Looking Hard at Claimed “In House” Expenses: Part 2
Forensic accountants explain the methodology to properly analyze economic losses that allegedly flow from construction defects.
(Part I of this three-part series explained ways in which a forensic accountant can assist counsel in analyzing and uncovering non-loss related elements in a damage claim in a construction defect case. Now we’ll see how additional issues continue to arise as the case unfolds.)
Construction defect cases attract a variety of forensic experts. While many lawyers concentrate on the “brick and mortar” aspect of proving the asserted defects, a forensic accountant can take that analysis to another level by providing 20/20 vision with respect to the parameters of the damage claim. Experience teaches that a forensic accountant steeped in damage analysis can help counsel discover and develop economic damages, fraud and business valuation aspects of a given claim or dispute.
In a construction case, the damage claim will naturally include an assessment of the alleged faulty work (and/or faulty materials) with an eye trained on the hard costs to correct the defects, along with labor, materials and out-of-pocket expenses.
But another key component to the claim frequently includes extra expenses and soft costs, such as lost profits and indirect expenses.
Let’s continue our discussion of the analysis and findings in a university housing example.
Hypothetical FactsA university has filed a claim for alleged construction defects in two student housing buildings. To correct the defects, the repair plan spans two school years and includes reconfiguring rooms to increase housing density. The claim includes costs to repair and replace alleged defects and expenses to mitigate lost earnings from taking rooms out of circulation.
In Part 1, we discussed claimed costs for furniture, moving and system reconfigurations.
Here we address claims for in-house costs allocated to the repairs.
Other Campus Costs
Within the university system, employees post hours worked to a specific work order number and project location. The claimed “Other Campus Costs” in our example include payroll for architect, engineering, fire safety and maintenance employees, including staff assigned full-time to campus duties and off-campus employees assigned to projects throughout the university system.
During the period when repairs were made, employees posted time and expenses (for blueprints, copying, surveying, etc.) to the construction defect work order number.
Costs claimed include time and expenses for both on- and off-campus employees. The university is claiming wages and benefits for on-campus employees, while off-campus employee time was claimed using a billing rate which covered wages, benefits, overhead and profit. Expenses claimed for off-campus employees include fees for on-campus parking.
The claim implies that all employee costs were over and above what would have been incurred but for the construction defect repairs. However, investigation reveals that the employees would have been employed by the university regardless of the defect repairs. The university did not incur expenses for these employees beyond what it otherwise would have (aside from some out-of-pocket expenses). It is unknown if the university would have had to retain an outside company if the employees had not worked on the defect project; and that value is not quantifiable.
If the university recovers damages for employee payroll it would amount to a windfall unless the university can demonstrate that the expense was extra—over and above what would have been incurred but for the construction defect repairs.
To demonstrate that the expense is extra, forensic accountants would expect to see:
- employees were paid for more hours during the repair period;
- the claimant hired additional employees during the repair period; or
- the claimant incurred added expenses for outside vendors to do work that otherwise would have been accomplished by employees.
One must consider if the asserted “in-house expense” is really over and above what would have been incurred normally.
In the case where a billing rate is claimed, further analyses is necessary to demonstrate if the claimant incurred additional overhead-type expenses.
In addition, any consideration for parking expense by off-campus employees would result in a windfall, too. In theory, the campus parking revenue was increased by off-campus employees having to pay for parking. To pay for the claimed expense would result in paying for campus parking a second time.
In our hypothetical example, the forensic accounting analysis revealed that the university didn’t incur any extra employee wages, but merely allocated payroll expense that would have been incurred regardless of the defect repairs.
One must also consider the expenses that are saved during the claimed period. During the construction defect repair period, the buildings under repair didn’t require any maintenance labor, parts and supplies. These saved expenses should be considered in the overall measurement of damages.
The use of a forensic accountant with experience reviewing damages, working in tandem with other professionals, can discover issues that are not immediately apparent to the untrained eye. The review in this hypothetical revealed that the in-house labor and a portion of the maintenance expenses were on-going or saved and not additional, and any consideration to the claimed “normal” expenses would result in a windfall to the claimant.
Coming next: Calculating lost income.
Mary E. Furst CPA, ABV, CFF, CFE is a partner in the San Francisco office and James W. McCurley CPA is a director in the Sacramento office of RGL Forensics, a leading financial investigations company.