How to Audit Engineering and Construction (E&C) Company

Overview of the industry

The classification of the construction industry is divided into different ways according to the approval definition.  The US Standard Industrial Classification (SIC) Manual are also divided this section into 3 main majors.

(1) Major Group 15: for Building Construction – Building General Contractors And Operative Builders which including such as single-family dwellings, apartment houses, some industrial plants, hospitals, office buildings, and warehouses.

(2) Major Group 16: for Nonbuilding Construction – Heavy Construction Other Than Building Construction Contractors such are dams, large bridges, tunnels, refineries, and electric power plants, highway and street construction.

(3) Major Group 17: Construction-Special Trade Contractors – included plumbing, Heat, Ventilation and Air conditioning (HVAC), painting, electrical work, masonry, and carpentry.

Internal Control and Test of Controls

For the internal control and testing of control for the E&C companies, there are main businesses processes or audit cycles which is usually we need to focus on such as contract revenue, contract cost, and contract evaluation and control which are including estimating and bidding.

1. Overview of the type of contract 

The contracts are the main documents for the Engineering & Construction Companies which the contract should be a valid and full presentation and to contains all necessary element inputs such as the financial information, legality, technical, and term and condition which both parties signed off in the term of obligation is to be done and fairly clauses for both sides.

As they general guide in the construction constructor, there are 4 fundamentals of the contract to understand the terms and their meaning as the below:

(a). A Fixed Price (Lump Sum) Contract: Stated the Lump-sum amounts or one-off amounts of the work to be completed or done as on the mentioned date on the contracts.

(b). A Unit Price Contract: This term is to mention that the contractor will be pay base on the fixed price of the project and as per the unit of the output that occurred.

(c). A Cost-Plus Contract: this is normally requiring the construction owner to pay the full amount of cost that occurred based on the request from the claim documents from the sub-constructor and or constructor. A Cost-Plus Contract unusually occurred in the form of claiming or requesting the cash to reimbursement to the cost such as labor fee, completeness output fee, and another fee.

(d). A Time and Material Constructor: this contract is required to the owner to pay the constructor on the basis of direct labor hours and the fixed hourly rate and the cost of material or the other specified costs.

2. Overview of the Revenue cycle

The auditor should consider the key audit objectives the amounts of the revenue come up with and also consider whether the amount is accurate and the revenue is properly cut off within the prior year and comply with GAAP.

For example as the below, the auditor should consider the Revenue cycle of E&C company as follow:

  • Approval agreement and Budget Expenses for construction.
  • Review the budget forecasting report to the actual result
  • Review the completion progress report which is normally approved from the site manager, construction supervisor.
  • Review the approval whether there is any change in construct term and condition agreement, claim method, and any issue as per agreed contract.
  • Prepared approval on the job/tasks costing as per request from the site.
  • Recording the job revenues and billings

3. Review of the Job Costing and related cycle

Besides the two significant cycles above, the auditor should also be considered the related to the costing that could be occurred as the expenses and which decrease the revenue of the projects when it is costly and ineffectiveness of the control on these cycles such are

  • The payment and Procurement of construction material
  • The payment to the subcontractor or outsources such as claims documents related to structure costing, wooden tasks costing, labor costing, MEP costing so on.
  • Worker Wages and Employee Compensation
  • Inventory / Material cost
  • Other indirect costing / Salvage income.

Risk Assessment for Engineering and Construction (E&C) Company

As for both whether internal or external auditing performance, the auditor must to consider the risks and key risks as to the first stage in the planning stage before further proceed to fieldwork or other performing on testing.

In this E&C company, the auditor should be considered as some examples of the key risks as bellow;

  • As in Financial Statement Auditing, the auditor should keep in mind that the recognition of revenue based on the estimation of completion of the construction is not completed.
  • There are overstated of revenue and understated of the expense are recorded in the period.
  • The recognize of the percentage of the job/tasks costing is not accurate.
  • The method of estimated completion of jobs/tasks is not presented and is accurate.
  • Lack of control on the contract/agreement review.
  • The contract between the company and the subcontractor is not fairly presented.
  • The subcontractor might manipulate the claim documents such as worker wages, percentage of completion job/task.
  • The delay in the construction is because of postponing of any assigned job/task by the subcontractor.