Construction Audit

Construction Audit
Uniqueness of Construction Auditing

 The taxation of construction contractors can be complex and typically requires

qualified expertise.
 The construction industry employs more people and contributes more to the

GNP than any other industry in this country. It is one of the largest segments

of the national economy, so it assumed that this sector generate more tax for

the gov’t
 Because of the ease of entry into the industry, many construction contractors

have been small, family-owned businesses. These kinds of businesses are

well-suited to the services provided and also easy ………………..to

evade tax.
 How to recognize revenue of Construction
 Determine the profit center of the project. That is, define the contract.
 Determine which accounting method to be apply.
Key elements to determine base of the contract agreement
 Contract Terms , and Contract Price that is Fixed-price or unit-
price.
Price redetermination
 Types of the project ,site location and duration of the project.
 Adjustment schedule based on application of economic price

adjustment.
 Incentives, Penalties.
 Material Supply agreement
 Definition of overhead recovery rates or fees.
 Fees based on performance criteria.
 Penalties relating to unde runs and overruns of target prices,

completion
Contract Options and Additions
 Contract options and additions are like change orders except
they are much larger in scope and may be treated as a separate
contra
 Options and additions should be treated as a separate contract in

any of the following circumstances:

 Service to be provided different from the original contract.

 The price of the new service is negotiated without regard to the

original contract
 The contract agreement amendment are similar to those under

the original contract.

 If an option or addition to an existing contract does not meet any

of the above conditions, it may be combined with the original

contract if it meets the criteria for combining contracts so any tax
auditor must be understand before start any procedure.
 Construction cost and its type

Direct Costs
Direct costs include material, labor, and subcontracting costs that are
clearly related to the job.
Indirect Costs
Indirect costs include the following:
• Indirect labor,
• Contract supervision.
• Tools and equipment.
• Supplies.
• Quality control and inspection.
• Insurance.
• Repairs and maintenance.
• Depreciation and amortization
 Types of construction agreement

There are four basic types of contracts:

 lump-sum contracts:- An agrement for a single price for the total
amount of work to be performed on a project. The price is usually not
subject to any adjustment by reason of the cost experience of the
contractor or the performance under the contract.
Example have part or ground site project agreement
 Fixed-price contract:- with the only variable being units of work

performed for example Communal house (condominium).

 Service and materials contracts:- Similar to a cost-plus contract, these

contracts generally provide for payments to the contractor on the basis of

direct labor hours at fixed hourly rates and cost of materials or other
specified costs.
 Sub contract

On a large contract, a general contractor will often hire a subcontractor to

perform a specified task or phase of the project.
During tax audit any auditor should confirm the legal matter of subcontractor
 Payment Certificate

 PC means a document verified by an architect, engineer, or owner

of a construction project that the noted work has been completed
and is approved for payment by the general contractor.
 Interim certificate: It is the certificate issued at regular intervals
prior to the completion of work. It is a concept similar to the
payment agreement in advance by the client to the contractor.
The actual payments are made at the regular intervals, however,
the agreement is made in advance.
 Practical completion certificate: It is the certificate that shows the
substantial completion of the project as stated in the contract. It
has a series of steps and several payments released along with
submission of various documents.
 Retention is a percentage of the amount certified
as due to the contractor on an interim certificate,
that is deducted from the amount due and
retained by the client.
 The purpose of retention is to ensure that the
contractor properly completes the activities
required of them under the contract.
 Certificate of non-completion: This certificate is
issued in case the contractor delays the delivery
of the project on the due date and the project is
not completed.
 Final certificate: This certificate is submitted at
the end of the contract after its successful
completion with the clearance of all the dues and
payments.
 Construction accounting Method
 The percentage-of-completion method requires construction
companies to recognize revenues, expenses, and estimated profits
on a construction project through the course of the project.
 Revenues are recognized when the company bills the project’s
owners. The revenue associated with the retention is recognized,
along with the revenues from the bill, unlike with the accrual
accounting method, which allows the company to defer recognizing
retention as revenue until it has the right to receive the retention.
 Expenses are recognized when the company receives a bill from the
supplier or subcontractors.
 Under the percentage-of completion method
the estimated profits must be equally
distributed over the entire project based on the
expected cost of the project.
 Revenues, expenses, and the estimated profits
are calculated based on the percentage of the
project that is complete.
◦ E.g. if the project were 40% complete a company would
recognize 40% of the expected revenue, 40% of the
expected costs, and 40% of the expected profit.
 Example
Assum that Xyz campany contruct agreement were
20,000,000 estimate cost 15,000,000, profit 5,000,000
based on the above information find
1. percent of completion for 2017,2018 and 2019
2 .Recognize Revenue of 2017,2018 and 2019
Assum that Xyz campany contruct agreement is 20mil,esti cost 15mil
profit 5mil

Item 2017 2018 2019

Cost incurred thus for 3,000,000.00 8,000,000.00 16,000,000.00

Estimated total costs 15,000,000.00 16,000,000.00 16,000,000.00

Billings 2,500,000.00 4,000,000.00 13,500,000.00

Cash collected 2,000,000.00 3,000,000.00 15,000,000.00

percent of completion ? ? ?
Recognized Revenue ? ? ?
 Answer

Contract agreement 20,000,000

year 2017 2018 2019

3/15mil*100 8/16mil*100 16/16mil*10
=20 = 0=100
%ge of comp. 50
20m*20/100=4 20m*50/100 20M*100/10
Recognized
Revenue mi -4mi=6m 0-4+6=10M
Gaaffii Garee

Ijaarsa waliigalaa XYZ jedhamu Galii ijaarsa giddugala gabaa I fi II irraa

argate bu’uura godhachuun Ibsa galmee herregaa bara 2012 akka armaan
gadiitti dhiyeeffatee jira.
 Galii TDQ dura qarshii 65,000,000
 Baasii (direct Cost) qarshii 55,000 bara darbe irra dhufe
 Bittaan meeshaa ijaarsaa bara kanaa 49,000,000
 Kan bara kana naana’e 30,000.00
 Dimshaasha gatii 49,025,000
 Bu’aa hinqulqula’in 15,975,000
 Baasii Bulchiinsa 14,500,000
 Bu’aa qulqulluu 1,475,000 beeksiseen qarshii 442,500beeksisee kaffalee
jira.
 Guyyaa P.C approved Work
Maqaa projektii mirkanahe Advance pay't excuted befor vat Total
Ijaarsa Giddugala
gaba -1 3/11/2011 4,000,000.00 - 4,000,000.00

Kaffaltii 1 25/11/2011 - 5,500,000.00 5,500,000.00

Kaffaltii 2 25/2/2012 2,000,000.00 12,000,000.00 14,000,000.00
Kaffaltii 3 4/4/2012 6,000,000.00 17,500,000.00 23,500,000.00
Kaffaltii 4 30/7/2012 - 22,000,000.00 22,000,000.00
Kaffaltii 5 10/10/2012 - 27,000,000.00 27,000,000.00
Ijaarsa Giddugala
gaba -2
Kaffaltii 1 30/12/2012 7,000,000.00 10,000,000.00 17,000,000.00
Kaffaltii 2 15/12/2012 - 18,000,000.00 18,000,000.00
Kaffaltii 3 10/2/2012 - 25,000,000.00 25,000,000.00
Kaffaltii 4 15/6/2012 - 32,000,000.00 32,000,000.00
Kaffaltii 5 20/8/2012 - 38,000,000.00 38,000,000.00
 summary

Any auditor before start audit process must understand

 Review the terms of contract and its agreement.

 Retention.

 advance payment.

 long term contract.

 Amendment contract price (additional).

 Way of an agreement on supply of building materials.

 Approval of the certificate by client and 3rd parties.

 Certificate approval date. Examining cash collection receipt (Manual

/Electronic.
 Examining all construction expense or cost relating to recognized revenue.

 direct construction material costs, direct labor costs indirect costs