Know All about Open Book Accounting in a challenging economy

What is Open Book Accounting?

The process of procuring work where contractors are paid on the basis of transparent accounting records showing the build-up of cost, rate, profit etc. is called open-book accounting.
This is typically used on incentivised alliances and cost-based contracts on construction projects. The parties collaborate, share gains, and savings, and collectively identify risks for profit/value creation
Buy-in to this principle of transparency by the contractors, and subcontracts who may even be engaged on a fixed price basis, and further down the supply chain to all parties on the project is key.

Open book accounting is used for sharing risks, gains, and cost savings. It requires full transparency with cost, profits, and access to all cost systems. This means that records need auditing by an independent third party. In challenging times when risks increase, the likelihood of transparency will reduce, and the experience of data analytics, applying a risk-based audit approach and judgment is vital.

12 Global Economic Indicators

Below we have listed 12 global indicators to evidence that we are indeed in challenging times globally.

Global PMI a 50.3 decrease – IHS Markit & JPMorgan’s snapshot of global manufacturing
Euro-Area a 9.1% increase in inflation – a measure watched by the European Central Bank
US employment a +315K decrease – a measure of labour in the world’s largest economy
U.S. consumer spending a 0.4 % increase – mainly one of the pillars of the world economy.
U.S. personal consumption expenditure +6.2% decrease Federal Reserve measure of inflation.
Brazil’s GDP +3.20% increase – a proxy for commodity exporters throughout the world.
Chile copper exports a $3.27M decrease – Andeans are the largest copper producers.
German Ifo is unchanged at 88.6 – the leading indicator of the health of Euro lynchpin economies.
China’s manufacturing PMI is 49.4 up an insight from the world’s largest global manufacturer
China PPI +2.3% decrease – Cost charging at China’s factories indication of global inflation.
Japan’s Inflation +2.8% increase – a measure of price pressures and fiscal monetary measures
South Korea’s Exports – insight into the demand for Asia’s key exporters especially for technology.

(Source: Bloomberg.com)

How Open Book Principles Should be Correctly Applied?

There are no standard industry guidelines on how and when costs should be audited, so communicating a cost assurance strategy to the supply chain early is key. This entails clear protocols at project inception for sharing and using sensitive commercial data and pre-agreeing a representative cost-effective sampling approach.
This includes the level of expected scrutiny, required records, and GDPR protocols for controlling data from financial systems and payroll systems. Contractors and subcontractors must buy-in and agree to grant secure access to confidential costs, records, and accounting systems.
Pre-agreeing how costs should be built-up, allocated, and reported is vital. Engineering construction contracts ICC, NEC, and JCT forms have standard formats stating defined costs, actual costs, or disallowed costs. They do not however specify the correct methods for cost build-up. Defense and energy contracts often require skills for additional scrutiny and regulation of costs.

“In several cases, despite being a contractual requirement, open book audit clauses are ignored until much later or until final accounts when it is too late to influence outturn costs or they are circumvented altogether. It is vital for the parties to agree on controls and protocols for administering open-book clauses early on before cost escalations begin.”

Guidelines for Open Book Principles

Communicating the strategy to the supply chain
Training staff/project teams on open-book principles
Ensuring that the systems are set up for the contract
Enforcing contractual open-book audit clauses
Establishing standard open-book protocols early
Signing GDPR /non-disclosure agreements early
Ensuring that open book is not used punitively
Reporting costs correctly as per the contract
Safeguarding commercially sensitive data
Training the supply chain on open book principles

What are the Challenges of Realising Open Book Benefits?

Cost efficiencies can be realised through targeted gain-share incentives and shared risks.
Value from investments can be increased by using open-book accounting to optimise costs.
Evidence can be used to predict issues, corrective action, and commercial negotiations.
Data can be used to monitor spending and to challenge cost increases ahead of final accounts.
Evidence can be used for contract evaluations to validate pain-gain-share and incentivized payments.
Collaborating to resolve issues will build long-term relationships that will boost future revenue.
Lessons on the conclusion of each audit should inform future decisions e.g. people, time, and productivity.

“Open-book must be used for the right reasons and as a strategy for the right type of projects. It is particularly useful for large complex infrastructure projects with significant risks. Open book clauses must be correctly applied by the parties This entails using sensitive data as intended to achieve the common goals, share gains, cost savings and realised value as planned.”

Guidelines to Realise Open Book Benefits

Using open book correctly for the right reasons
Setting up processes for shared economic risks
Communicating plans early to the supply chain
The parties must not circumvent audit clauses
Not waiting until final accounts before auditing
Aligning strategic interests of parties involved
Jointly managing pressure from unforeseen risks
Not using access to sensitive data punitively
Ensuring correct leadership/people behaviours
Training of teams/parties involved in open book
Managing the right behaviours to ensure buy-in

What access to records and cost systems are required?

Due to the commercial and personal sensitivity of data and records that auditors have to access, contractors and subcontractors are required to sign a non-disclosure separate from the contract.
General Data Protection Regulation (GDPR) rules of 2018 also mean there are strict legal rules around ownership, access, and control of personal data and how these must be used fairly and kept secure.
Using an independent third party is necessary as project teams frown at the employer team having access to payroll data. An independent team can report without influence on major issues identified.

“Open book accounting requires an independent team with expertise in data capture, data analytics, cost systems, and financial and commercial controls. Also, knowledge of construction contracts and audit experience are key. Due to sensitive data e.g. pay and employment records, an independent third (line of the defense) audit team is best placed to be objective.”

Indicative List of Records & Systems

Access to cost capture/reporting systems
Access to raw financial systems data
Access to a chart of account & cost codes
Staff, rates, payroll, expenses & payments
Labor rate, payroll, expenses & payment
People’s employment & insurance records
Records of project and overhead time
Plant time records, rates & operatives
Material rate, storage & payments
Cost reports of actual and forecast
Contract, changes, and variations
Cost reports and supporting records
Cost application and supplier payments
Purchase Order, Invoices & agreements
Subcontract cost, agreement & payment
Design cost, agreement, time & payment
Risk, early warnings & change registers
Contract appendices and rate build-up
Asset register for plant and materials
Overhead cost and time allocation
Rebates, credits, and volume discounts
Overhead fee, contract fee & calculations
Applied for cost and supporting records
Intercompany agreements and rates

This indicative list is not limited to the above.

How to Minimise Disallowed Costs in Challenging Times?

Minimizing disallowed costs early involves ensuring that commercial, finance, and project teams are trained in advance on the protocols and contractual knowledge needed for open-book clauses.
This includes the right behaviors and robust control systems to provide confidence to funders and clients on the effectiveness of contract controls, and providing timely access to records and systems.
Ensuring also that the financial system’s hierarchy of accounts are set up to correctly administer the contract open book clause and that there is transparency on the build-up of rates, fees, and profit.

“Communicating the cost assurance strategy and audit programme early to the parties and the supply chain is key. This will ensure that from the start the right behaviours and tone are set. This includes ensuring that cost reviews or assurance engagements and audits are initiated for the right reasons with timely access to cost records provided.”

Discussions to Minimise Disallowed Costs

Timely notification of early warning notices
Jointly reviewed risk and change registers
Joint clarity on allowed cost in rate build-up
Joint clarify on overhead cost and time
Timely approval of variations and change orders
Pre-agreeing staff rate & resource changes
Pre-agreeing labor rate & resource changes
Pre-agreeing subcontract rate/resource changes
Pre-agreeing plant rate & operatives changes
Pre-agreeing design rate & resource changes
Agreeing on ownership of unforeseen risks
Working collaboratively to save costs
Working collaboratively to drive value/efficiency

How to Manage Open Book in a Challenging Economy?

In challenging times, the parties to a contract will probably review the contract and quickly conclude that, except in cases of a serious breach, termination is unlikely to be the best remedy. Nevertheless, contracts should include specific termination right. This is an extremely crucial clause in the contract.
The most likely solutions are, initially, a degree of escalation through commercial governance arrangements on the contract to take it to the next level, the board or the Chief Executive level. This also needs to be supported by remedies via a payment performance regime.
Typically these are key performance indicators and performance payment deductions; however, also frequently, we’ve seen the use of cash withholding, and profit holding back to affect the supplier’s financial situation.

“Leveraging existing or new technologies, giving secure access, and deploying a risk-based approach can be used to manage open book principles in a challenging economy. Early dialogue, and setting up control systems and records will make contract cost reviews, assurance, and audits more efficient and will ensure that correct records exist when things go wrong and there is dispute or litigation.”

Discussions on Macroeconomic Risks

Interest rate/inflation increases and fluctuations
Global inflation impact on raw material cost
Inflation and export impact on plant cost
Global manufacturing impact on project costs
Discussing the effect of project labour shortages
Increasing staff costs salary & expenses increase
Renegotiating untenable fixed-cost contracts
Effect of Global Inflation on goods & material Costs
Increase in import costs e.g. copper for wiring
Strength of Euro/GBP currencies and economies.
Inflation, export & manufacturing charges in Asia
Cost of scope variations and extension of time
Early collaboration to avoid contract termination
Working collaboratively to manage economic risks

Global Trends of Open Book Accounting in Construction

“Open book accounting on infrastructure projects requires an independent team with expertise in data capture, analytics, knowledge of construction contracts, financial and cost systems, and audit experience. Including the ability to apply judgment and a risk-based approach to assurance on infrastructure projects.”

(Source: NAO Percentage of Contracts with Open Book Clauses)

In the UK, the Ministry of Defence has been using open-book accounting for a longer period of time than other government bodies. According to a survey by the National Audit Office, 31% of contracts have provisions permitting the government to obtain open-book data. Of high-value contracts </>£50m 65%/56% have open-book clauses.

In the US, open book principles are applied on cost-plus contracts where contractors are reimbursed for l allowed costs plus a profit. Cost-based contracts differ from fixed-price contracts where contractors are paid a fixed amount regardless of incurred costs. Risks largely sit with the contractor resulting in claims and disputes. From the data above, Asia / Middle East which mainly uses this form has the highest disputes.

In a challenging economy where risks are heightened, open book cost-based and alliancing contracts allow for risk and gains to be shared. In a July 2022 poll by the multi-disciplinary cost assurance steering group, 59% stated that guidance on protocols for open book alliance arrangements and carbon costs as top priority.

How can Open Book Help with Carbon & ESG Challenges?

A rise in Greenwashing, a practice where businesses inaccurately portray the extent of their green credentials is not a sustainable practice.
For many businesses, the challenge of ESG reporting is data and not the application of frameworks like the UN SDGs, ISSB, TCFD, or another relevant standard.
The difficulty is in gathering sensitive comparable benchmarking data, the practicalities of capturing the data, and applying these to key business metrics.

“Concerns about if the transparency of data being reported by businesses can be relied on by investors and stakeholders are creating increased global compliance requirements (such as the ISSB, TCFD framework, and Z clauses in NEC contracts. Open book audits enable real-time audit, review, and independent reporting of non-financial sustainability and ESG metrics.”

Guidelines Using Open Book For ESG Metrics

Using independent audit to deter greenwashing
Collecting sustainability data/evidence in
Highlighting potential threats and opportunities
Flagging weaknesses and mitigating ESG risks
Taking advantage of opportunities early on
Coordinating internal, ESG, cost & external audit
Identifying weaknesses in governance regimes
Flagging environmental greenhouse gas risks
Highlighting carbon cost and social impact risks
Flagging risks to long-term business viability
Controls for potential threats and opportunities
Using the triple-bottom-line approach
Incorporating ESG into CSR initiatives
Including ESG in balanced scorecard reports

Frequently asked Open Book Questions (FAQs)

“Questions are often asked about open book limitations. For example open book will require upfront time and resource investment. With the right behaviours, the long-term strategic value, financial and commercial benefits are huge. Data from the audit will provide robust evidence to influence decisions in real-time and data to influence future project cost decisions.”

Why are cost assurance audits is needed?

It is vital for cost certainty and risk identification.

Why is cost assurance important?

It helps with achieving the commercial and financial strategy.

Why is an initial risk assessment fundamental?

It is a key to a risk-based approach for audits.

What competency is key for cost assurance?

Data analytics, audit judgment & contract risk

How does technology help?

Through storing records, data capture, analytics, and reporting.

Why are GDPR, privacy, and confidentiality key?

It involves sensitive personal & commercial data.

What key issues are often identified?

Incorrect profit, overhead assumption & unforeseen risk.

What best practice cost assurance is?

Contract, people, process, systems & sustainability controls

What are best practices for people’s behaviours?

Buy-in, transparency, data access & contract compliance.

What do typical cost assurance audit cycles entail?

The contract, people, process, systems, and controls

How can lessons learned and technology be used?

To inform future rates, people & data-led decisions.

What is the outlook for cost assurance & audits?

A draw on technology for issues like cost efficiency

What are the emerging issues for cost assurance?

ESG supply chain, carbon & people cost risks will increase.

How are cost/alliancing contracts being used?

They are being used for strategic delivery, sharing risks and gaining on projects

How CFBL consulting can help?

Undertaking pre-audit diagnostic and current state risk assessment
Perform Independent actual carbon cost audits to prevent greenwashing
Engaging with key stakeholders, board, and leadership for buy-in
Communicating with stakeholders and the supply chain early on
Establishing protocols for your net zero strategy
Implementing protocols through workshops and training
Benchmarking your carbon footprint for carbon reduction and offset
Developing the investment business cases, for decarbonization
Establishing a sustainable, ESG, and Net Zero strategy
Independently reporting actual impact against goals
Account, tax, and compliance reporting for ESG and carbon cost

References

https://www.nao.org.uk/wp-content/uploads/2015/07/Open-book-accounting.pdf
https://www.publicfinance.co.uk/opinion/2015/07/time-make-open-book-accounting-standard-public-service-contracts
https://www.upcounsel.com/open-book-contract
https://www.bloomberg.com/graphics/world-economic-indicators-dashboard/?leadSource=uverify%20wall
https://www.statista.com/statistics/731808/global-construction-dispute-values-by-region/
https://www.cfbusinesslinks.com/steering-group-csr
https://afitac.com/2020/06/16/fidic-contracts-in-the-middle-east/

What does CFBL Consulting do?

CFBL consulting offers cost-assurance audits and sustainable strategy consulting services. This includes an initial ESG assessment, an X-ray view of actual costs to prevent or evidence greenwashing, impact reporting, a payroll audit to safeguard equal pay, and practical training on how to embed ESG KPIs into finance, commercial, and project investment decisions. We identify, resolve, and follow through. By establishing ourselves as strategic partners, we govern and help implement sustainable strategies. Our roadmaps ensure that project plans are successful, as a result, we measure our success by yours.

Who We Work With and What We Do

Infrastructure project: cost assurance audits, systems payroll HR audits & Protocols
SME Business Strategy: 5-Yr strategic business plans and financial statements
Fintech/Transformation advisory: minimising risk and optimising business case ROI
Sustainability & ESG: pay-gap carbon cost audits reporting ESG finance training
Training: delivering case-based training for buy-in to technology & staff upskilling
Fintech & Digital: strategy cost optimisation & digital transformation advisory
Steering Group (CSR): cost assurance and audits on infrastructure projects/contracts

Sustainability & ESG Strategy Tips – How can CFBL Consulting help

Developing and implementing a sustainable business strategy for growth/scaling
Sustainability/ESG strategy: implementing, carbon measurement and benchmarking
HR/Payroll audit: Independent HR, payroll cost, pay-gap gender balance auditing
Sustainability & ESG: strategy implementation, carbon cost auditing/impact reporting
ESG Finance training: upskilling staff/supply chain on ESG KPIs in decision making
ESG protocols: training & designing controls, tools, and templates for ESG reporting

Infrastructure Projects – Tips & How can CFBL Consulting help

Cost assurance: implementing capex people, processes, systems & controls
Protocols: training & designing project/contracts process, tools, templates
Independent cost audits: verifying actual/ defined cost on cost/open book contracts
Systems auditor: examining financial records, controls, and cost systems for integrity
Pre-audit diagnostic: identifying risks on cost-based/open book alliance contracts
Independent contract auditor role: Undertaking internal project/contract auditor role
Legal records: facilitating records for legal compliance on cost/open book contracts
Payroll audit: Independent HR, payroll, carbon cost, gender pay-gap/balance audit
Business case: Implementing Capex strategy/developing investment business cases
ESG Finance training: upskilling staff/supply chain on ESG KPIs in decision-making
ESG protocols: training & designing controls, tools, and templates for ESG reporting

SME Business Strategy -Tips & How can CFBL Consulting help

Scale-up investor funding pitch diagnostic assessment and recommendations
Developing a sustainable business plan for scaling up, funding, and advisory
Developing/implementing strategy: sustainable business strategy for growth/scaling
5-Yr Strategic business planning: financial statements, analysis for funding & grants
People training & upskilling: business and supply chain engagement and training
Independent Fintech/Transformation Advisory: minimising risk and optimising ROI
Capex Investments: optimising grants, funding R&D tax credits & capital allowances
Financial management: tax, planning & implementing financial controls for resilience
Finance business partnering providing strategic advice in financial decision making

Fintech & Digital Transformation Advisory – How can CFBL Consulting help

Commercial systems: advisory on commercial, contract, cost, audits & projects
Financial systems: advisory on financial, HR, management, and reporting systems
ESG KPI reporting: Insight and benchmarking for reporting and competitive edge
Independent advisory on payroll, project, contract, cost, audit and reporting software
Independent advisory on technology that best aligns with strategic objectives
Training: delivering case-based training, for buy-in to technology & staff upskilling

Know it all about Open Book Accounting