Here’s an attention-getting statistic: A typical case of fraud in the construction industry has a median loss of $227,000, according to the 2018 Report to the Nations issued by the Association of Certified Fraud Examiners (ACFE) on occupational or internal fraud. This report further showed that the construction industry’s median loss is approximately $119,000 higher than the average fraud losses across all industries.

Construction companies are most at risk for fraud related to corruption (such as bribes and kickbacks), billing related schemes, expense reimbursements, check tampering and equipment or material theft.

This brings up three important questions:

• What are the fraud schemes affecting your company?
• How can contractors keep their companies from experiencing these types of fraud?
• What is the profile of fraudster?

The threat of fraud can never be wholly removed; however, companies should take steps to identify likely fraud schemes they might face. Below are a number of schemes frequently used to defraud construction companies.

1. Bid Rigging and Corruption

Contractors are subject to the risk of bid rigging and other forms of corruption. In the ACFE study, 42% of the fraud cases examined in the construction industry had an element of corruption.

Whether it was bribery, kickbacks or quid pro quo situations, the bid process can be riddled with opportunity for this type of fraud.

2. Billing Schemes

 The ACFE report indicates that billing schemes account for 37% of the fraudulent activity in construction companies.

The schemes can be payments to fictitious vendors, overpayment to vendors (often through collusion with an internal employee) and purchase of personal items with company funds.

3. Expense Reimbursements

The construction industry is subject to the same fraudulent activities faced by almost every other industry when it comes to expense reimbursements. Overstated expense reports accounted for 23% of fraudulent activity found in construction companies.

4. Theft

The construction industry is particularly susceptible to theft of materials due to the location of jobs and the difficulty of tracking construction materials. Jobsites can be in remote areas or some distance from the corporate headquarters and subject to less supervision.

Additionally, materials on jobsites are hard to track and measure during the construction process. Items lying around a jobsite such as lumber, concrete, copper pipe, wire and cable can create an opportunity for thieves if proper controls are not in place.

5. Misuse of Company Equipment

Similar to theft of materials, misuse of company equipment can also become an issue if there is a lack of controls present. For instance, an employee could operate a side business using a company’s idle equipment.

The Importance of Internal Controls

 A company must design a control structure that will reduce the opportunity for fraud and increase the chances fraud will be detected. Although there are no guarantees related to fraud, the foundation to a strong internal control environment is proper segregation of duties.

For example, the person in charge of setting up vendors should not be the person who approves vendor payments or reconciles bank statements. Moreover, the payroll clerk should not be the same person who disburses paychecks.

Proper segregation of duties applies to all areas of business and can be employed effectively at little or no cost.

Here are some other simple yet effective internal controls that can be implemented with relative ease.

• Check all estimates for accuracy of calculations, labor rates and correspondence with drawings.
• Compare job cost estimates with actual costs. Require approvals for cost adjustments or transfers of costs between jobs.
• Require that materials estimates above a specified amount include quotes from two or more vendors.
• Make purchases only with pre-numbered purchase orders and match them to receiving reports and invoices before payment is made.
• Review all billings for timeliness, accuracy, conformity with contract terms and correct customer information.
• Reconcile contract billings with general ledgers monthly and calculate under billings and overbillings.
• Prepare and review financial statements monthly and reconcile them to supporting ledgers, bank statements and loan schedules.

Preparing financial statements on a monthly basis can be very helpful for understanding the health and viability of a business in addition to maintaining a secure control structure.

It is important not to put too much reliance on a single control, but rather have a series of processes that will prevent and detect fraud.

Know the Signs

It can be just as important to understand the profile of a fraudster as it is to know the typical fraud schemes. Less than 10% of the fraudsters had been previously convicted of a fraud-related offense prior to committing the crimes examined in the ACFE study.

Additionally, 82% of fraudsters had never been punished or terminated by an employer for fraud-related conduct. This shows that while background checks are useful in screening out some bad applicants, they might not be effective in predicting fraudulent behavior.

Most fraudsters display some warning signs, such as living beyond their means, financial difficulties or having unusually close associations with vendors or customers.

Training for employees, management and auditors to recognize these warning signs is important to help detect fraudulent behavior.