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Why audits and good procedures are not just for big companies

After recent corporate failures questions are being asked in the boardroom about corporate governance, says Andy Doyle

With the construction industry enjoying a successful period, worrying about whether all business units are properly applying policies and procedures that have been developed and approved by the board may be low on the list of priorities.

However, recent corporate failures have raised the profile of business transparency for medium-sized companies. Hard questions are now being asked in the boardroom about how long it has been since there was an in-depth and focused root and branch review of the quality of its internal controls.

Work in progress

Generally, the construction sector performs well. But sometimes it is found wanting, especially when you consider how much of a construction business's reporting regime relies on subjective judgements relating to long term contracts, work in progress and profit recognition.

The growing awareness of corporate governance has seen a marked shift by businesses - and more importantly their banks, lenders and shareholders - to seek increased transparency and understanding of site-based operations on construction projects.

Cost and value reporting together with good cash management has always been the bread and butter of any successful contractor. But businesses are now reinforcing their procedures to ensure a more comprehensive and transparent understanding of their projects and wider business performance is achieved.

So, what are some of the common control violations that happen?

  • Stretching the forecast to complete parameters.

  • Always expecting the contract to turn the corner in the next few months.

  • The recognition of variation income either in the contract to date or the forecast to complete without likelihood of recovery.

  • Understating the final costs, letting them drip-feed into the accounts over time rather than recognising their full impact.

  • Transferring irrecoverable costs from one contract to another.

  • Overstating the estimated recovery of plant or materials.

All these matters will lead to difficulties. Many don't have a direct cash outlay problem. But, first, bonuses are often related to profit and not cash flow; second, the more inflated the asset, the more income that is recognised and, hence, more tax that is paid.

So, what steps should you consider to avoid some of the issues that have affected others in the sector and provide assurance to your stakeholders that everything is in good shape?

  • Do regular bottom-up reviews of business operations, from site activity through to management reporting.

  • Where appropriate, consider doing a robust internal audits.

  • Provide clearly defined commercial policies and pro-cedures on what (and when) contract value should be recognised.

If this seems too much then, be it by subsidiary, division or branch, just map the cumulative operating profit and cumulative operating cash flow for the last five to 10 years and see if you can explain it.

Andy Doyle is assistant director at Deloitte