Virtual Conference SEPTEMBER 20-29, 2022

Virtual Conference SEPTEMBER 20-29, 2022

Labor Rate Workshop Presented By: Paul Donovan, C.C.A., C.P.A., J.D. 2023 Normandy Court, Palm Springs CA 92264 (978) 339-3978 ([email protected]) DISCLAIMER: Paul Donovan is not in the business of providing legal advice. The examples in this presentation are for illustrative purposes only. Please consult an attorney for legal advice. Paul Donovan performs consulting engagements and it does not perform audits or reviews in accordance with the audit standards promulgated by the AICPA for the United States.

Why should we ‘audit’ or ‘review’ or analyze labor rates or for that matter any other Project Costs? Save money by finding and recovering overcharges Maybe legal requirement to do so. Maybe hidden “Profit Center” due to low construction management fees Improve Contractor’s Care with Billings, Reduce Errors and Potential of Fraud For Colleges and Non Profit Organizations: Demonstrate good stewardship of funds to Donors and Board of Trustees For Colleges and Non Profit Organizations : Address Conflict of Interest concerns where trustee is associated with the contractor.

Cost reimbursable/ cost plus contracts Guaranteed Maximum Price (GMP) – Construction Manager (CM) agrees to perform work at a guaranteed price for a fee. CM is at risk, CM may share in cost savings If non-GMP – CM reimbursed for allowable costs and a fee. Most contracts that are audited are GMP contracts. Provides owner substantial control over design phase. Pre construction services – CM acts as advisor. Construction phase – CM generally at risk. Owner retains architect/ project managers to monitor progress Average time to construct the project AUDIT POTENTIAL- Generally can audit all costs unless excluded in contract.

What is the Standard to Review the Labor Rates and Other Project Costs? Depends on the Contract Terms 1. Costs Necessarily Incurred A cost necessarily incurred in carrying out the Project. Such costs shall be at rates not higher than the standard paid at the place of the Project except with prior consent of the Owner. 2. Actual Costs The term Cost of the Work shall mean actual costs incurred by the Contractor in the proper performance of the Work. Such costs shall be at rates not higher than the standard paid at the place of the Project except with prior consent of the Owner. Essential the same standard, second one is much stronger in making points and writing reports. Also, if Billing Rates are attached to a Cost Plus Contract Agreement, the Billing Rates may be reviewed unless specifically prohibited.

Overcharges to the Owner are often due to Excessive Labor Burden in Contractor’s Employees’ and Subcontractors’ Employees’ Labor Rates: A. Statutory caps on payroll taxes are not adhered to: 15,000 limit for Massachusetts Unemployment Taxes in 2022. (Maximum amount depends on employer’s experience factor. 7,000 for Federal Unemployment Taxes in 2022. (Maximum amount 42 per person - 7,000 x .6%. This takes the state tax credit into account.) 147,000 for Social Security Taxes in 2022. (Maximum amount is 9,114 per person - 147,000 x 6.2%.) (There is no limit on Medicare taxes – 1.45%) B. Workers compensation costs are excessive: Policy - Contractor/ Subcontractor has a favorable experience modification rating (EMR) factor but it does not reduce the workers compensation costs in the labor burden Self-Insured - Reserves (management’s estimate of liability) are too large based upon historical experience.

Overcharges to the Owner are often due to Excessive Labor Burden in Contractor’s Employees’ and Subcontractors’ Employees’ Labor Rates (continued): C. Bonuses Charged to the Project Charging bonuses to project which should be paid from contractor’s overhead and profit unless approved by the Owner D. Deferred compensation This is a type of bonus that rewards longevity. Usually only vests after a very lengthy period and may never be paid to the employee. E. Use of maximum contributions in 401(k) and other Plans Often the contractor will use the maximum matching contribution although many employees have elected a smaller amount or are not enrolled in the Plan at all. (Owner may consider capping the contributions to be included in the labor rates at a set percentage.)

Overcharges to the Owner are often due to Excessive Labor Burden in Contractor’s Employees’ and Subcontractors’ Employees’ Labor Rates (continued): F. Inclusion of overhead costs unrelated to the Project Internal computer department costs (Example: 5.00 per hour) Accounting costs unrelated to the Project Corporate home office salaries and overhead Employee referral bonuses Tuition reimbursement Holiday parties and summer outings; other employees’ perks G. Other Examples No reduction for portion of health insurance costs paid by employees. Inclusion of insurance costs in the labor rates although there is either an OCIP or CCIP in place. Labor rates charged to Project do not agree with Contractor’s own analysis of its employees’ labor rates. Union labor rates include costs paid by the union worker such as vacation and dues. Time and One - Half (Overtime) and Double Time labor rates are not calculated correctly. Double mark-ups for overhead and profit in the labor rates.

Polling Question: GMP Contracts are most likely to be audited. True or False (true)

Massachusetts Notice of Unemployment Insurance Rate Statement of Account Balance

Owner Controlled Insurance Program (OCIP) or Contractor Controlled Insurance Program (CCIP) To Save on Insurance Costs in Labor Rates An OCIP or CCIP provides insurance coverage to contractors and subcontractors including workers compensation, general liability and umbrella coverage. OCIP generally beneficial when owner has large multi-year construction program or one large project.

Owner Controlled Insurance Program (OCIP) or Contractor Controlled Insurance Program (CCIP) To Save on Insurance Costs in Labor Rates (continued) Advantage to Owner: Owner and Contractor /or should be able to purchase insurance coverage at low rates due to volume and ultimately save substantial costs. Disadvantages to Owner: OCIP- Puts financial risk on owner CCIP- puts financial risk on Contractor – may purchase excess coverage policies to minimize risk. Costs of program including administration and safety programs. These programs may require an “audit.” Can create confusion for contractor and subcontractor (example, overtime wages.) In general, the benefits of the OCIP or CCIP outweigh the disadvantages.

Contractor’s Salaried Employees’ Labor Rates Submitted By Contractor (Example 1)

Contractor’s Salaried Employees’ Labor Rates Submitted By Contractor (Example 1 continued)

Contractor’s Salaried Employees’ Labor Rates Submitted By Contractor (Example 2)

Contractor’s Salaried Employees’ Labor Rates Submitted By Contractor (Example 2 continued)

CM Labor Burden Example

Union Rate Sheet Example 1

Union Rate Sheet Example 2

Union Rate Sheet Example 3

Polling Question: In general, the disadvantages of an OCIP or CCIP outweigh the advantages. True or False (false)

Union Rate Sheet Example 4

Union Rate Sheet Example 5

Subcontractor’s Hourly Union Mechanic’s Labor Rates Submitted by Subcontractor

Contractor’s Hourly Union Employees’ Labor Rates Submitted By Contractor

Auditing / Calculation of Payroll Taxes in Labor Rates The calculation of payroll taxes included in the hourly labor rate used for change order work is a gray area. This causes the biggest disputes with subcontractors. It is not cost effective to calculate the exact amount. For example, when the subcontractor submits a bid, for an electrical subcontract, it presumably has already included all of its payroll taxes in its bid. So it should only be invoicing its incremental payroll taxes when using a labor rate to bill for change order work. Further, to the extent the subcontractor worked on other Projects using the same workers prior to the commencement of this Project, than some of the payroll taxes have already been incurred and paid to the subcontractor. We use the following conventions to calculate the payroll taxes, which most subcontractors have accepted. FICA Taxes – Multiply the labor wage by .062% but limit the cost to the maximum social security threshold of 147,000 in 2022 divided by 2,080 hours (52 weeks X 40 hours per week) 4.38. This would generally be applicable to time and one half rates and double time rates. Medicare Taxes – No limit. Multiply the labor wage by 1.45%. Federal Unemployment Taxes - 42 per year divided by 2,080 hours .02. We allow it for straight time but not for not time and one half or double time. State Unemployment Taxes – In Massachusetts: 15,000 annual limit times divided by 2,080 hours x the subcontractor’s rate (assume maximum rate of 13.22%) .95. We allow it for straight time but not for time and one half or double time. Some subcontractors will argue that they are using different crews to perform the work so the threshold of 15,000 is not reached. However, review of this indicates that generally the same union workers are used week after week on the

Auditing / Calculation of Insurance Costs in Labor Rates Generally, contractors and subcontractors will include workers’ compensation costs, general liability costs and umbrella costs in their employees’ labor rates. Other allowable insurance costs would include automobile insurance and contractor’s pollution insurance although most contractors and subcontractors do not include these costs in their employees’ labor rates. Insurance costs that should be excluded include directors’ and officer’s liability insurance, property insurance, and crime / fidelity insurance costs. Workers Compensation Costs Usually each state has a standard rate per hundred dollars of payroll for each classification of employee and the initial invoice to the contractor/ subcontractor will include these rates. In the Worcester example (Slide 31), the standard rate for Window Shop Employees, Code 1234 is 7.77 per hundred dollars of payroll costs and for the Window Installers, it is 6.89 per hundred dollars of payroll costs. However, additional costs or credits may factor in to the final cost of the workers compensation costs. These items are listed in the audited premiums. (Slide 31) which include additional credits and costs, some based on favorable or unfavorable experience modification ratings. The audited premiums should always be requested from the contractor and subcontractors. In the Worcester example, the actual cost of the workers compensation was 36% more than the initial cost. Based on my experience, the audited costs are usually lower and the owner will be due a credit.

Auditing / Calculation of Insurance Costs in Labor Rates (continued) General Liability and Umbrella Insurance Costs Virtually every contractor and subcontractor will have general liability and umbrella policies to mitigate their financial exposure to acts of negligence, etc. The costs of these policies are usually based on revenue rather than payroll costs. Some contractors will bill this as a separate item in their applications for payment and will exclude these costs from their employees’ labor rates. In the case where the policy cost is based on revenues, the costs must be converted to payroll costs. One way to do this is to divide the total of the shop payroll and field payroll by the policy costs. Executive compensation and clerical employee payroll is excluded from this calculation because generally potential acts of negligence will not be caused by these categories of employees. In the Worcester example, the shop payroll is 977,961 and the field payroll is 908,378 for a total payroll cost of 1,886,339. Assume the cost of a general liability policy is 21,400 then the cost to include in the labor rate is approximately 1.13 per hundred dollars of payroll.

Polling Question: Calculation of payroll taxes in subcontractors’ labor rates is the largest area of dispute between the subcontractor and the auditor. True or False

Analysis of Subcontractor’s Employees’ Labor Rates Worcester Custom Windows (Worcester) Worcester, a subcontractor, used non-union designers, non–union window fabricators and union window installers for change order work. For its Window Installers, Worcester provided internally prepared labor cost breakdowns, one for the journeymen and the other for its foremen, which states these breakdowns were prepared in accordance with rates published by the XYZ Building Group. It did not provide the relevant union rate sheets. Worcester did not cap the unemployment taxes at the Federal and Massachusetts statutory rates of 7,000 and 15,000 respectively.

Analysis of Subcontractor’s Employees’ Labor Rates (continued) The benefits are a high percentage of the base salaries. For example, health and welfare is 26% of the base wage, which may be correct if Worcester is paying all of the health insurance costs for these employees. Worcester did not provide any documentation to support its percentage of 26% but we have not adjusted it at this time. Worcester used an hourly rate of 2.00 for holidays and 2.50 for vacation based on an hourly base wage of 27 for the window designers. This is the equivalent of 18 holidays ( 2.00 / 27 7% (52 weeks X 5 days per week 260 days) X 7% 18 days). This is also the equivalent of 24 days of vacation ( 2.50 / 27 9.26% (52 weeks X 5 days per week 260 days) X 9.26% 24 days). For the designers Worcester used 2.50 per hour for both vacation and holidays. Based upon an hourly wage of 30.00 this is the equivalent of 21.7 days of holiday and 21.7 days of vacation. No support was provided for this time off and we have reduced holidays to ten days and vacation to three weeks in our analysis.

Analysis of Subcontractor’s Employees’ Labor Rates (continued) The worker compensation rates provided from Big Insurance Company listed rates of 7.77 and .09 per 100 of wages for the window fabricators and designers (who would be considered clerical office workers) respectively. Worcester has additional premium costs of 36% due to an unfavorable EMR of 1.17% and other factors. Worcester’s adjusted rates are 10.56% ( 7.77 x 1.36%) and .12 (.09 x 1.36%) respectively. However, Worcester used percentages of 49% ( 13.23 / 27.00) and 7.13% ( 2.14 / 30.00) in its calculations. Worcester’s high unfavorable EMR factor increases the Owner’s costs and may affect its potential liability, if there is an accident at the Project or other issue due to potential negligence or poor safety habits. For general liability insurance costs, Worcester used a factor of 17.82% for the window fabricators and 16% for the designers. Worcester provided an invoice from Big Insurance Company which stated that its total general liability premium was 61,983. The portion attributable to Massachusetts was approximately 85.2% ( 52,855 / 61,983).

Analysis of Subcontractor’s Employees’ Labor Rates (continued) Worcester has a separate policy for umbrella insurance, which costs 37,000. This cost was based upon revenue rather than compensation. Using the percentage calculated above, the cost attributable to Massachusetts would approximate 31,524 ( 37,000 X 85.2% 31,254). Therefore, the total Massachusetts liability and umbrella insurance costs approximate 84,109 ( 52,855 31,254 84,109). The workers compensation audited premiums indicates that total Massachusetts compensation is estimated to be 3,312,143. Therefore, the rate would be approximately 2.5% of wages ( 84,109 / 3,312,143). Worcester used a 17.81% mark-up for these workers.

Analysis of Subcontractor’s Employees’ Labor Rates (continued)

Worcester Custom Windows Subcontractor Labor Rate Analysis

Adjustment for Overcharges in Subcontractors’ Labor Rates This subcontractor used a 10% mark-up for overhead on the base labor only and a 5% mark-up for profit on the base rate only. However, the subcontractor then added an additional 15% mark-up in error totaling 12,065.30 when billing the Project. We used one 15% mark-up on all of the labor costs. We have calculated the adjustment as follows:

Labor Rates as of April 1, 2015 Source: Boston Construction Company Position Regular Rate Time and One-Half Project Manager General Superintendent Admin - CFO Superintendent Estimating Foreman Carpenter Admin - Accounting Supervisor Laborer Admin - Accounts Payable Truck with Driver Service with Truck 70.00 60.00 60.00 55.00 50.00 50.00 45.00 35.00 33.00 30.00 70.00 75.00 105.00 90.00 90.00 82.50 75.00 75.00 67.50 52.50 49.50 45.00 105.00 112.50 Double Time 140.00 120.00 120.00 110.00 100.00 100.00 90.00 70.00 66.00 60.00 140.00 150.00

Billing Rates: April 1, 2015 Source: Boston Construction Company Billing Rate Actual Wages Union Carpenters 17.73 (A) Components of Fringe Benefits FICA & Medicare 7.65% State Unemployment 5.40% Federal Unemployment 0.80% Union Benefits 32.88% (A) Workers Compensation 42.07% Holidays & Vacations *** 6.69% 95.49% Source: Union Contract Fringe Benefits 16.92 (A) % Billing Rate Per Hour 95.43% 34.66 *** 5 Working Days x 52 weeks Less Holidays/ Vacations 16 divided by 239 9% or .0669456 Should be 16/246 9% or .065041 (A) Union Wages per Union Contract - 17.73 Union Benefits Per Union Contract- 5.83 or 32.88% Used by Contractor 45.00 260 -16 246

Workers Compensation Rates Source: Insurance Company

Workers Compensation Rates Source: Insurance Company

Example of Overcharges in Subcontractors’ Labor Rates

Analysis of Subcontractor’s Employees’ Labor Rates Straight Time, Non Union, CCIP (no insurance costs)

Analysis of Subcontractor’s Employees’ Labor Rates Over Time, Non Union, CCIP (no insurance costs)

General Liability and Umbrella Insurance Overcharges

Example – Insurance Overcharge in Labor Burden The Construction Manager is charging the Project for Miscellaneous Insurance as follows: ABC Insurance Broker (ABC) charges the Construction Manager a fee for maintaining its fee-based insurance programs such as general liability, automobile liability, etc. It also charges a 15,000 fee to track up to 650 Certificates of Insurance for the Construction Manager’s subcontractors.

Example – Insurance Overcharge in Labor Burden (continued) The Construction Manager has entered into an agreement with XYZ Insurance Consultant to provide risk management services. XYZ Insurance Consultant’s proposal dated April 4, 2013 to the Construction Manager states the purpose is to assist in the design, and implementation of Risk Management as a Profit Center which is designed to significantly contribute to gross margin. This program is primarily for the Construction Manager’s benefit and somewhat duplicates the services provided by ABC. The Owner is already paying for both the CCIP and the Construction Manager’s other insurance costs. The XYZ fee is corporate overhead and should be disallowed. The Contract Agreement prohibits reimbursement for overhead and general expenses except as may be expressly included in in the Contract Agreement The Construction Manager has also included the costs of a Crime Policy, Employment Practices, Directors’ and Officers’ Liability and Fiduciary Liability in its miscellaneous insurance costs. These costs are also corporate overhead, not required by the Contract Agreement, and are not reimbursable.

Example – Insurance Overcharge in Labor Burden (continued)

Labor Burden Findings from a Construction Cost Review 1. The Construction Manager charged the Project for insurance costs at 5% of employees’ salaries although the university had established an OCIP that paid covered this insurance. This resulted in an overcharge of 265,000 at the end of the period. 2. The Construction Manager paid supplemental compensation to its employees equal to one half month’s salary, calculated at 6.62% and referred to as End of Year Premium Pay. 3. The CM also paid awards for safety, continuous improvements and for referral for finding new employees. All of these costs are overhead and disallowed. 4. The CM provided other training and development to its employees known as ABC State Supplemental Benefits. We note that the CM itself recognized that these are not typical benefits as follows: In addition to typical company provided benefits (noted above) the ABC State Division provides at no cost to its employees additional benefits that facilitate training and development to coincide with the aggressive and diverse ABC region. These costs which represent 6% of salaries charged to the Project are overhead and should not be reimbursed.

Labor Burden Findings from a Construction Cost Review (continued)

Other Examples of Overcharges in Labor Costs and Labor Burden OVERTIME/ ACCELERATION One Client accelerated its Project and the subcontractors billed 2,800,000. Review of the certified payrolls determined that the actual costs were 1,300,000. The CM acknowledged the error stating it had lost control of the process and reimbursed the Client 1,500,000. (The CM stated that an intern was in charge of tracking the costs.) OCIP CREDITS The same Client used a local insurance administrator to administer its OCIP. Our review indicated that the Administrators had not collected 420,000 in credits from the subcontractors. The largest variance of 320,000 related to a drywall company whose payroll costs were 3,200,000 although the Administrator calculated the amount of 1,600,000. HOME OFFICE OVERHEAD One Construction Manager billed a college nine (9%) percent of the salaries of its employees assigned to the Project in their labor rates to cover home office overhead. The Contract Agreement specifically prohibited reimbursement of these costs. Total overcharges were approximately 500,000.