Psst... ...don’t tell the client!

Readers of a certain age will remember the classic advert in which a set of visiting robotic aliens view through their telescopes the image of a British housewife making mashed potato by hand. At the sight of this they all roll around, holding their metal bellies laughing like fools at the absurd actions of the backward humans. A moment such as this happened recently to me while conducting a contractor selection interview and the topic of open-book accounting was raised. The contractor, reacting to a question about the possibility of the open-book accounting process being open to abuse, opened his eyes wide and declared himself too naïve to consider such matters. My sides?

They almost split.

With the current prevalence of target cost projects and partnering, many more projects will adopt open-book principles - particularly as Efficiency Reviews and Gershon bite into public sector works. This is nothing new and is, in essence, a cost reimbursable or prime contract by another name. To the uninitiated, open-book accounting is a system where contractors demonstrate their actual cost of providing the works, by showing receipts, timesheets etc. to which is added an agreed fee, normally a blend of head office overheads and profit (HOOP). The theory is, of course, that they are unable to load the price to the client by including a variable HOOP element to individual items and everything is transparent and above board. Aren’t theories great?

Leaving theories aside, let’s look at some of the areas in which an innocent contractor and the trusting client may genuinely overlook a price leakage; or to you and me, a fiddle.

One of the first areas we need to keep a close eye on is that other great favourite of all things partnered; the supply chain. When Mega-Build Limited (MBI) orders its materials, it probably does so from one of its sister companies or a supplier who provides it with a healthy group discount at the end of each year. Such discounts should, under most partnering contracts, be credited to the client, not the contractor. The annual group discount can be hard to find and harder to assess as MBI may deal with this matter wholly outside the cost-reporting system used for an individual scheme, and usually argues they cannot work out how much of this discount should be attributed to the individual scheme. During tendering, it would be nice to identify which suppliers MBI has such arrangements with, or better still in a letter direct to the regional director ask if the company benefits from such agreements? Why not write to your contractors and ask them the same question?

On the same theme is the sister company and the internal arrangements many linked companies have for ordering, invoicing and charging materials and plant hire. While most tender packages require the divulgence of linked companies, most clients pay little attention to the fact that MBI buys all its glue from its sister company Brown & Sticky Ltd. The two companies may have any number of arrangements in place for dealing with such transactions, which will involve an accountant, a slide rule and an offshore company.

Through the net

Another slippery supply chain item is where the main contractor is working with the same subcontractor on a number of schemes, some of which may involve disputed items. In these situations a quid pro quo approach develops whereby a disputed item on another scheme is paid for, through the open-book scheme, by the submission of elevated rates. Since open-book accounting relies on the contractor submitting its receipts, vouchers, labour sheets and so on in its payment submission, it can put forward the elevated rates it has agreed with the subcontractor as its actual cost. Unless the client’s cost controllers have the time and resources to check on individual receipts, then this kind of problem can easily slip through. The project manager with authority under the contract to assess and certify payments must have the power to reject receipts which do not reflect the work or materials supplied. On a civil engineering project, a colleague performing an audit found that the contractor had submitted various invoices for the labourers’ costs that included a number of, ahem, top-shelf magazines! Even the most devoted partnering client has to draw the line somewhere, but when things have gone this far it does sharpen one’s interest as to what else has been declared as an ‘actual cost’.

Cost control staff need to keep an eye on the issue of wastage and credits. Any contractor can happily show you it has paid for 1000 kerb stones, but how many have actually been used on this project? Since open-book accounting relies upon actual cost being demonstrated rather than full re-measurement of works it can be very difficult on larger projects to assess what has been incorporated into the project, what has been wasted and what has found itself a new home! One of the cleverest men I know, an ex-bricklayer, recounts the story of how whenever his bricklaying gang started a new housing job one of them would approach the site foreman with the request for ‘20 bricks to build a small barbecue’. Every day, 20 bricks would be loaded into the van, and on that one occasion the security guard enquired about the bricks they would be pointed in the direction of the foreman. Yes, many a kitchen extension started life as a 20 brick barbecue.

Go on. define your ‘costs’

One of the most difficult areas to address for many open-book accounting projects involves the apparently innocuous definition of ‘cost’. In very simple terms the ‘cost’ is how much a contractor pays to obtain something and the ‘price’ is how much he will then provide that same thing for to the client including his HOOP. Most contracts list what is included in the term, ‘cost’ and will also define ‘disallowed costs’. For example the cost of labour and materials may be allowed but poorly executed work would fall under the disallowed cost heading. There is often a considerable difference between the way in which contractors and client’s systems record and deal with such information. The varying definitions of what are and what are not actual costs must be clearly established within the contract and the compatibility and format of the information provided by the contractor must be consistent with the needs of the clients cost control department.

many qss will shake their heads and mutter ‘that could never happen on my job’. well, whether by design or accident, it does

And what of ‘overheads’ for HOOP figures? Many anomalies can happen here, such as staff that are actually part of the company overhead, but then submit timesheets to the scheme. An organisational (organigram) chart is required to see who and what is an overhead and what ain’t. Similar problems occur when resources that might actually be covered by the overhead are charged to the scheme, or an internal plant hire charge turns out to be in excess of commercial rates.

Other elements falling within the overhead element of HOOP can include group resource plant and equipment. When such items are damaged, the client may be charged for repairs that are then claimed by the contractor through an insurance scheme. The client rarely, if ever, sees a credit of the insurance it may actually be paying for. Depreciation rates and maintenance charges can also find their way into actual cost and can tend to be heavier than normal or undertaken outside normal cycles.

In most open-book accounting projects on a target cost basis, the information required in the contractor’s application should include receipts for payments made, not invoices due. These can be considered accruals, and individual suppliers or subcontractors may be extending significant payment periods to main contractors. While the contractor may well have had the 1000 kerbs delivered, the question to ask is when will he actually pay for and use them?

If you allow him the apparent cost of a delivery now, which he will not pay until 60 days later, then you are effectively financing the scheme. And this is expressly excluded from many contracts. Paying on the basis of delivery sheets can miss the fact that the delivery price may not actually be the same as that paid in 60 days’ time.

Policing matters

Many quantity surveyors reading the above will shake their heads and mutter ‘that could never happen on my job’. Well, it is happening whether by design or by accident.

So how do we stop it? First up, the client must realise that its own cost control team will need to take the time to investigate contractors’ submissions. The trouble is, of course, that these will not resemble, or be controlled through, bills of quantities or standard methods of measurement.

Within such contracts it is common to use the gain/pain sharing feature. However, the true advantage of such an incentive cannot be realised if the target cost is continually moving upwards, and any change should not automatically trigger an increase in the target. So, include a ceiling price - the amount beyond which the client will make no further contribution. The combination of well-resourced cost control and a commercially drafted contract will help to avoid the kind of examples listed above.

‘But this is partnering,’ I hear you say. ‘What about trust?’ Well, let us remind ourselves that trust is a two-way street. And both parties must clearly demonstrate that they are prepared to walk down it.