Inflated Purchase Orders – Overstating the Cost of Materials

INTRODUCTION

In the complex and dynamic realm of Engineering, Procurement, and Construction (EPC) projects, cost management and control stand as pillars of successful project delivery. However, malpractices and irregularities, such as inflated purchase orders, threaten to undermine these foundations, leading to financial losses, project delays, and tarnished reputations. Addressing these challenges demands a systematic approach to monitoring and controlling project activities, especially within the procurement function, where cost accuracy is paramount.

This article delves into the malpractice of inflated purchase orders—overstating the cost of materials—and explores practical strategies to mitigate its impact. With a structured approach, we will examine the nature of this malpractice, real-world examples, preventive measures, monitoring strategies, control mechanisms, and potential loopholes that may persist in the system. Additionally, I will add actionable templates to guide professionals in implementing robust practices that ensure transparency and accountability.

The content presented here is not merely theoretical but draws from industry practices, case studies, and established standards, offering a blend of knowledge and actionable insights. The article concludes with curated resources for further reading, empowering practitioners to deepen their understanding and refine their methods.

I intend to write articles covering almost all the probable malpractices and irregularities around the cost management, including its prevention and control measures. let me know if you have any specific topic concerning to malpractices and irregularities around cost management. It is my hope that this exploration will serve as a valuable reference for project controls professionals, procurement teams, and stakeholders striving for excellence in cost management.

Malpractice and Irregularity: Inflated Purchase Order

Inflated purchase orders involve overstating the cost of materials on purchase orders, which can lead to financial discrepancies, increased project costs, and potential fraud. This malpractice distorts the actual expenditure and can lead to budget overruns.

Real World Issues:

• A procurement manager inflated the cost of raw materials on purchase orders, leading to excess payments to suppliers.
• A contractor submitted purchase orders with exaggerated unit prices for construction materials, resulting in significant overcharges.
• An equipment supplier provided purchase orders with higher than actual costs for machinery, causing budget overruns.
• A subcontractor issued inflated purchase orders for minor materials, which were paid without proper verification.
• A project team authorized purchase orders with padded costs for logistics services, impacting the overall project budget.

Measures to Avoid:

Preventive Measure No - 01: Implement Rigorous Purchase Order Approval Processes

Establish a thorough approval process for purchase orders, including multiple levels of review to verify cost accuracy.

An example of approval process (template):

Preventive Measure No - 02 : Utilize Market Rate Benchmarks

Compare purchase order costs with current market rates to ensure prices are reasonable and reflect true costs.

You may prepare comparison table as follows (template):

Preventive Measure No - 03: Regular Supplier Audits

Conduct regular audits of suppliers to ensure pricing is consistent with agreed terms and market standards.

Audits status shall be recorded as follows: (template)

Measures to Monitor:

Monitoring Measure No - 01: Implement Automated Cost Tracking Systems

Use automated systems to track and compare purchase order costs against budget and market rates in real-time.

Cost tracking system is to maintain real-time oversight of purchase order costs. By continuously monitoring and analyzing data, it ensures that any irregularities, such as inflated figures, are promptly identified. This enables immediate corrective action, reducing the risk of financial discrepancies escalating into larger issues.

Budget monitoring system is to ensure financial discipline by comparing actual expenditures against the allocated budget. This helps detect cost overruns or anomalies that could indicate malpractice, ensuring that spending remains aligned with project financial plans. Together, these measures foster transparency and accountability in procurement activities.

Monitoring Measure No - 02: Conduct Purchase Order Reviews

Regularly review purchase orders for accuracy and compliance with approved budgets and market rates which shall be recorded and reviewed on regular basis.

Monitoring Measure No - 03: Track Supplier Pricing Changes

Monitor and document changes in supplier pricing to identify any significant deviations from market rates.

Measures to Control:

Control Measure No - 01: Enforce Contractual Price Terms

Ensure that all purchase orders comply with agreed-upon contractual terms and pricing to avoid inflated costs. See the following example with least records.

Control Measure No - 02: Implement Budget Reconciliation Procedures

Regularly reconcile purchase orders with project budgets to ensure adherence to financial plans and prevent overstatements. Records shall be maintained as follows:

Control Measure No - 03: Strengthen Procurement Controls

Enhance procurement controls to ensure that purchase orders are accurate and aligned with project requirements, including at least following information:

Loopholes to Look For:

• Lack of Verification Procedures: Inadequate verification of purchase orders against market rates and budget.
• Inconsistent Pricing Data: Lack of consistency in pricing data or failure to update rates regularly.
• Weak Contract Management: Insufficient enforcement of contractual price terms and conditions.

Further Reading:

If you are interested in reading more info on the topic, you may seek guidance and knowledge through following publications:

1. “Fraud Examination” by W. Steve Albrecht, Conan C. Albrecht, and Chad O. Albrecht

This book provides a detailed overview of various types of fraud, including overbilling and false invoicing, with practical guidance on detection and prevention.

2. “Financial Statement Fraud: Prevention and Detection” by Zabihollah Rezaee

Offers comprehensive coverage of financial statement fraud, including overbilling and false invoicing, with techniques for prevention and detection.

3. “The Complete Guide to Internal Auditing” by K. H. Spencer Pickett

A practical guide to internal auditing, including sections on fraud detection and prevention related to invoicing and billing practices.

Let me know, Which monitoring and control measure you have implemented to handle inflated purchase orders, as part of cost management?

Tune in to read about the next topic - "Ghost Employees" of Malpractices and Irregularities in EPC Project, and its monitoring and control measures under cost management domain.