TECHNICAL ARTICLE Construction Audit—An …

1 T ECHNICAL A RTICLE. of a company's financial statements and records, in order to provide reasonable Construction Audit An Essential assurance that the data is accurate and complete, and is presented according to Project Controls Function generally accepted accounting principles (GAAP). There are several kinds of finance-related audits, but the best known Alexia Nalewaik, CCE is a direct result of Sarbanes-Oxley section 404 an audit of the entity's internal ABSTRACT: Many Construction projects, both publicly - and privately- funded , require that a proj- control structure for financial reporting ect audit be performed by an independent party. The audit not only tests the accuracy of invoic- and safeguarding assets. es and other charges incurred against the Construction project, but may include a review of In contrast, a performance audit processes used in project management and project cost/ schedule controls, and a comparison of provides an independent assessment of those processes to industry best practices.

2 Thus, the audit function is an essential project con- trols tool. performance, with the purpose of determining how well established goals KEY WORDS: Audit, Construction , cost, project and schedule controls, and management and objectives are being achieved, and with the additional objective of identifying opportunities for improvement. any Construction projects, both With capital expenditures given such M publicly and privately funded , require that a project audit be performed by an independent party. The high visibility on the financial statement, and with increasing corporate awareness of accountability and expenditure controls, it Performance audits may include functional audits for economy and efficiency, evaluating the planning process, space use, staffing, and established audit not only tests the accuracy of invoices is the rare Construction contract that does procedures. A performance audit for a and other charges incurred against the not contain a right to audit clause.

3 Construction program will typically Construction project, but may include a The clause is commonly found in combine an in-depth review of review of processes used in project government contracts, and is increasingly expenditures with an analysis of management and project cost/schedule being included in private-sector contracts. compliance with applicable laws and controls, and a comparison of those The language varies from contract to funding requirements, and may also processes to industry best practices. Thus, contract, but the clause typically provides include an examination of the program the audit function is an essential project the owner with a restricted or unrestricted management plan and its effectiveness as controls tool. right to audit operations, contracts, practiced. projects, programs, and expenses. In this capacity, the auditor for a The Right to Audit The owner may choose to audit performance audit is acting in an advisory The Public Company Accounting continuously, at intervals, or at closeout.

4 Role, where the performance audit results Reform and Investor Protection Act of The clause allows the owner the right of in findings, conclusions, and 2002, also known as the Sarbanes-Oxley access to all of the contractor's files during recommendations presented for the Act of 2002, was a US federal act created to the contract term, and often for a specified purpose of client decision-making. protect shareholders and public interest. period following final payment on the Some broad audit scopes may include In addition to other requirements, contract. Audits are becoming an integral a review of installed materials and certain sections of the act require all and unavoidable part of any Construction equipment to ensure that the contract regulated companies to establish an audit project. specifications have been satisfied and the committee, to document internal controls quantities billed match those installed.

5 And evaluate their effectiveness, and to Audit Scope Audit work of this type requires the use of certify that financial statements fairly When the owner exercises their right TECHNICAL auditors who have an reflect the company's financial situation to audit, the objective may be a financial engineering background and experience and operations for the period presented. audit, a performance audit, or some with specifications compliance. The Sarbanes-Oxley Act has had an combination of the two. The scope of the impact on Construction projects because audit is determined by the owner, who may Conducting the Audit capital expenditures for new Construction , elect to audit a Construction contract, a Once the owner determines to renovations, and expansion represent a specific supplier, a Construction project, or perform an audit, whether through an substantial investment, usually shown on the entire Construction program.

6 Audits of outside consultant or through their own the balance sheet as assets. Such items as publicly funded Construction may be internal audit department, an audit team capital assets, Construction in progress, required by law, whereas private sector will be assembled. Typically, this blended bond issuances, leases, depreciation and audits are typically requested by internal team will consist of the auditors, and capitalized interest may be reflected in corporate governance, as a representation representatives from the owner and the several places in the financial statement, of accountability to shareholders and contractor. Owner team members may including the aforementioned balance stakeholders. include staff from internal audit, finance, sheet, income statement, cash flow Financial audits include financial and project management. Contractor team statements, and notes to the financial statement and finance-related audits.

7 A. members may include the project statement. financial statement audit is an examination 20 Cost Engineering Vol. 49/No. 10 OCTOBER 2007. executive and staff from project The audit will also require sampling is the most frequently used management, project controls, and participation on the owner's side, with method of selection because it is easy to corporate finance. requests for such documentation as the apply and its arbitrary nature guarantees At the kickoff meeting attended by the following. impartiality it is typically used for large audit team, the audit scope will be populations of data. reviewed and the work plan will be executive- or board-level authorization The tested sample will be used to discussed. The audit may be conducted in for capital project; ensure that the contractor's payment phases by one team, or smaller teams may cash flow analysis; applications agree with the terms of the be assigned to specific portions of the audit.

8 Corporate request for and approval of contract, verify that items billed on the The owner may provide the auditors funding; payment application have been incurred with a list of specific issues to investigate. list of individuals approved to issue by the contractor, identify non- The auditors will require work space at contracts or approve payment reimbursable items and duplicate both the owner's and the contractor's applications; payments, and ensure that project offices, either at corporate headquarters or correspondence; reporting includes all costs incurred by in the Construction trailer. A spirit of purchasing files; both the contractor and the owner. Labor cooperation will need to be emphasized, presentations and reporting to and material charges will typically be because the contractor (and sometimes the stakeholders, including annual reports; traced back to their origin, such as owner's staff) tend to view the audit as an and timesheets, payroll records, subcontractor intrusion.

9 Policies and procedures. invoices, and bill of materials. During or immediately prior to the Failure to provide information, or kickoff meeting, a document request will The auditors need to quickly become delays in responsiveness, will prolong the be provided to both the owner and the acquainted with the history of the project, audit and will increase the cost of the audit. contractor, so that the necessary the roles and responsibilities of the project However, a dedicated audit team will not documentation may be made available to team, and project risks. This is most easily allow an uncooperative contractor to affect the auditor in a timely fashion. accomplished by reviewing the monthly their scope of work in fact, upon For Construction projects, the owner narrative status reports for the project, and encountering opposition from those being will typically require the contractor to keep conducting interviews with members of the audited, an audit team will often be records of all labor, materials, and other owner and contractor project team.

10 Motivated to investigate further. When a items furnished during Construction or the Key project team members, such as document cannot be provided promptly, performance of services. These records the project executive, project manager, the auditor may assume that the document may be requested for review during the project controls, purchasing, contracting, does not exist and (if there is substantial audit, including the following. and finance, can expect to answer delay) may further suspect that the questions about existing policies and document has been created specifically in employee timesheets; procedures, gaps and challenges, project response to the audit request. daily logs; cost and schedule status, lessons learned, Field observations also contribute to payroll records; successes and failures. the audit. The auditor may request a tour of subcontract and vendor files with bid Audit testing represents the bulk of the the Construction site, and will also record documentation; audit work plan.