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Guidelines for the Audit of Construction Projects
Construction projects cover many aspects. However, audit may be limited to specific aspects that may be relevant. Relevant aspects are as follows:
[a] Audit from the Owners’ Perspective – Protecting his Interests
[b] Organizing the Construction Project Management
[c] Process of Design and Construction
[d] Utilization of Resources [Labor, Materials, Equipment]
[e] Project Cost – Estimation vis-à-vis costing
[f] Justification - Economic Evaluation of the Project
[g] Finance Costs and Sources of Funding
[h] Methods of Contracting [Award Process] and Pricing [Sum, BOQ, Drwgs. & Sch. of Rates, Turnkey, BOT, D & B, Cost-Plus, Others]
[i] Planning and Scheduling Procedures
[j] Project Control and Monitoring [Contract Registers, Site Records and Reports]
[k] Cost Controls and Accounting
[l] Quality Controls and Safety Procedures
[m] Project Usage and Management Organization
The following paragraphs provide detailed guidelines for the audit of construction projects. However, it should be noted that each practitioner of auditing would have his/her own categorization of titles/headings and views. While all auditors would have similar academic audit theories and knowledge the practical experience of the individuals would differ as it would have been accumulated from the audits that they have undertaken over the years.
1.0 INTRODUCTION
1.1 The construction industry is a multi-billion dollar industry in almost all countries around the world whether it is developed, developing or under-developed. Unfortunately it is given a comparative low priority by the Audit profession and only lip service being provided with very little tangible support of the management. It is not the intention to reduce the importance of financial, IT or other types of audit that also involve large financial resources. The audit of construction projects [buildings & infrastructure] 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 [and management] that are mainly involved with construction and property development. In addition there are other companies that 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, post-construction aspects, etc.
1.2 It must be remembered that the construction industry is a gold mine for fraudulent opportunists and possibilities. The objective of the foregoing is to equip the auditors with some knowledge that has been gathered from personal experience during audit of construction projects and 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 others who have undertaken contracts project audits. This is essential as there is scarcity of published books on this subject.
2.0 OBJECTIVES OF AUDIT
2.1 Objectives are as follows:
[a] Obtain confidence in the economic viability of the project
[b] Implementation is as per approved client guidelines and industry standards
[c] Ascertain causes of claims, delays and changes and their financial implications
[d] Identify fraud situations & possibilities and suggest preventive measures
[e] Examine justification, accuracy & suggest alternatives to minimize their costs
[f] 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 internal 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. Some of the Stages are listed below.
[a] Project Approval Stage
[b] Appointment of Technical and any other Professionals
[c] Receipt of any Reports [Feasibility, Environmental, Financial, Site Conditions]
[d] Invitation of Tenders
[e] Award of Tenders and 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]
6.0 SCOPE OF AUDIT
6.1 The Scope of audit should 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 and Costs]
[d] Project Implementation Procedures and Safeguards, Company Guidelines
[e] Professional Consultants’ Agreements [Technical, Others]
[f] Construction Contract Formats [Approved by local authorities/organizations]
[g] Statutory Requirements, Approvals, Special Conditions and Transfer of Technology
[h] Construction Supervision and Monitoring Controls and Reports
[i] Performance Bonds, Guarantees and Insurance Policies
[j] Engineer’s Instructions and Site Records
[k] Contract Register/Site Records/Documentation
[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]
[p] Evaluation of Implementation, Performance of Contractors & Technical Consultants
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 Management is requested only in exceptional cases as the auditor normally has discretionary powers in most audits.
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, ICQ'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 are in compliance 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 and have discussions and scrutinize the project documents.
9.5 It is important for clients to have access to documents of contractors/suppliers and sub-contractors to ensure reasonability of quantum of claims for progress payment and for claims for any changes/variations for which there may not be any existing rate. It is observed that such a provision is included in contracts in developed countries and also those originating from the developed countries for international contracts. Unfortunately it is noted that such a provision may not be available in contracts within or originating from developing/underdeveloped countries. Thus it is important that the auditors advise their clients for inclusion of this provision in all their contracts as it should result in cost efficient audits that can contribute to better management of contracts and cost efficiencies.
9.6 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 & Internet.
*DURING THE AUDIT
9.7 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
9.8 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.
9.9 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 over claims/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 Over claimed [Total Savings of RM3.1million]
[e] Tech. Consultants’ Professional Fee Computations – Three Cases of Over claims
[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, management 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 decide not 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 including not instituting any 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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AUDIT ASSISTS THE MANAGEMENT IN:
[a] EFFECTIVE MANAGEMENT OF CONSTRUCTION PROJECTS
[b] ENSURING CONTRACTS ARE CONSTRUCTED IN COST EFFICIENT MANNER
[c] IDENTIFICATION OF WEAKNESSES & FRAUDULENT OPPORTUNITIES AND PROVIDES REMEDIAL MEASURES IN THEIR AVOIDANCE MINIMIZING
AUDIT CAN & SHOULD ADD VALUE TO PROFITABILITY
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GSK/July 06
GURSHARAN SINGH C.M.I.I.A. [Trainer
–Audit Officer]
116 Jln. Hujan Manik, O.U.G. Jln Kelang 58200 K Lumpur, Malaysia
Tel. No. [H] 603-79808549 [H/P] 019-2927178
E-mail: gursharan38@gmail.com, sharwant38@yahoo.com
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