Internal Controls in the Construction Industry

Managing potential internal control risks

Five years ago, the COVID-19 pandemic abruptly changed not only everyone’s everyday lives, but also the workplace. Companies went from having their employees in a centralized location, the office, to having employees working from their homes, and companies had to increase their reliability in technology to be connected with their employees. While construction companies did not have the possibility of transitioning to a fully remote environment, technology still played a big role in performing everyday functions. The implementation of technology and its ever-evolving role in companies’ operations may have created internal control gaps. In a constantly changing world, contractors should evaluate their company’s control environment to assess and identify risk exposure and to design and implement controls for accurate reporting and safeguarding of assets to address such risks.

While there are innate risks in the industry, such as employee safety on job sites or environment considerations, contractors should evaluate if the company is subject to any external risks, such as changes in laws or regulations, sudden economic changes or a change in the competition. Contractors should consider whether any new internal risks have risen, such as a decrease in productivity or job margins due to internal errors, or even employee turnover. Once potential risks have been identified, contractors should then evaluate the company’s existing internal control processes and the likelihood of fraud going undetected.

Preventing fraudulent transactions in estimating and bidding

From a financial statement reporting prospective, one of the most critical areas is the controls around estimating and bidding. Not only are estimates a key component in the decision-making process to bid on a potential project, estimates are also a main driver to revenue recognition, job performance, and percentage of completion. When there is a gap in internal controls, bad actors could manipulate these estimates to achieve a more desirable end result. While there is no “one size fits all” control to be implemented to ensure strong internal controls, below are some common controls that could reduce and detect potential fraudulent transactions:

• Proper segregation of duties: ensuring no single person has control over an entire transaction
• Approval process: requiring each budget, estimated bid, or change order to be reviewed and approved by at least two people
• Limited access: ensuring only authorized personnel has access to bid sheets, quotes, and invoices
• Proper technology use: ideally, project management software should be used to keep track of biddings and job costs. In the event Excel is used, the workpaper should be set up to only allow certain people to manipulate certain cells.
• Recurring reconciliations to budget: regularly comparing budget to actual figures to ensure all costs are properly recorded and promptly addressing any discrepancies

To conclude, contactors should evaluate the company’s control environment and determine if the controls in place are appropriate to mitigate any potential risk, whether internal or external. If gaps or vulnerabilities are identified, contractors should consider mitigating best processes to implement to prevent or detect fraudulent transactions. By doing so, the company would achieve a stronger control environment, and reduced risk of profits being negatively impacted by fraudulent transactions.

If you need further expansion or have specific questions about these concepts, please contact your Keiter Opportunity Advisor. Interested in learning how Keiter’s Construction Industry team can assist your construction business strengthen internal controls? Contact us.

Optimizing Construction Company Internal Controls: Billing Practices