Audit of Construction Projects

[Buildings and Infrastructures]

 by Gursharan Singh C.M.I.I.A.

 

1.0     INTRODUCTION

1.1 The construction industry is a multi-million/billion dollar industry in most countries in the world. Unfortunately, it is given comparatively low priority by the audit profession and receives little support from the owners/management. While financial outlay may amount to 80% of the resources on construction and 20% on other aspects, 80% of  the audit resources are assigned to this 20% whereas less than 20% are assigned to the construction portion. This is also referred to as the 20/80 theory. It is not the intention to belittle the importance of financial, IT or other types of audit that also involve large financial resources.

1.2 The audit of construction projects is a multi-faceted assignment that should receive high priority and be given serious attention by auditors [internal/external] entrusted with the responsibility of audit of companies that are mainly involved with construction and property development. In addition, other companies are also involved on an ad-hoc basis. Their need for an audit would be even greater because of the almost total dependency they may have on external technical and other professional expertise for advice in all spheres such as planning, design, implementation, supervision, monitoring, post-construction aspects, etc.

1.3 The objective of the foregoing is to give some guidelines on the more important aspects of audit of construction projects. The auditor will have to create his own data and supplement his knowledge from his own experiences and of others who have undertaken contracts project audits. This is essential, as there is scarcity of published books and guides on this subject. However, the internet is a good source of information and knowledge and one of the sites is the ‘AuditNet’ that is totally dedicated to auditing.  

2.0 OBJECTIVES OF AUDIT

2.1 Objectives are as follows:

[a] Obtain confidence in the economic viability of the project

[b] Selection of implementation methodology, evaluation of contractors & contract values and implementation is as per client’s approved guidelines and industry standards

[c] Relevancy of terms & conditions, documentation, and monitoring

[d] Ascertain cause of claims, delays and changes and their financial implications

[e] Identify fraud situations & possibilities and suggest preventive measures

[f] Examine justification, accuracy & suggest alternatives to minimize costs

[g] Recoveries from third parties, where applicable

3.0 SELECTION OF PROJECTS TO BE AUDITED

3.1 The projects to be audited can be:

[a] Selected by the auditor [Planned or Random] or

[b] Management directive [board members, audit committee or management]

4.0 BASIS OF SELECTION

4.1 The basis can be any one or a combination of several causes as listed below:

           [a] High Cost Investment [b] Cost Escalation      [c] Fraud Situation 

           [d] Delays in Progress or Postponement [with subsequent Re-Commencement] 

           [e] Claims – Direct or Indirect [Legal Actions, Post construction Defects]

           [f] Changes [in Site, Design, Specifications, Laws, Abandonment]

           [g] Rehabilitation of an Abandoned Project

5.0 AUDIT ENTRY

5.1 Commencement of an audit can be at any stage of project implementation including stages prior to its physical implementation and after project completion. Some of the stages are listed below.

[a] Project Approval Stage

[b] Appointment of Technical Consultants and any other Professionals

[c] Receipt of any Reports [Feasibility, Environmental, Financial, Soil/Site Conditions]

[d] Invitation of Tenders

[e] Issue of Letter of Award or Signing of Formal Contract Documents

[f] Financial and Physical Progress [10%, 50%, 95%, Final Accounts]

[g] Prior to Expiry of Defects Liability Period

[h] Post construction Period for Usability [where owner-occupied]

5.2 Audit entry will depend on the party on whose behalf the audit is to be undertaken. This is because the interest for clients, contractors and sub-contractors will vary as correspondingly the aspects to be given emphasis will vary. This article is written on the assumption that the interests of a client [or project owner] are to be protected. However, it is substantially applicable though with some modifications, if the audit was to be done to safeguard the interests of the contractors or sub-contractors.  

6.0 SCOPE OF AUDIT

6.1 The scope of audit would include, among others, the following.

[a] Land [Acquisition, Usage [and Conversion, if necessary], Conditions and Availability

[b] Reports/Studies [Impacts and Costs]

[c] Funds [Sources, Costs and Rate of Return for Commercial Projects]

[d] Project Implementation Procedures and Safeguards, Company Guidelines

[e] Professional Consultants’ Agreements [Technical, Others]

[f] Construction Contract Formats [PAM, CIDB, JKR, FIDIC, Others]

[g] Statutory Requirements, Approvals, Special Conditions and Transfer of Technology

[h] Construction Supervision and Monitoring – Documentation, Controls and Reports

[i] Performance Bonds, Advance Payments, Guarantees and Insurance Policies

[j] Engineer’s Instructions and Site Records

[k] Contract Register and Site Records

[l] Specifications, Changes and Delays

[m] Interim Payments, Claims, Compensation, Advances, Penalties and Final Accounts

[n] Post construction Period Aspects [D.L.P., Guarantees, Warranties, etc]

[o] As-Built Drawings, Manuals and Certificate of Fitness [or Occupation incl. Partial]

[p] Evaluation of Contract Implementation including Performance of Contractors and Technical Consultants & Other Appointed Professionals

6.2 The scope of the audit can be either comprehensive to cover every known aspect of the project or be targeted and limited to any specific aspect of the project.

7.0 AUDIT ASSIGNMENT

7.1 Where the selected project is a mega project or could be controversial in nature the auditor should prepare a project paper to obtain the prior approval of the management. The paper should provide the below listed minimum information.

[a] Project Particulars [Scope, Cost, Locality, Technical [and other] Consultants, etc]

[b] Audit Team [Scope, Manpower, Time, Cost, Logistics, Anticipated Benefits, etc]

[c] Audit Process [Interviews, Access & Scrutinize Documents, Site Visits, Compliance With Company Policies, Guidelines, Controls, Industry Standards, Reports, etc]

[d] Anticipated Benefits of the audit Assignment

7.2 The comprehensiveness of the project paper should be commensurate with the scope of the audit assignment. Prior approval of the Board may be required only in exceptional cases as the internal auditor generally has discretionary powers in most audits. However, the external auditor would need prior approval as this would constitute a special assignment for which separate fees will have to be negotiated.

8.0 LIMITATION OF SCOPE OF SPECIFIC AUDIT ASSIGNMENTS

8.1 The scope of audit should be limited to areas that have indications of weaknesses. Some of the more important areas are listed below. Auditors should pay special attention as all of these have financial/legal implications and possibilities of fraud that could be detrimental to the interests of the client 

[a] Process of Selection and Award Process of Contracts and Technical Consultants

[b] Selection of Formats of construction Contracts and Tech. Consultants’ Agreements

[c] Mode of Project Implementation [B.Q.Pricing, Lump Sum, Conventional, Turnkey, Fixed Completion Period, Reward & Penalty, Fast Track, etc]

[d] Professional Fee Computations [Percentage, Man-months, Negotiated, Fixed, etc]

[e] Facilities provided by Client to Contractors & Consultants and Reimbursable Claims

[f] Special Conditions, Financial Safeguards and Compliance with Approved Procedures

[g] Interim Payments, Advances, Variations, Delays, Rewards, Penalties, Compensation, In-house Supplies, Recoveries, Final Accounts, Statutory Payments [Adv. or Final]

[h] Monitoring Procedures: Contract Register, Progress Reports [incl. Video],

[i] Engineer’s Instructions, Site Records, Statutory Requirements. etc.

[j] Post construction Period Defects Remedies, Guarantees, Warranties, Usage, etc.

[k] Safe Custody of Documents with Legal and Financial Implications and the duration

8.2 However the scope of audit should be flexible and expanded or reduced as the confidence level in the process varies. The rationale of any subsequent change should be subject to prior approval of the relevant authority and properly documented. The cost of the audit should be borne in mind during selection of any project/contract for audit.

9.0 AUDIT PROCESS

BEFORE COMMENCEMENT

*AUDIT PROGRAM

9.1 The audit team leader should prepare for audit and do the following

[a] Prepare an audit Program listing the Manpower and its individual responsibilities

[b] Infrastructure Requirements: type and duration

[c] Period of audit

[d] Relevant Notes, Checklists, I.C.Q.s and Time Sheets with unit costs

[e] Working Files of Previous audits, if any, for clearance of any outstanding matters.

[e] Permanent File and Formats to be filled for proper documentation

[f] Informing the auditee Department of the Scope of audit

[g] Providing the auditee with a list of Requirements especially documents and Availability of personnel who may be needed including duration

*MEETING WITH AUDITEE

9.2 The team leader should always ensure that his audit would not disrupt the duties of the auditee and his staff nor hinder the smooth operations of the department being audited. Thus it is of utmost important that he is flexible and as far as practical, and able to accommodate the needs of the auditee. In addition, the auditor should do his best to convince the auditee that the objective of the audit is to assist and ensure that all company operations and transactions comply with approved company procedures and guidelines. It is not the function of audit to find mistakes or punish but to learn from any mistakes that may be discovered during audit.

*LOCATION OF DOCUMENTS

9.3 Most of the documents, especially the more important ones, will be available at the various departments [Finance, Accounts, Legal, Company Secretary, Project Development and Management] situated in the main office. However, some documents will be available at the site office where the project is being constructed.

9.4 In some cases, it may be more beneficial to view some documents that may be in the offices of technical [and other] consultants. To obtain the best results, the auditor should take the opportunity and visit these consultants, as this will also create good communications. It may be necessary to make provision in the Agreements to authorize the auditors to visit the consultants’ offices, have discussions, and scrutinize the project documents.    The old ‘3L’ [Look, Listen & Learn] habit of younger days is very valuable and can produce extremely beneficial results even in these modern hi-Tech days of IT and Internet.

*DURING THE AUDIT

9.5 The auditor should then commence his audit systematically and in accordance with the approved program. The auditor should ensure the following.

[a] Have an opening conference with the auditee and those involved, explaining the Scope, Duration, Need for Documents, etc. and providing explanations as necessary

[b] Visiting the Site of the Project, obtain a Briefing and getting the feel of the Works

[c] Scrutinizing Engineer’s Instructions, Site Conditions, Progress, Materials, etc.

[d] Examine documents pertaining to Financial Aspects and those having Financial Implications including justifications and computation accuracy.

[e] Verify the legal validity of the relevant documents [Contractual Documents and Agreements, Bonds, Insurances, Guarantees]

[f] Scrutinize the Implications of Special Conditions, Endorsements, Non-Standard Documents or any Changes to Terms & Conditions in Standard Forms or Company Approved Formats/Procedures.

[g] Clarify; obtain Explanations and Remedy where necessary with verbal/ written Responses

[h] Brief the auditee and Management periodically either verbally or with written reports

*AT THE END OF AUDIT 

9.6 The auditor should have a final closing meeting with the auditee [at site and at the main office] covering all relevant matters. The following steps are important.

[a] The result of the discussions should be documented

[b] Instances where the auditee disputes the auditor’s findings or does not agree with his Views and recommendations should be recorded together with the auditee’s rationale and supporting reasons

[c] Prepare the Working Papers and filing and indexing them in acceptable formats

[d] Up-date the Permanent File where necessary

[e] Prepare a Draft Final audit Report [in Summary and Detailed form] and send it to the Management and other relevant persons for their responses before finalizing it

[f] Prepare and Issue a Final audit Report [Summarized and Detailed] to the audit Committee for discussions where necessary before it is submitted to the Board.

9.7 It is important that due appreciation is recorded in the audit reports regarding the performance of the auditee and his staff and the level of co-operation and assistance provided during the audit.

10.0 PERFORMANCE EVALUATION REPORT OF THE AUDIT ASSIGNMENT

10.1 The result of the audit should be evaluated in line with the objectives of the audit, basis of the project’s selection and scope of the audit. A performance evaluation report should be prepared wherein the following, among other aspects, should be highlighted.

[a] Cost of audit against budgeted cost [Savings or Over-run with reasons]

[b] Extent to which the Objectives were achieved

[c] Financial Recoveries Achieved

[d] Potential Savings Identified

[e] Fraud Situations Identified with Remedial Measures Recommended

[f] Weaknesses Observed in Policies, Guidelines and Procedures with Proposed Remedial Recommendations

[g] Recommendations in construction Projects Management and Implementation with Emphasis on Contract/Agreement Documentation Formats, Terms, Conditions, Specifications, Pricing, Claims, Delays, Contract Register, etc. where necessary

10.2 The Performance Evaluation Report should result in improvements to the audit Department and the Companies Operations that should bring greater Financial Rewards and Job Satisfaction to all 

10.3 Actual Findings of Substantial Overclaims/Overpayments resulting from audit of several Mega construction Projects [Infrastructure/Buildings] have been written [and some have been published]. The main cases are listed below.

[a] Fraud in Relation to construction Contracts

[b] The ‘Forgotten’ US$367.0million [Overseas Purchase Contract]

[c] construction Contracts - Levy Payments to C.I.D.B.

[d] RM2.3million Professional Fee Overclaimed [Total Savings of RM3.1million]

[e] Tech. Consultants’ Professional Fee Computations – Three Cases of Overclaims

[f]     “            “           - Dangers of Fee Negotiations [Losses to Clients or Consultants]

[g]    “            “           - Fee for Re-designed Project

     [Over claim Recovered - RM9.555million and Identified Additional RM3.045million]

[h] Construction Projects – Deposits with Local Authorities Accounted as “Expenditure’ 

10.4 It may be noted that while the audit may have identified overpayments, quantified and substantiated the amount overpaid, managements may decide not to pursue and recover the amount overpaid. The management decision could be based on other considerations that it feels should not be disclosed to the auditor. The auditor would then submit his report to the audit committee for appropriate action and decision. It could be possible that the audit committee also decides not to take further action. This does not mean that resources on the audit have been wasted or the auditor is not effective. 

11.0 CONCLUSION

11.1 It must be remembered that the responsibility and role of the auditor ends with the audit report and recommendations being submitted to the audit committee who may accept the Board’s reasons or decision for not instituting recovery action. auditors should not be disheartened or feel frustrated by this lack of action or perceived lack of support to the efforts of the auditor. They should continue to perform their audit functions and discharge their responsibilities to the best of their abilities, as is prescribed in the audit charter and as expected of them.

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