Construction
Auditing
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Welcome and Introductions
Welcome to the Construction
Auditor Seminar
Introductions
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Objectives of the Seminar
Seminar will focus on the ―cradle to grave‖
approach to audit construction projects and
related activities.
Focus will be on the entire life cycle of a
construction project.
We will review Why, When and How to audit a
construction project.
Seminar will cover 13 Units.
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Construction
Auditing
Unit One
“Why Audit Construction Contracts”
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Overview
• Capital construction projects can create significant
exposure for organizations that are unaware of the risks
associated with excessive cost, project delay and quality
issues. We will review the principal reasons for auditing
construction projects and the benefits that can be
derived which will serve as the platform for the learning
objectives of the course.
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Reasons for Auditing
Construction Contracts
• Projects are costly, many opportunities for
overcharges
• Recommend controls
• Enhance cost/schedule performance and
reduce scope creep
• Protect employees
• Reinforce project governance
• Assist in mitigating risk
• Assess impact to operating budget
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Risks and Controls
• Financial Risk
• Construction Risk
• Compliance and Safety
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Why Audit Construction
Projects
• Top management is concerned and exposed
• Projects are costly and subject to overcharges
• Identify opportunities for cost savings and/or cost
recovery
• Provide independent verification of payments
• Delays can result in lost market opportunity and
revenue
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Why Audit Construction
Projects (cont 2)
• Important assessment of the effectiveness of
internal control
• Recommend controls to prevent potential
problems
• Reinforce integrity of contractors
• Helps keep project on track
• Protects employees
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Why Audit Construction
Projects (cont 2)
• Reduces reputational risk
• Minimize disputes and litigation with
contractor
• Assess impact to operating budget
• Valuable tool for lessons learned
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Construction
Auditing
Unit Two
“Key Stakeholders”
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Overview
• There are a number of key stakeholders involved in
construction projects. Each has a specific role and
responsibility related to construction activities and/or
the governance and oversight process. An integral part
of the audit process is to assess whether each
stakeholder has met their responsibility and mitigated
the risk that is inherent in construction projects.
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Key Stakeholders
The Internal Project Management Team:
• Owner – Responsible for the Scope, Cost,
Quality, and Safety of the Project
• Construction Management/Engineering –
Design, Scheduling, Construction Monitoring
• Budget – Financing and Budget Control
• Procurement – Bid and Selection Process and
Contract Administration
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Key Stakeholders
• Legal – Contract Terms and Conditions
• Controller/Accounts Payable – Pays
approved invoices
• Risk Management – Insurance, Bonding
& Safety
• Internal Audit – Monitoring and
Oversight
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Key Stakeholders (cont)
External Project Team (depends on
delivery method):
• Construction Manager – Agent of the
Owner
• Architect/Engineers – Designs Project
• General Contractor – Prime Builder
• Sub-contractors - Specialist
• Suppliers – Material & Equipment
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Construction
Auditing
Unit Three
“The Construction Life Cycle”
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Overview
• There are four (4) major stages in the
life cycle of a construction process. This
module will discuss the components of
each phase and touch on the possible
risks in each phase.
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The Construction Life
Cycle
• There are four major stages :
– Planning /Program & Design
– Bid/Procurement
– Construction
– Close-Out
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1. Planning and Design
Phase
• Planning and Feasibility Study
• Design
• Contract Document Development
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Risks
• Inadequate Scope
• Incomplete data
• Poor estimating
• Lack of details in building model
• Over design
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Controls
• Project manager should review and approve
design documents to confirm consistency with
project objectives
• Evaluate bid packages to confirm materials are
consistent and complete
• Have an independent constructability review
undertaken
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2. Bid and Procurement
Phase
• Construction Bidding
• Bid Solicitation
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Risks
• Lack of competition
• Incomplete bid documents
• Timing
• Fraud
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Controls
• Review process used or followed to
solicit, receive and review bids
• Review contractor pre-qualification
process
• Review contract award process
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3. Construction Phase
• Divided into two stages:
– Project mobilization
– Construction
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Risks
• Delays
• Cost overruns and numerous change orders
• Quality issues
• Financial exposure due to unsafe work conditions
• Regulatory, financial and reputational exposure due to
adverse environmental impacts
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Controls
• Cost accounting and project tracking system
• Robust change order review and approval process
• Monitoring of quality and quantity of work
• Safety audits
• Processes and procedures to monitor, record and
account for environmental compliance
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4. Project Close-out Phase
• Also divided into two stages:
– Completion of work that must be done at
work site
• Substantial completion, final punch list,
cleanup, testing, start up of mechanical
and electrical systems, etc
– Providing all required documents
• As built drawings, manuals, warranties,
certification of completion, etc
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Risks
• Claims made by the contractor for additional cost or
work not included in the contract and/or by change
order
• Liquidated damages—claims made by the owner against
the contractor for the failure to complete the project by
the established date
• Adequacy of the final testing of the mechanical and
electrical systems
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Risks (cont)
• Resolution of items included on the punch list
• Payment to subcontractors and suppliers
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Controls
• Closeout audit of billings and payments
• Audit of claims and assessment of liquidated
damages
• Confirmation of the receipt of final deliverables
• Verification of acceptance testing and
warranties
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Construction
Auditing
Unit Four
“Types of Construction Contracts and
Construction Project Delivery Methodologies”
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Overview
• There are several different types of
contracts and delivery methods that can
be used in construction
projects/activities. We will discuss the
risks and benefits of each type. This will
serve as the basis for the following
modules on deciding what types of
projects to audit.
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Types of Construction
Contracts
• Fixed Price or Lump Sum
• Unit Priced
• Guaranteed Maximum Price
• Cost Plus/Cost Reimbursable/ CPFF
• Time and Materials
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Type of Contract and
Associated Risk
Fixed Price/ Lump Sum
• Contractor assumes all Risk
• May attempt to minimize risk if actual
cost exceeds bid price
• Poor Quality or Inferior Materials
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Types of Contract and
Associated Risk
Cost Plus/Cost Reimbursable Contract
• Owner Assumes Risk
• Contractor has little incentive to control
cost
• Contract should have a GMP
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Delivery Methods (1)
• Design-Bid-Build
Owner
Architect
General Contractor
Sub-contractors
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Three Sequential Phases
• Design Phase
– Owner hires team of architects and engineers to build
plans and specs used to solicit bids
• Bid Phase
– ―open process‖-any qualified bidder
– ―select process‖-limited number of pre-selected bidders
• Construction Phase
– Winning contractor becomes General Contractor
– General Contractor hires sub-contractors
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Benefits to owner
• Process well understood
• Design Team impartial
• Complete set of documents up front
• Same set of documents to all
• Ensures fairness to bidders
• Assists in reasonable prices
• Uses competition
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Risks to owner
• Failure of design team to be current with construction
cost
• Potential cost increases
• Lowest bidder may be undesirable
• GC’s bidding may include low bidder
• No up front input from GC
• Potential adversarial relationship between designer and
builder
• Final costs unknown until bids are finalized
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Delivery Methods (2)
• Design-Build
Owner
General Contractor/Joint Venture
Architect Sub-contractors
Suppliers
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Characteristics
• Design and construction by single entity
• Used to minimize project risk to owner
• Reduced delivery schedule
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Benefits to owner
• Saves time
• Early agreement on cost and schedule
control
• Less ―finger pointing‖
• Reduces change order liability to owner
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Risks to owner
• Fast track eliminates integrated design
• Must have right team
• Potential loss of control of project
• Decisions by builder may lead to
dissatisfaction and adversarial
relationship
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Delivery Methods (3)
• Construction Management
Owner
Construction Manager
Architect
Prime/Multiple prime contractors
Trade contractors
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Characteristics
Owner hires, under two separate
contracts,
– Architect to design the project
– Construction Professional-‖Construction Manager‖
(CM) who works with design team to ensure design
can be built for reasonable cost, and that contractor
can understand drawings and specs
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Construction Manager
• Generally does not perform construction work
• Is an agent of the owner
• May be engaged in lieu or in addition to general
contractor
• Engaged as either:
– (a)―Agency Construction Manager‖
– (b)―Construction Manager at Risk‖
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(a) Agency Construction
Manager
• CM acts as an agent or consultant to the owner-
fiduciary capacity
• CM has no legal responsibility for actual construction
performance
• Has no prime or sub-contractors
• Manages general contractor or multi-trade contractors
• Offers advice without potential conflicts of interest
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(b) Construction Manager
At-Risk
• Acts as a General Contractor
• Assumes responsibility and liability for
construction work
• Responsible for means, methods, and
sequence of construction
• Has ultimate authority over the trade
contractors
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Construction
Auditing
Unit Five
“Audit Planning”
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Overview
• We will review the process for selecting
which construction project or
construction activity to audit and why.
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What Drives a
Construction Project?
• Schedule/Time
• Cost
• Quality
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How Should Projects Be
Selected For Audit
• Size
• High Profile/High Risk
• Fast-Track Schedule
• Complex Contract Terms
• Type of Contract
• Experience of Owner Representative
• Experience of General Contractor
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When Should Construction
Projects be Audited?
• Begin at the Planning and Design
• Contracting Stage
• During the Construction Period
• Project Close-out
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Goals and Objectives of
Construction Audit
• Safeguard owner’s interest
• Confirm you got what you paid for
• Identify cost avoidance opportunities
• Identify overcharges and/or undercharges
• Ensure appropriate owner and contractor controls in
place
• Avoid litigation
• Mitigate risk
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Keys to Success
• Appropriateness of project
• Effective and thorough planning
• Selection of delivery method
• Robust contracts
• Addressing project risk
• Accessing project controls
• Effective ongoing monitoring
• Controlling cost
• Qualified personnel
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Things to Remember
• All types of contracts can be audited
• All construction projects could be audited to
reinforce a level of comfort
• Contracts should include a ―right to audit‖
clause
• Audit should be of both the Prime and
Subcontractors
• Need for properly skilled auditors
• Consider assigning auditors to the
construction site
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Construction
Auditing
Unit Eight
“Construction Life Cycle-Construction
Phase”
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Overview
• In this module we will review some of
the risks and exposures (delays, change
orders, claims, contractor billings,
progress payments, quality issues, use
of approved contractors, etc.) during
this phase of the process and develop
audit objectives and strategies
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Audit Focus
• Typically will include:
– Contract review
– Cost accounting and project scheduling
– Verification of quantity and quality of materials
– Subcontractor approval process
– Change order process
– Billing tests
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Lump Sum or Fixed Price
Contract
• Remember characteristics:
– Contractor is paid pre-agreed fixed amount
irrespective of actual cost
– Contractor assumes all the risk that project will be
completed for less than fixed price-profit; if more,
contract or loses money
• Risk
– Contractor tries to ―cut corners‖ by not adhering to
all requirements of contract
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Lump Sum or Fixed Price
Contract (cont)
• Audit considerations
– Prepare cost control schedule
– Review pricing schedule and reconcile summary of
payments
– Look for duplicate payments or overpayments due to
change orders
– Confirm contractor has appropriate and adequate
insurance and bonding
– Verify change order process has been followed and priced
in accordance with the contract
– Others
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Cost Plus Fee Type
Contracts
• Remember Characteristics-
– Guaranteed Maximum Price/Cost
Reimbursable
– Cost of project to owner consists of all
direct costs-labor, materials, equipment-
plus overhead and profit
– All costs must be incurred/invoiced before
payment
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Overall Audit Strategy &
Focus
• Perform billing tests of contractor’s progress
billings
• Tests will include:
– Labor
– Material
– Overhead
– Contractor fee
– Field and Home Office charges
– Subcontractor charges,
– Etc
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Overall Audit Strategy &
Focus (cont)
• Must be thoroughly familiar with contract
terms and allowable vs unallowable expenses
– Prepare cost control schedule
– Review pricing schedule and reconcile summary of
payments made to contractor
– Prepare a breakdown of payments by major cost
elements. Look for duplicate or overpayments
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(1) Direct Labor
• Audit Objective
– ensure all costs related to direct labor are reimbursable, have
occurred, and are billed as actual costs as defined in the contract.
• Audit Procedures
– Review contractor’s payroll and certified payroll information to
verify billed wages agree with wages paid
– Review employee time sheets and reconcile to certified payroll to
verify hours billed
– Review union agreements to verify that proper rates were billed
– Compare payroll information to ensure that the employees are
not be charged by both the prime and subcontractor
– Trace payments to canceled checks
– Conduct a payroll distribution
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(2) Labor Burden
• Audit Objective
– Same as Direct Labor
• Audit Procedures
– Review contractor’s charges for payroll taxes, fringe benefits and
insurance, FICA, Federal and State Unemployment taxes,
Worker’s Compensation
– Confirm that accurate rates were used and that employee payroll
limits were not exceeded
– Review union agreements to determine the accuracy of charges
for union benefits
– Verify that employees being charged for benefits are eligible to
receive benefits and that they were actually receiving the benefit.
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Common Audit
Adjustments
• Incorrect hours charged to project
• Unauthorized or excess employees charged to
project
• Unauthorized/unnecessary overtime
• Workers Comp- contractor does not pay at rate
charged
• Inflated burden rates
• Taxes continued to be charged after payroll limits
are reached
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(3) Material Purchases
• Audit Objective
– Same as Direct Labor but also verify materials purchased
were not of a lesser quality and for quantities not specified
in contract
• Audit Procedures
– Compare quantities installed with contract drawings and
specifications, follow up on significant differences
– Confirm competitive quotes used and reasonable purchase prices
– Compare invoices from suppliers for compliance with contract
prices and if any discounts were received
– Reconcile total quantities purchased, with amounts delivered and
installed
– Check to see that the owner gets credited for returned or unused
materials
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Common Audit
Adjustments
• Materials billed but not used at site/used at
another site
• Materials of a lesser quality than required
• Overstated quantities delivered to site
• Failure to receive discounts
• Failure to use competitive process to procure
materials
• Insufficient documentation to support amounts
charged
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(4) Equipment Rental
• A variety of equipment required for projects. Equipment
can be contractor owned, leased from a third party or
job owned—purchased and charged to the job
• Audit Objective
– Same as Direct Labor but also, if equipment is job
owned, verify that owner receives credit for all
equipment purchased and charged to the job
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(4) Equipment Rental
(cont)
– Contractor owned and third party rental usually billed on
time used and rate per hour of use
• Audit Procedures
– Review contract for rates to be charged and basis for rate
– Confirm that multiple quotes were received
– Analyze and confirm rates charged are in agreement with
contract
– Review daily job reports and time sheets of machine
operators to determine equipment usage
– Contact vendor if different leasing options were available
and that the most cost effective was in use
– Determine if beneficial to have a lease purchase option
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Common Audit
Adjustments
• Inappropriate rates charged
• Excessive hours
• Project billed for non-existent equipment
• Equipment leased from related parties
• Equipment billed while not being utilized
• Failure to gain possession or get credit for job
purchased equipment
• Cost included in base rate also charged as a direct
expense
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(5) Other Costs
• Travel Related Expenses, Overhead Expenses, Field
Office Expenses, Sales Tax
• Audit Objectives
– Same as Direct Labor
• Audit Procedures
– Review travel expenses to ensure in line with
contract
– Review annual overhead rates
– Review field office expenses
– Sales tax
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(6) Change Orders
• Are variations or modifications to original contract for
any number of reasons
• Original contract should have specific language
regarding documentation and authorization required,
process to price or value
• Owner decides if change is made to contract
• All changes should be processed by Procurement to
ensure contract is amended accordingly
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(6) Change Orders (cont)
• Audit Objective
– Understand the need/justification for the
modification
– If change results in reduced scope, confirm owner
received credit
– If change requires additional work, ascertain work is
not included in original contract
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(6) Change Orders
(cont 2)
• Audit Considerations
– Identification of cause of change order
– Assessment of liability-design error or omission,
contractor performance
– Review internal estimate of cost of change
– Review documentation or records of negotiations
– Excessive Change Orders
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(7) Other Audit
Considerations
• IA should review the process established to
assure quality management and control
including
– Use of qualified sub-contractors
– Inspection of purchased materials and equipment
– Field verification of project work
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Construction
Auditing
Unit Nine
“Construction Life Cycle-Close out
Process”
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Overview
• In this module we will review some of
the risks and exposures (receipt of all
deliverables prior to final acceptance,
final review of contractor billings,
payments to sub-contractors, etc.)
during this phase of the process and
develop audit objectives and strategies
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Closeout Process
• Consists of three components
– Physical
– Financial
– Administrative
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Physical Closeout
• First step in closeout process
• Owner or representative determines if
requirements met
• Includes
– Testing and startup
– Cleanup
– Final punch lists
– Final inspection
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Financial Closeout
• Encompasses all monetary matters
• Results in final payment and release of
retainage
• Includes:
– Closeout audit of contractor costs
– Final review on contractor’s billing
– Confirmation sub-contractors paid
– Resolution of claims
– Satisfaction of liquidated damages
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Administrative Closeout
• Includes receipt of all required documents,
warranties, and training
– Certificate of Substantial Completion
– Certificate for Payment
– Certificate of Occupancy
– As-Built Drawings
– Operating and Maintenance Manuals
– Warranties
– Training
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Audit Considerations
• Final review of contractor’s billings
• Review contract and consider developing a check list to
determine all deliverables have been received
• Confirmation that sub-contractors have been paid
• Confirm prime and sub-contractors have provided final
release or waiver of lien
• Confirm all certificates have been received, reviewed,
and certified
• Confirm that warranty provisions and training provided
was consistent with requirements of contract
• Verify that all required assets were transferred to owner
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Construction
Auditing
Unit Ten
“Issues Related to the Use of Sub-
Contractors”
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Overview
• Quite often, construction projects require the
use of multiple sub-contractors of all sizes and
skills. This module will address the risks
inherent with the use of sub-contractors( sub-
contractor approval process, common terms
and condition with prime contractor, etc.) and
the audit strategies to employ
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Sub-contractors
• Remember:
– Sub-contractors engaged to perform portion of work
not undertaken by contractor
– Used primarily for skills and/or equipment not
resident with General Contractor (GC)
– GC responsible for quality of sub-contractor work
and any delays caused by them
– Sub-contractors employed to meet DBE contract
requirements
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Risks
• Poor sub-contractor performance
• Related party transactions
• Fictitious companies
• General Contractor/Sub-contractor
billing disputes
• Non payment to subs by General
Contractor
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Controls
• Sub-contractor approval process
• Require pre-qualification or competitive
bidding selection
• Same contract terms and conditions as
General Contractor
• Right to audit clause
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Audit Objectives
• Ensure
– Sub-contractors selected in accordance with contract
terms
– Sub-contractors are qualified to perform the work
– Work performed met contract standards
– Costs billed for sub-contractors were actually
incurred and accurate
– That subcontractor is not a subsidiary company or a
related party
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Audit Procedures
• Assess compliance with subcontractor approval process
• Independently verify existence of sub-contractors and
quality of past performance
• Reconcile payments to sub-contractors with cancelled
checks to confirm actual payment
• Confirm subs satisfy bond and insurance requirements
• Conduct a cost audit of selected subcontractors
• Review subcontractor change orders and verify basis for
charges
• Verify that owner was credited with subs discounts
• confirm no outstanding billing disputes with GC
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Disadvantaged Owned
Business Enterprise (DBE)
• Is a for profit, small business concern
• 51% owned by socially and
economically disadvantaged
individual(s) or business
• Management and daily operations
controlled by people who own it
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Audit Objective
• Ascertain firms engaged to meet
DBE/MBE/WBE participation goals have
met all the required criteria to be
certified as a DBE/MBE/WBE and have
actually performed sub-contracting
work
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Construction
Auditing
Unit Eleven
“Safety and Insurance Related Issues”
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Overview
• This module will focus on the risks and
exposures related to a contractor’s
safety record, insurance coverage, and
the potential financial and reputational
impact on construction projects
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Safety
• Can have significant negative impact on
project
• Accidents happen but risk increases
when safety is ignored
• Contractors legally and contractually
required to operate a safe workplace
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Safety (cont)
• Subcontractors should also be required
to comply with safety aspects
• Reminder: Past record of contractor and
sub-contractors regarding safety should
be a qualification for contract award
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Risks
• Increase job costs
• Law suits
• Higher insurance premiums
• Project delays
• Lost worker productivity
• Property loss
• Damages to facilities and equipment
• Reputational damage
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Controls
• Incorporate safety in project design
• Tone at the Top-workplace safety highest priority
• Safety program, policy statements, training
• Regular safety inspections and meetings
• Utilization of posters and warning signs
• Safety audits
• Safety recordkeeping
• Accident and hazardous reporting
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Bonding
• Owners often require GC to purchase
guarantee or surety bond
• Purpose-if GC fails to finish project, funds
available to hire replacement contractor
• GC’s bonding capability based on financial
statement and past performance
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Risks
• Contractor allowed to initiate
construction prior to receipt of bonds
• Contractor exceeds bonding capacity
• Bonds provided by agent or broker
rather than insurance company
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Audit Focus
• Verify all required bonds were in place prior to
initiation of construction
• Ascertain that bonds were issued by an
approved surety bond/insurance company
• Obtain copies of bonds as proof of existence
• Confirm bonds remain in existence for term of
project
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Insurance
• General condition of contract
• Requires contractor to carry different types:
– Could include:
• Property insurance
• Builder’s risk (provides coverage on
contract works due to a fire or storm)
• Liability (protects contractor against
liability by public, not employees)
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Audit Focus
• Verify all required insurance in place
prior to initiation of construction
• Ascertain insurance with an approved
carrier
• Obtain certificates of insurance
• Confirm policy in force
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Construction
Auditing
Unit Twelve
“Other Audit Considerations”
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Overview
• In this unit we will discuss other areas
for audit consideration depending on
the size of the owner company,
industry, etc., that may provide
opportunities to enhance the
governance process and construction
oversight
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(1) Environmental
Compliance
• Variety of laws and regulations
• Many of the required permits are for environmental
protection
• Owners and contractors have ethical obligation
• Issues subject to monitoring and control
– Solid waste disposal
– Products of demolition and renovation
– Water drainage or discharge
– Air and noise pollution
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Risks
• Contaminated materials are owned
―cradle to grave‖
• Fines and penalties
• Delays-Stoppage of work
• Law suits
• Remediation
• Reputation
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Controls
• Establish a program to monitor contractor
compliance
• Conduct inspections
• Contract to specify action regarding removal
and disposition of waste
• Documentation to support disposition
• Certification hazardous materials disposed in
required sites
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Wrap Up
Summary of Key Learning Objectives
• Why audit contracts?
• What should be audited?
• When should the audit take place?
• Who should be doing the review(s)?
• Where should it be conducted?
• How should it be done?
• Course Evaluation
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Thank you for
your participation!
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