Construction Contractors Advanced Issues

• Chapter 1 - Nature and Significance of the Construction Industry
  • Learning Objectives
  • Introduction
  • Construction Industry Overview
  • Types of Contractors
  • Players in the Industry
    • Players within the Contractor Client
  • Types of Contracts
  • The Role of the Surety
  • Contract Accounting
    • Percentage of Completion
    • Completed Contract
  • Additional Resources for the Construction Industry
  • Summary
• Chapter 2 - Internal Controls for the Contractor
  • Learning Objectives
  • Introduction
  • What Are Internal Controls
  • Components of Internal Control
    • Control Environment
    • Risk Assessment
    • Control Activities
    • Information and Communication
    • Monitoring
    • Control Environment Questionnaire
  • Controls Specific to Construction Contractors
    • Estimating and Bidding
    • Project Administration and Contract Evaluation
    • Job Site Accounting and Controls
    • Billing Procedures
    • Contract Revenues
    • Equipment
    • Contract Costs
    • Payroll Costs
  • Communicating Internal Control Matters
  • Summary
• Chapter 3 - SAS No. 99 and the Contractor
  • Learning Objectives
  • Introduction
  • SAS No. 99, Consideration of Fraud in a Financial Statement Audit
  • Mandatory Identification of Certain Fraud Risks
    • Management’s Ability to Override Controls
    • Revenue Recognition
  • Required Brainstorming Session
  • Increased Inquiry
  • Expanded Use of Analytical Procedures
  • Consideration of Other Information
  • Fraud Considerations in a Review Engagement
  • Accounting Malpractice Litigation
    • Audit Claims Brought by Claimants
    • Malpractice Case Examples
  • Summary
• Chapter 4 - Cash Management for the Contractor
  • Learning Objectives
  • Introduction
  • Sources of Cash for the Contractor
  • Contractor Cash Flow
    • General and Administrative Expenses
    • Job Cash Flow
    • Cash Flow Analysis
    • Practices to Improve Cash Management
  • Summary
• Chapter 5 - Accounting Joint Ventures
  • Learning Objectives
  • Introduction
  • The Joint Venture
    • Advantages and Disadvantages
  • Accounting for a Joint Venture
    • Accounting for a Joint Venture as a Stand-Alone Entity
    • Accounting for a Joint Venture as a Member
  • The Joint Venture Agreement
  • Method of Organization
    • Partnerships
    • Corporations
  • Members Ownership Percentage
  • Method of Accounting for the Member
    • Cost Method
    • Full Consolidation Method
    • Equity Method
    • Partial or Proportionate Consolidation Method
  • Disclosures by Members of Joint Ventures
  • Impact of Joint Ventures Due to FASB ASC 460, Guarantees (FIN 45)
  • Impact of FASB ASC 810, Consolidation [FIN 46(R)]
    • The Typical Contractor FASB ASC 810, Consolidation [FIN 46(R)] Situation
    • Member Owns 50% or More and Assumes Majority Risk
    • The Joint Venture Structure
    • Options Involving the Attest Function
  • Summary
• Chapter 6 - Benchmarking the Contractor
  • Learning Objectives
  • Introduction
  • Financial Benchmarking
    • Liquidity Ratios
    • Profitability Ratios
    • Leverage Ratios
    • Efficiency Ratios
• Healthy Contractor Benchmarks
• Non-Financial Benchmarking
  • Time
  • Performance of Work
  • Performance of Employees
  • Sources for Developing Benchmarks
• Summary
• Chapter 7 - Construction Cost Allocations
  • Learning Objectives
  • Introduction
  • Components of Job Costs
    • Labor Costs
    • Material and Subcontract Costs
    • Equipment Costs
    • Job Overhead or General Conditions
  • The Impact on Estimators and Project Managers
    • Alternative Overhead Strategies When Contract Volumes are Low
  • Selling, General, and Administrative Costs
    • Break-Even Analysis
  • Summary
• Chapter 8 - Assisting the Financially Troubled Contractor
  • Learning Objectives
  • Introduction
  • Why Contractors Are Prone To Failure
    • The Nature of the Beast
    • Ease of Entry
  • Warning Signs for Potential Business Failures
    • Surety Warning Signs
    • Cash Flow Warning Signs
    • Fraud Warning Signs
    • Other Business Failure Warning Signs
  • Saving the Financially Troubled Contractor
  • Go from Attitude to Action
    • We Must Look at What We Have on Hand
    • We Must Prepare the Turnaround Plan
    • Implement the Turnaround Plan
    • Accountability to the Plan
  • Summary
• Chapter 9 - Audit Risks of a Contractor
  • Learning Objectives
  • Introduction
  • Audit Risk and the Audit Risk Model
  • Contractor Audit Risk Areas
    • Assessing the Risk of the Individual Contract
    • Determining Whether the Contracts Have Unapproved Change Orders or Claims
    • Auditing Estimated Costs to Complete
    • Confirmation of the Contract
    • Reading of the Contract
    • Workers’ Compensation Issues
    • Contractor’s Accounting Systems
    • Fraud in the Financial Statements and at the Individual Contract Level
    • Understanding the Use of the Financial Statements by Third Parties
    • Evaluating the Contractor as a Going Concern
    • The Implication of Deferred Taxes
  • Warning Signs for the Auditor
  • Applicability to a Review Engagement
    • The Review Level Engagement
    • Application of Top Eleven to a Review Level Engagement
  • Summary
• Chapter 10 - Deferred Income Taxes
  • Learning Objectives
  • Introduction
  • Permanent and Temporary Differences
    • Application to the Construction Industry
    • Differences between the Percentage of Completion Method and Other Methods Used for Income Tax Reporting
    • Differences between GAAP and Tax with the Recognition of Income for “Contract-related” Services
    • Differences in Calculation of Percentage of Completion
    • Differences in Depreciation Methods
    • Differences Due to the Provision for Losses on Uncompleted Contracts
    • Differences Arising from Joint Ventures
  • The Utilization of Enacted Tax Rates
    • Calculating the Deferred Tax Provision
    • Valuation Allowance
  • FIN 48 Accounting for Uncertainty in Income Taxes — an interpretation of SFAS No. 109
    • The Effective Date of This Interpretation
    • FSP FIN 48-2, Effective Date of FASB Interpretation No. 48 for Certain Nonpublic Enterprises
    • FSP FIN 48-1, Definition of Settlement in FASB Interpretation No. 48
  • Summary
• Chapter 11 - Alternative Minimum Tax Considerations for Contractors
  • Learning Objectives
  • Introduction
  • Exemptions from Alternative Minimum Tax
    • Home Construction Contracts
    • “Small Corporations” Exception
  • Calculation of the Alternative Minimum Tax
    • Long-Term Contract Adjustment
  • Minimizing the Minimum Tax
    • Evaluating the Usage of Material on Jobs in Progress
    • Control Subcontractor Front Loading
    • Explore the Usage of the Simplified Cost Method
    • Exercise the All-Events Test and Economic Performance
    • Re-Evaluate the Estimated Costs to Complete
  • Summary
• Chapter 12 - Look-Back Method
  • Learning Objectives
  • Introduction
  • Reporting the Calculation
    • Exceptions to the Calculation
    • The De Minimis Election
    • Look Back? What is Look Back?
  • The Computation of the Look-Back Calculation
    • Simplified Marginal Impact Method
    • Other Considerations
  • Summary
• Chapter 13 - Tax Planning for the Contractor
  • Learning Objectives
  • Introduction
  • Financial Analysis
  • Tax Planning Process
    • Tax Planning Options
  • Summary
• Chapter 14 - Latest Developments
• Value Aid Audit Risk Alert, Real Estate and Construction Industry Developments

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What Are Internal Controls

At times, we accountants get too caught up in defining internal controls as procedures that are put in place to protect the theft of cash or the prevention of fraud. It is true that internal controls assist in accomplishing these issues, but for a business the internal controls are much broader than those defined by most auditors. Every company has processes and procedures that must be performed in order for any company to succeed and grow. If a $5 million organization has policies and procedures in place that are appropriate for a $50 million organization, then that $5 million organization has a strong foundation to grow and to expand much more rapidly than most of its counterparts. On the other hand, if a $50 million organization has the same policies and procedures in place as that of a $5 million organization, then expect many troubles and the organization's inability to handle a risk of failure.

Internal controls are designed to carry out an entity's processes. Such processes should provide the owner, management, and employees reasonable assurance that certain defined objectives are being achieved. A company will have a difficult time achieving its objectives if the primary means of handling the details are not being achieved. These details should include

1. The reliability of data,

2. The efficiency and effectiveness of operations,

3. The protection and safeguarding of the entity's assets, and

4. The compliance of applicable laws and regulations.

Therefore, the term "control" is not necessarily a theft deterrent, but more of a process or procedure whereby defined objectives set by management can be achieved. Such controls may or may not be documented. The reason why most small entities do not have such controls documented is mostly due to time and priorities set by the company. However, the problem with lack of documented policies, procedures, and internal controls is guidance. Such policies and procedures will allow employees of organizations to understand their job, their purpose for being an integral part of the company, and direction to where the company is heading.

Components of Internal Control

Internal control is made up of the following five interrelated components:

• Control environment

• Risk assessment

• Control activities

• Information and communication

• Monitoring

Control Environment

The design and implementation of any internal control system is subject to the control environment the system operates within. In simple form, the control environment can be defined as the organization's culture or the "tone at the top" set by management as it relates to the internal control function. Multiple internal control policies and procedures can be written and dictated to staff, but if the attitude and behavior of the company's top management toward these policies and procedures is abusive, the purpose and objective of the internal control structure is lost.

Appendix B, Internal Control Components, of SAS No. 109, Understanding the Entity and Its Environment and Assessing the Risks of Material Misstatement, identifies the following elements of an entity's control environment

a. Communication and enforcement of integrity and ethical values. The effectiveness of controls cannot rise above the integrity and ethical values of the people who create, administer, and monitor them. Integrity and ethical values are essential elements of the control environment that influence the effectiveness of the design, administration, and monitoring of other components of internal control. Integrity and ethical behavior are the product of the entity's ethical and behavioral standards, how they are communicated, and how they are reinforced in practice. They include management's actions to remove or reduce incentives and temptations that might prompt personnel to engage in dishonest, illegal, or unethical acts. They also include the communication of entity values and behavioral standards to personnel through policy statements and codes of conduct and by example.

b. Commitment to competence. Competence is the knowledge and skills necessary to accomplish tasks that define the individual's job. Commitment to competence includes management's consideration of the competence levels for particular jobs and how those levels translate into requisite skills and knowledge.

c. Participation of those charged with governance. An entity's control consciousness is significantly influenced by those charged with governance. Attributes include those charged with governance's independence from management, the experience and stature of its members, the extent of its involvement and scrutiny of activities, the appropriateness of its actions, the information it receives, the degree to which difficult questions are raised and pursued with management, and its interaction with internal and external auditors. The importance of responsibilities of those charged with governance is recognized in codes of practice and other regulations or guidance produced for the benefit of those charged with governance. Other responsibilities of those charged with governance include oversight of the design and effective operation of whistle-blower procedures and of the process for reviewing the effectiveness of the entity's internal control.

d. Management's philosophy and operating style. Management's philosophy and operating style encompass a broad range of characteristics. Such characteristics may include the following: management's approach to taking and monitoring business risks; management's attitudes and actions toward financial reporting (conservative or aggressive selection from available alternative accounting principles, and conscientiousness and conservatism with which accounting estimates are developed); and management's attitudes toward information processing and accounting functions and personnel.

e. Organizational structure. An entity's organizational structure provides the framework within which its activities for achieving entity-wide objectives are planned, executed, controlled, and reviewed. Establishing a relevant organizational structure includes considering key areas of authority and responsibility and appropriate lines of reporting. An entity develops an organizational structure suited to its needs. The appropriateness of an entity's organizational structure depends in part on its size and the nature of its activities.

f. Assignment of authority and responsibility. This factor includes how authority and responsibility for operating activities are assigned and how reporting relationships and authorization hierarchies are established. It also includes policies relating to appropriate business practices, knowledge and experience of key personnel, and resources provided for carrying out duties. In addition, it includes policies and communications directed at ensuring that all personnel understand the entity's objectives, know how their individual actions interrelate and contribute to those objectives, and recognize how and for what they will be held accountable.

g. Human resource policies and practices. Human resource policies and practices relate to recruitment, orientation, training, evaluating, counseling, promoting, compensating, and remedial actions. For example, standards for recruiting the most qualified individuals - with emphasis on educational background, prior work experience, past accomplishments, and evidence of integrity and ethical behavior - demonstrate an entity's commitment to competent and trustworthy people.

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