In the construction industry, financial transparency and accountability are critical. With multiple projects, varying revenue recognition methods, and complex contracts, construction companies must ensure their financials are accurate and compliant. This is where a construction company audit comes in. But what does such an audit entail, why is it necessary, and how can a company prepare for it? This article will explore all of this in detail, from the elements of a construction audit to its importance in securing financing or bonding and even the associated costs.
What Do Construction Audits Include?
A construction company audit is a comprehensive review of a company’s financial and operational practices, designed to ensure compliance with regulations, identify inefficiencies, and reduce risk. Audits are often essential for construction companies seeking bonding, securing loans, or working with investors, as they verify financial accuracy and project controls.
Key components of a typical construction audit include:
- Job Cost Accounting and Work-in-Progress (WIP) Schedules: Auditors review job cost tracking, comparing actual costs to budgeted ones and verifying the accuracy of WIP reports.
- Revenue Recognition and Contract Billing Methods: The audit examines how revenue is recognized (e.g., using the percentage-of-completion method) and ensures that contract billing is compliant with accounting principles.
- Change Orders, Subcontractor Agreements, and Retainage Balances: The audit verifies that change orders are properly documented and that subcontractor agreements and retainage balances align with contract terms.
- Payroll Compliance: Particularly important in construction, auditors ensure payroll compliance with labor laws, such as the Davis-Bacon Act, which mandates prevailing wage rates for federal projects.
- Bonding and Surety Requirements: Ensuring the company meets bonding requirements is critical for contractors working on large projects or with government contracts.
- Material and Equipment Purchases vs. Job Allocation: The audit checks if materials and equipment purchases are appropriately allocated to specific projects.
- Cash Flow and Accounts Receivable/Payable: Auditors will analyze cash flow, accounts receivable, accounts payable, and any over/under billing discrepancies.
External audits may extend to reviewing tax positions, financial ratios, and compliance with industry-specific regulations such as state licensing or union requirements.
How to Do an Internal Audit of a Construction Company
Internal audits are an essential tool for companies looking to assess and improve their internal controls before a formal external audit. Here’s how to conduct a basic internal audit of your construction company:
- Identify High-Risk Areas: Start by identifying high-risk areas in your operations. This may include large, long-term projects or frequent change orders that could lead to cost overruns.
- Review Internal Controls: Evaluate internal controls related to bidding, procurement, billing, and cost reporting. Are processes standardized, and are there clear checks and balances?
- Verify Accuracy of Job Costing: Review your general ledger and WIP schedule to ensure job costs are accurately recorded and reported. Any discrepancies should be addressed immediately.
- Ensure Compliance with Accounting Standards: Make sure that your company is adhering to Generally Accepted Accounting Principles (GAAP) or tax-basis accounting as applicable.
- Conduct Staff Interviews: Meet with key personnel such as project managers, accountants, and estimators to understand how processes are being executed and to assess areas for improvement.
- Document Findings and Action Plans: Document all findings, including any deficiencies, and create an action plan to address them.
- Utilize Tools: Use tools like checklists, risk matrices, and sample-based testing to make your audit more efficient and thorough.
How Much Does It Cost to Get a Construction Company Audited?
The cost of an audit varies depending on several factors, including the size of the company, the complexity of its projects, and the type of audit (internal vs. external). Here’s a rough breakdown:
- Small firms (<$5M revenue): $7,000 – $12,000
- Mid-sized firms ($5M–$20M): $12,000 – $25,000
- Large contractors (>$20M): $25,000 – $50,000+
Additionally, specialized audits (forensic audits, bond compliance audits, or audits for federal contracts) can add extra costs. For example, companies dealing with multi-entity consolidations or working on high-risk projects (e.g., HUD or Department of Defense contracts) may incur additional fees.
Why Are Audits Important for Construction Companies?
Construction company audits serve several critical functions beyond just compliance. Here’s why they are essential:
- Ensure Financial Accuracy and Transparency: Regular audits help ensure that the financial statements reflect the true financial health of the company, reducing the risk of errors or fraud.
- Improve Cost Control and Profitability Tracking: By analyzing job costs and reviewing WIP schedules, audits help identify areas where costs can be controlled, leading to better project profitability.
- Satisfy Bonding and Lender Requirements: Many bonding companies and lenders require an audit to verify the financial health of a company before agreeing to terms.
- Detect Fraud or Misallocation: Auditors help uncover potential fraud, errors in financial reporting, or misallocation of funds that could hurt the company’s bottom line.
- Boost Investor and Stakeholder Confidence: For companies with investors or external stakeholders, an audit offers confidence that the company is operating in a financially sound and transparent manner.
- Support Year-End Closings and Tax Planning: Audits streamline the year-end closing process and can help prepare the company for tax planning, ensuring compliance with tax regulations.
How to Prepare for a Construction Audit
Preparation is key to a smooth audit process. Here’s a checklist for your construction company to prepare for an audit:
- Reconcile Financial Statements: Ensure that all financial statements, including balance sheets, income statements, and cash flow statements, are finalized and reconciled.
- Align WIP Schedule with General Ledger: Verify that your WIP schedule aligns with your general ledger and accurately reflects all project costs.
- Organize Contract Files and Change Orders: Ensure that all contract documentation, including change orders, subcontractor agreements, and supporting documents, are organized and readily available for the auditor.
- Review Internal Processes: Evaluate your internal processes around estimating, billing, and cost tracking to ensure everything is up to standard.
- Communicate with Project Managers: Inform project managers about the audit timeline and the necessary documents they’ll need to provide. Clear communication helps streamline the audit process.
Conclusion
A construction company audit is not just a regulatory requirement—it’s an essential part of maintaining financial control, improving operational efficiency, and ensuring long-term success in a high-risk, project-driven industry. Whether conducted internally or externally, audits help companies improve compliance, reduce risks, and build confidence with investors, lenders, and bonding agents. Proper preparation and understanding of what an audit entails can significantly improve the process and outcomes.
To make the most of your next audit, download our Construction Audit Preparation Toolkit or schedule a discovery call with our expert audit team.
FAQs
What do construction audits include?
A construction audit includes a detailed review of job cost accounting, revenue recognition, change orders, payroll compliance, bonding requirements, and internal controls, among other factors.
How to do an internal audit of a construction company?
An internal audit involves reviewing high-risk areas, verifying job costing and WIP schedules, assessing compliance with accounting standards, and interviewing key staff to identify potential issues.
How much does it cost to get a company audited?
Audit costs vary depending on the size of the company and the complexity of the audit. Costs typically range from $7,000 to $50,000+, with additional fees for specialized audits.
