Construction Contract Audits: Safeguarding Your Project’s Bottom Line

February 2, 2024

Construction projects are all about building and creating something new. But the often time-consuming, capital intensive process can lead to costly overcharges, unnecessary waste, and damaging fraud. To help reduce those risks, an independent, third-party construction audit can provide an objective analysis to help identify opportunities for stronger controls and while recommending improvements for project performance.
A construction contract audit is typically conducted at the culmination of a project as an opportunity for project owners to affirm that all contractual agreements were upheld and address any financial discrepancies. While they are a helpful tool in this capacity, conducting contract audits earlier in a project — and more frequently — may help identify potential risks sooner, as well as identify areas for possible cost savings.

Construction contract auditing is a safeguarding practice that can help you reduce the likelihood of project disputes and legal issues that could directly impact your bottom line. Ultimately, audits provide project owners with greater control over their contracts.

Objectives of Construction Contract Audits

The most common use for construction contract audits is verifying that all parties involved in a project adhere to the terms and conditions outlined in the contract. This includes verifying project costs against contractual obligations. By enforcing contractual compliance, audits help contribute to fair and transparent project execution, reducing the likelihood of disputes and legal issues.

Another key objective of a construction contract audit is to establish cost control. These audits are instrumental in safeguarding effective budget management and financial controls throughout the project. An audit will meticulously examine invoices and project records to catch any discrepancies that may lead to overpayments. By reviewing the cost structure, audits can help prevent budget overruns, identify areas for potential cost savings, and ensure financial resources are allocated efficiently across the project.

The financial transparency provided by periodic contract audits can make them even more compelling in the face of continued supply chain constraints and a challenging economic environment. Companies may use audits to help recover overpayments made during a project and empower project owners to rectify financial errors and protect their interests.

Insight

Contract audits are a critical tool to help owners of construction projects in the following areas:

  • Financial Control and Compliance: Audits assess and manage project costs, ensuring that resources are used efficiently and that projects are completed within budget.
  • Risk Management: Audits help identify potential risks early in the construction process, allowing for timely mitigation strategies to be implemented, and reducing the risk of project delays and cost overruns.
  • Quality Assurance: Audits enhance the quality of work performed and materials used in construction by ensuring that the final product meets the required standards and specifications.
  • Schedule Adherence: Audits can monitor a construction project and determine if it is progressing according to the established schedule. Delays can be addressed promptly, allowing the project to stay on schedule.
  • Contractual Compliance: Audits review contracts and agreements to ensure that owners, contractors, subs, and other stakeholders are meeting their obligations.
  • Fraud Prevention: Audits expose fraudulent activities or discrepancies throughout transactions. This is essential to maintaining the integrity of a construction project and preventing financial losses.
  • Documentation and Record Keeping: Audits verify the accuracy of project documentation and records. Proper documentation is critical for future reference, dispute resolution, and accountability.
  • Communication: Audits promote transparency amongst stakeholders by providing an objective assessment of the project’s financial and operational performance. This transparency can promote trust and increase communication among stakeholders.
  • Continuous Improvement: Audits provide an opportunity for project teams to learn from past experiences. By identifying areas of improvement, future projects can be better planned and executed.

Timeline Considerations

While many project owners are familiar with close-out audits performed at project completion, construction contract audits come in several forms and can be conducted at various stages of a project’s timeline. Each serves a specific purpose in risk mitigation.

Close-out audits are generally performed to verify that legal compliance requirements have been met and that the project adheres to contractual obligations and applicable regulations. These audits also aid financial reconciliation and address any related discrepancies or irregularities. Project owners find close-out audits to be a helpful tool for measuring the overall success of a completed project.

Construction contract audits are most effective when started from the pre-construction phase. Pre-construction audits offer a proactive approach to project and cost management. These audits run at a project’s outset and play a vital role in preventing overbilling by notifying contractors upfront of the rigorous financial standards in place and the expected level of diligence required.

In addition to considering a pre-construction audit, project owners may find conducting early audits during the project to be beneficial. Early audits aid in the timely detection of potential risks and help companies identify areas for possible cost savings. They also enable early course correction, which could save on potential issues at a later stage.

Value of Proactive Audits

The construction industry is built on relationships. Strong relationships foster effective collaboration and communication and help meet execution expectations, goals, and timelines. That said, maintaining a strong relationship with contractors, subcontractors, and suppliers does not negate the need for audits. Conversely, audits — especially those that are proactive — serve as a mechanism to improve processes and in many cases can strengthen relationships by transparently identifying areas for improvement and growth.

By taking a proactive approach, such as conducting front-end construction contract audits, project owners may unlock more substantial cost savings and risk reduction than by waiting until after issues arise. Front-end construction contract audits can help set appropriate guardrails for budgetary management and financial control. They also help in the efficient allocation of financial resources across the project.

Maintaining an early audit schedule can also help mitigate risk and guard against surprises as a project progresses. This practice can allow project owners to address any nascent issues related to contract administration, procurement, and overall governance — setting a strong foundation for the remainder of a project.

In the ever-evolving construction landscape, contract changes, supply chain disruptions, and other external factors are expected to pose new compliance challenges that require vigilant auditing. Proactivity also means keeping up with the latest practices and audit innovations, such as the use of generative AI to help stay agile and alert to emerging compliance challenges while unlocking value across the project.

Safeguard Your Bottom Line

The construction industry is evolving, with new and increased risks that call for proactive audit strategies.

A proactive approach, such as initiating front-end audits or pursuing audits at different stages of project completion, can help bolster risk mitigation, cost control, and contractual compliance.

Owners may be tempted to rely on contractors, architects, and contract managers having the project’s best interest in mind. However, it is unrealistic to expect all stakeholders, including employees and subcontractors, to operate with the owner’s best interest as their top priority at all times. Additionally, even if the stakeholders do have the best of intentions, errors can impact billings, and a construction contract audit is another line of protection against those errors.

Waiting until the end of a project to audit, as the industry has traditionally done, can lead to increased litigation, claims, and difficulties in recovering funds. Early audits not only help save costs, but also provide project owners greater control over their contracts.

Construction audits contribute to the overall success of construction projects by providing greater insight into financial accountability, adherence to quality standards, risk management, and compliance with contractual obligations. They serve as a valuable tool for project owners, investors, and other stakeholders to monitor and help optimize the construction process.

Written by Janet Smith. Copyright © 2024 BDO USA, P.C. All rights reserved. www.bdo.com