Substantiation is of limited value
Under cost reimbursable or target cost arrangements, clients need to know that they are paying the right amounts to contractors. They almost always employ a team (often a third party) to check that costs are fairly stated.
The traditional approach used by the majority of teams to check costs involves the, “substantiation” of transactions on a regular basis by asking for hard copies of supporting invoices or timesheets. The cost checkers will ask for either a sample of documents or a hard copy file of everything. A typical sample size or, “coverage” is between 10% and 20% of the value of amounts applied for on a monthly basis.
Cost checking based on this traditional approach has evolved over a period of years and in some cases is supported by the use of analytical tools. It is however of limited value. It will act as a deterrent and may pick up some issues but:
- is inconsistently applied as it relies on the motivation, experience and knowledge of the individual checker
- ignores best practice cost auditing standards
- is not carried out by trained and qualified auditors (the top degree courses for quantity surveying do not include Cost Verification Audit in their curriculum)
Here are some real examples based on our experience of where the traditional approach doesn’t work:
The traditional approach will miss transactions charged more than once
Cost charged twice to different projects
A supplier working on more than one project may charge the same transaction to both projects without the checkers identifying a duplicate. They will both be able to “substantiate” the transaction.
Costs charged twice to different months
A supplier may charge the same transaction on the same project in different months without the checkers identifying a duplicate. The checker will be able to “substantiate” the transaction in each month.
The traditional approach will not identify transactions which are “substantiated” by documentation but still overstate costs
Costs are not offset by credits
A supplier may charge a transaction but not off-set a credit causing costs to be overstated. The checker will be able to “substantiate” the transaction but will not pick up the credit note.
The traditional approach may achieve 10% coverage by picking one large value invoice, but miss issues in other invoices
With the substantiation approach you can achieve 10% coverage by picking just one large invoice, but this may not be the riskiest item – for example the repetition of the same value in multiple invoices or an invoice which doesn’t add up as illustrated below.
A more effective way of checking cost is to rely on a best practice, risk based approach set out in the cost auditing standards, accepted throughout the world, and built on the accountancy profession’s experience of auditing financial information.
A best practice, risk based methodology lies at the heart of The Orange Partnership approach.