Financial audits in construction can be challenging, especially for small and mid-sized businesses facing their first audit with many projects. Audits require strong preparation and a firm grasp of both project management processes and accounting practices.
Since audits may occur without much warning, chief financial officers (CFOs) and financial managers should ensure ongoing audit readiness. Coordinating operations and accounting by organizing data and aligning financial records with projects streamlines the process. Proactive preparation not only ensures compliance but can also reveal cost-saving opportunities that boost project profitability and support sustainable growth.
Understanding Construction Audits: Purpose and Scope
In the construction industry, audits play a crucial role in evaluating the financial health and operational efficiency of projects for key stakeholders such as banks, bonding companies and government agencies. For instance, sureties and lenders frequently require verification of a subcontractor’s financial information before issuing a bond or loan, while property owners often request audits prior to awarding a contract.
Construction companies pursuing larger projects, expanding their bonding capacity or seeking new financing may be required — or strongly encouraged — to undergo an audit. Common scenarios include:
- The company carries debt exceeding $5 – $10 million.
- The company is seeking surety bonds greater than $2 million.
- The company is contracting with government agencies or large general contractors.
- The company is preparing for mergers, acquisitions or succession planning.
During the audit process, an external auditor conducts a detailed review of contracts, financial records and project management practices to ensure that construction projects adhere to industry standards and regulatory requirements.
Audits focus on several key areas:
- Compliance with Generally Accepted Accounting Principles (GAAP) and accuracy of financial statements, including income statements, balance sheets and cash flow statements.
- Supporting documentation for revenue recognition and expenses, such as work-in-progress (WIP) reports relevant to the audit period.
- Evaluation of project management effectiveness, internal controls and risk management practices.
Successful audits can identify discrepancies and help prevent costly overruns. Additionally, they provide valuable insights that inform and enhance future project outcomes. When financial leaders understand the purpose and scope of audits, they are better equipped to streamline internal processes and foster organizational success. This foundational knowledge is essential for achieving audit readiness.
Key Elements of Audit Readiness
Achieving audit readiness demands careful preparation and thoughtful planning. This includes organizing data, setting up internal controls and verifying data accuracy — all of which lay the groundwork for an efficient audit process and positive results.
A thorough plan for audit readiness should cover:
- Robust financial systems (such as job costing, WIP reporting and a well-structured chart of accounts) along with a clean opening balance sheet.
- Complete and orderly records of finances, leases and equipment, including their terms and payment schedules.
- Clear, documented accounting policies and procedures for revenue recognition, capitalization, and indirect costs.
- Strong internal controls (like segregating duties, approval workflows and fraud prevention measures) to safeguard the business and provide auditors with confidence.
- Effective communication practices with auditors.
Maintaining consistent financial documentation is essential for successful audits, as it reduces mistakes and saves time during retrieval. On the other hand, inconsistent records may cause delays and increase auditing costs.
Regularly review accounting practices and train staff to improve audit efficiency. Preparing for audits — ideally over 12 to 24 months — reduces stress, but quicker turnarounds are sometimes needed. Conducting internal audits during the year helps catch issues early. Focusing on these principles promotes smooth audits and strengthens organizational resilience.
Building a Construction Audit Checklist
Creating a thorough audit checklist is crucial for comprehensive audit preparation. In addition to the finance team, project managers play a vital role in maintaining accurate and up-to-date documentation for each project, ensuring all records are organized and readily accessible for audits.
Components of a construction audit checklist may include:
- Verification of project contracts and change orders: Project managers are responsible for ensuring these are properly documented and any modifications are clearly tracked.
- Examination of billing and payment records: Project managers help maintain accurate records of all transactions and ensure supporting documentation is available.
- Review of project timelines and milestones: Project managers monitor progress, document milestone achievements and keep schedules updated for audit review.
Strengthening Core Financial Systems for Audit Readiness
GAAP Conversion
As construction companies progress and expand, financial reporting requirements become increasingly sophisticated. Many firms begin as cash-basis, family-operated businesses. However, as the organization grows and interacts with additional lenders and bonding agents, the necessity for financial statements prepared in accordance with GAAP or undergoing full audits rises considerably.
This shift entails several important components:
- Accrual Accounting: Recognizing revenue and expenses when they are earned or incurred, rather than upon the exchange of cash, is fundamental.
- ASC 606: This accounting standard requires that revenue be recognized based on performance obligations and the percentage of project completion.
- ASC 842: Leases — including those for equipment and property — must be reported on the balance sheet.
Although migrating to GAAP standards can be complex, it remains essential for building a robust framework for audit readiness. Job costing, WIP reporting and a chart of accounts are key practices to adopt.
Job Costing
Accurate job costing is vital in construction accounting, allowing real-time tracking of labor, materials, equipment, subcontractor costs and overhead. This leads to dependable percentage-of-completion calculations for audits, improved forecasting and better profitability analysis. Proper allocation of indirect costs like insurance, labor burden, and fuel, along with consistent use of cost codes and staff training, strengthens job cost reporting.
To ensure effective job costing, it is essential to allocate indirect costs such as insurance, labor burden, and fuel appropriately. Additionally, consistently utilizing those cost codes and providing proper training to staff can significantly enhance the quality of job cost reporting.
WIP Reporting
WIP reports play a vital role in reconciling billed amounts, costs incurred and project completion levels. Monthly WIP reviews assist in:
- Identifying underbilling or overbilling situations, which can lead to cash flow issues.
- Spotting margin erosion early, enabling timely corrective actions.
- Ensuring that revenue is recognized appropriately as per GAAP standards.
Importantly, this process is highly collaborative between accounting teams and project managers. By working together, they ensure that project financial data is accurate and up-to-date, enhancing the quality of WIP reporting. Regular WIP reviews not only enhance financial transparency and facilitate smoother audit processes by demonstrating meticulous project management, but they also foster ongoing communication and alignment between financial and operational stakeholders.
Chart of Accounts
A well-structured chart of accounts simplifies reporting and audit preparation. It should:
- Separate operational metrics from financial reporting to provide clear insights.
- Align with GAAP categories, particularly with respect to over/under billings.
- Maintain consistency across projects and departments to ensure accurate internal and external financial analysis.
Maintaining an organized and up-to-date chart of accounts is vital for effective management and positive auditing results. By prioritizing these aspects and reinforcing main financial systems, construction companies can achieve audit readiness that goes beyond meeting compliance standards — setting their businesses up for long-term growth and success.
Organizing Documentation and Financial Records
Proper organization of documentation and financial records is a cornerstone of audit readiness. A systematized approach helps streamline the audit process and reduces last-minute scrambles. Ensure all documents are complete, accurate and easily accessible.
Key documentation includes, but is not limited to:
- An up-to-date general ledger that covers the entire audit period
- A/R aging reports
- Contract schedules and WIP reports
- Schedule of inventory and storage fees
- Fixed assets and depreciation schedules
- Vendor invoices and pay apps from lower-tier subs
- Bank statements and canceled checks
- Proof of prepaid expenses
- Schedules of loans and other liabilities with lenders and creditors
- Permits, insurance certificates and payroll records
- OSHA, ADA, NEC and other regulatory documentation
Financial leaders and project managers should ask their external auditor for a list of documents and materials they’ll need before they start the audit.
Leveraging Technology and Automation Tools for Audit Readiness
Enterprise resource planning (ERP) systems serve as the backbone of technology in construction audits, providing a centralized platform for data management and documentation. Leveraging ERP solutions — such as Sage Intacct Construction — empowers construction companies with efficient tools for tracking project details and maintaining comprehensive records. These integrated systems play a pivotal role in streamlining audit preparation and execution by enabling businesses to:
- Utilize ERP-based project management and job costing modules for real-time data tracking.
- Take advantage of cloud-enabled ERP document storage for secure and easily accessible records.
- Deploy ERP dashboarding features to monitor financials and automate report generation.
By positioning ERP at the center of their technology strategy, project managers and financial leaders increase audit readiness, minimize manual errors and boost transparency — ultimately setting the stage for successful audits.
Tips for a Smooth Audit Process
Ensuring a seamless audit involves adopting proven practices. These strategies focus on preparation, collaboration and communication, reducing stress and improving results. By following structured methods, construction companies can streamline the entire audit process.
For CFOs, financial leaders and project managers, organizing an audit around best practices includes:
- Allocating enough time for thorough preparation.
- Training staff on audit objectives and processes.
- Conducting pre-audit reviews with internal teams to identify gaps.
- Engaging experienced auditors to benefit from their knowledge, guidance through GAAP conversions, building reliable WIP reports and leveraging technology tools.
Be sure to foster open communication with external auditors by establishing clear expectations and maintaining transparency throughout. Regular updates and discussions can uncover concerns before they become major issues.
Furthermore, continuously refine processes using lessons from past audits. Document these insights to refine strategies and enhance future readiness. A proactive approach not only facilitates a smoother audit but also strengthens organizational resilience. Being audit-ready can make or break the next big construction project opportunity.
Conclusion: Achieving Audit-ready Status for Sustainable Growth
Achieving audit readiness can be more than just a compliance “checkbox” exercise. It's about building a foundation for better data and controls, which will ultimately lead to a finance function that supports sustainable business growth. By thoroughly preparing and modernizing financial reporting, financial leaders position their organization to handle audits efficiently and leverage insights for improvement.
Let Us Guide You Forward
Adaptability and preparedness are key in a dynamic economic landscape, and Cherry Bekaert's dedicated Accounting Advisory Services and Real Estate & Construction industry professionals stand ready to assist in getting your construction business audit-ready. Our team can provide the necessary guidance and solutions to help you close the books efficiently, consistently and predictably.
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