The dawning of a new year is a great time to evaluate your business and to ensure that you have a strong system of checks and balances in your organization for the year ahead. In this newsletter, we discuss those checks and balances, or internal controls, which can protect you and your company. We will also summarize for you the impact of accounting's new revenue recognition standards on contractors. 

Key Internal Controls for Contractors

The construction industry is a risky one. While contractors can't do much about economic ups and downs, they can make sure their companies have strong internal controls to help guard against business risks. In an uncertain environment, well-run companies that have strong controls in place are more likely to gain the confidence of sureties, lenders, and customers/owners. There are several important construction-specific areas you should focus on.

Estimating and Bidding Controls
Without reliable estimates, it is difficult to bid properly or decide whether a job is worth doing. You should have an established process in place for estimating and bidding. Assign a manager to review the estimates based on each project's specifications and plans. There should be adequate documentation supporting the estimated costs for materials and labor, such as vendor price quotes and payroll data. Additionally, labor burden percentages should be checked to ensure they are adequate. Designate a senior person to verify the clerical accuracy of final contract estimates. All bids should be approved by management before they are submitted.

Project Monitoring Controls
Hitting profit targets on each project is generally dependent on the efficient management of the actual construction process. Efficient management requires that you have controls in place to monitor results on an ongoing basis. To do this, you will need job progress reports that outline the actual costs incurred on a job and the projected costs to complete it.

Changes in Work Scope and Conditions
Changes are part and parcel of the contracting business. How well you monitor and manage them can determine whether a project makes or loses money. There are steps you can take to identify and control changes that may occur during the course of a job. For starters, make sure your on-site supervisors are aware of what is and is not included in the contract. Whenever customers want changes made after the job has started, your supervisors should follow pre-established procedures to first get the changes approved and then to make sure the changes will be billed. Have written, signed change orders before any additional work is begun.

Fraud and Theft Controls
Without adequate internal controls, you have an increased chance of falling victim to theft and fraud. To limit the potential for losses, have estimators obtain more than a single quote and require management authorization of job site material purchases. In addition, set limits on the amounts site managers can spend without an additional, higher level of management authorization. Require employees to check delivery receipts to ensure that all ordered items have been received, have procedures for managing purchased materials on the job site, and periodically verify materials inventories. You will also want to keep a log of small tools and equipment used on site and the individuals responsible for them. Emphasize proper job site security and hold employees accountable for following established security procedures.

The Financial Accounting Standards Board (FASB) issued a new revenue recognition standard early last year. The release, Revenue from Contracts with Customers, is part of an effort to create a single worldwide revenue recognition standard. Over 700 pages in length, the new standard is complex and will have an impact on the financial statements of companies in many industries, including construction.

Why the Change?
Financial statement users look at revenue figures when assessing a company's financial performance. However, transactions that are economically similar may receive different accounting treatment under existing International Financial Reporting Standards (IFRS) and U.S. Generally Accepted Accounting Principles (GAAP). According to the FASB, the new converged standard will enhance the quality and consistency of how revenue is reported and improve comparability in the financial statements of companies reporting using these two main accounting standards.

New Requirements
A major change made by the new standard is that it involves recognizing revenue upon completion of a "performance obligation." The rules determining what is and is not a performance obligation are detailed. The new standard also increases the information that must be disclosed in the financial statement footnotes. Private companies in the U.S. will apply the new standard for annual reporting periods beginning after December 15, 2017. Public companies using U.S. GAAP are required to apply the standard for annual reporting periods beginning after December 15, 2016. The changes will affect different industries to different degrees. It's not too soon to begin an analysis of the best way to adapt to the new standard. We would be happy to help your company prepare for potential changes in how it reports revenues.