporarily expired as of December 31, 2014, which has happened numerous times over the past 30+ years of the credit. It is likely, however, that the credit will be extended retroactively back to January 1, 2015 at some point this year.)

The R&D credit is not just for those in the computer and technology industries; it can also apply to construction businesses. For tax purposes, the IRS’ rules define research to include development of new customer products, improvements on existing customer products, the improvement or development of a process, software development and many others. The new process or product that is developed must only be new to the construction company as a taxpayer, and not to the construction industry as a whole. Research expenditures from both successful and failed projects can be used to calculate the R&D credit. Some possible applications in the construction industry could include: development of electrical or plumbing systems; LEED project design and certification; HVAC system design; development of energy-efficient systems; structural design for highway infrastructure; development of alternative building materials; and other activities involving the development of a new product of process.

To calculate the R&D credit, taxpayers must identify its “qualified research expenses” (“QREs”). QREs must contain the following three elements to secure any R&D credit: process of experimentation, technological in nature and new or improved business component.

Once the research project meets the above subjective tests, the project costs are further evaluated as only certain costs qualify as QREs. QREs include wages of personnel involved (often engineers, architects and designers, but can include some clerical support staff and even some supervision), supplies used in the project and 65 percent of “contract research” if certain conditions are met. It is critical for taxpayers to document their QREs; an R&D credit is allowed only if the business has adequate documentation. Once the research projects are identified and QREs are determined, the next step is to calculate the R&D credit, and this calculation recently changed. The R&D credit using the new “alternative simplified credit” (“ASC”) method is calculated as follows: 14 percent of the excess of current year QREs over 50 percent of the average QREs for the previous three years. While the original method is still available, many taxpayers find the ASC calculation to be less complex. Additionally, the ASC method does not require an increase in QREs to receive the credit.

With the variety of activities qualifying for the R&D credit and with the simplification of the credit calculation, the R&D credit is more attractive to taxpayers than in the past. In addition, many states also offer their own R&D tax credits (some Midwestern states with R&D tax incentives are Wisconsin, Illinois, Indiana, Iowa, Missouri and Minnesota). Construction businesses should analyze their operations to identify R&D projects and the costs associated with these projects to determine any available tax incentives.

Jim can be reached at [email protected] or 262.754.9400.

Research Tax Credit: One More Item for Your Tax “Punch List” By Jim Brandenburg, CPA, MST; Partner, Sikich

New Revenue Recognition Standards, continued...

1415 W. Diehl Road, Suite 400Naperville, Illinois 60563

Is Your Business Prepared for the Unexpected?By Joe Kulek, CPA, CCIFP, MBA; Partner, Sikich

Business owners often spend so much time pouring sweat and tears into managing their company they forget to plan for the future. Exiting a business can be almost as complex and challenging as starting one. In many cases, business survival may depend on succession plans implemented long before the owner actually leaves the company.

Succession planning begins with four fundamental questions that help define your planning objectives:

1. Who do you want to own and manage the business?

2. How much longer do you want to work?

3. What income will achieve your desired lifestyle?

4. How can you transfer ownership in a tax-efficient manner?

A construction owner might choose to do one of several things as they exit the company. They could outright sell it to someone else, transition it to key employees, transfer it to family members or shut it down. There is no “one right way” to exit a business. It’s a personal decision for the business owner that should take

into account financial, legal, tax and personal issues, as well as guidance from trusted, experienced professionals.

We work with construction clients to help them answer these questions, protect the value of their business and structure a tax-efficient exit. In our planning process, we consider what steps need to be taken to protect the business value, including taking care of key employees or addressing other risks that could significantly impact its value. Business succession planning can be complex; thus, it is critical to identify the appropriate team to assist in achieving your objectives.

It is never too early to start the planning process. Plan for the unexpected. This includes a buyer or strategic partner unexpectedly approaching you with an opportunity that you may want to pursue. However, if you haven’t addressed all business risks and other planning issues that would arise in due diligence by this buyer or strategic partner, you may miss the opportunity of a lifetime. Plan for the unexpected now in order to relax and let go later.

Joe can be reached at [email protected] or 217.862.1858.

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