How to Prepare for Your First Audit as a Construction Contractor

Most contractors get their first audit because bonding capacity outgrew a reviewed statement. The surety, the bank or a large general contractor wants audited numbers before it will back bigger jobs. Getting ready means one thing above all: a work-in-progress (WIP) schedule that ties to the general ledger and that your project managers will defend line by line.

Start about 90 days before year end. The auditor will spend most of the engagement on open contracts, so the cleaner your job cost records and estimates to complete, the faster fieldwork goes and the fewer surprises land on your income statement.

Who is asking for the audit?

The request almost always comes from outside. A surety sets underwriting conditions as your bonded program grows, a bank adds an audit covenant to a larger line of credit, or a project owner writes audited statements into a prequalification packet. Read the actual letter or loan agreement. It tells you the due date after year end, whether comparative years are needed, and whether the WIP schedule must appear as supplementary information. For how sureties read CPA reports, see construction surety bonding and CPA reports.

What will the auditor focus on?

Revenue over time. Under ASC 606, most construction contracts meet one of the criteria in ASC 606-10-25-27 for recognizing revenue over time, often because the customer controls the work as it is built. Contractors usually measure progress with cost to cost: costs incurred divided by total estimated costs. That makes your estimates the single biggest judgment in the statements. The auditor-side detail is in construction contractor audits under ASC 606.

Estimates to complete. The auditor will compare prior estimates to how jobs actually finished, interview project managers, and look hard at jobs with fading margins. A job that is expected to lose money needs the whole expected loss booked now, not spread over the remaining work. See estimate-to-complete and loss contract testing.

Over and under billings. The difference between what you billed and what you earned becomes a contract asset or contract liability. Large underbillings draw questions about whether the revenue is real.

Retainage, change orders and claims. Retainage receivable and payable need their own subledgers. Unapproved change orders and claims are variable consideration, included in the transaction price only to the extent it is probable that a significant reversal of revenue will not occur when the uncertainty is resolved.

Equipment and leases. Owned equipment falls under ASC 360 and leased equipment and yard space under ASC 842. First-time audited contractors often discover equipment rentals that are really leases.

A 90-day readiness plan

Days 90 to 61: fix the job cost foundation

• Reconcile the job cost module to the general ledger by cost type. Every dollar of cost of revenue should sit on a job or a clearly labeled overhead pool.
• Decide what counts as a contract cost. Field labor burden, small tools and equipment charges need a consistent allocation method you can explain.
• Close out finished jobs. A completed job with a stray $3,000 accrual still open distorts the WIP schedule.
• Ask your auditor for the PBC list now, not in January. The generic version is in the PBC list guide.

Days 60 to 31: rebuild estimates

• Have each project manager re-estimate cost to complete on every open job, signed and dated.
• Document the support for big swings: a revised subcontract, a rebid, a weather delay.
• Log pending change orders with status, customer correspondence and your basis for including or excluding them.
• Pull every lease and long-term equipment rental and decide which ones belong on the balance sheet.

Days 30 to 0: close the year like an audited company

• Cut off costs carefully. Subcontractor pay applications for work through year end must be accrued even if they arrive in late January.
• Run the year-end WIP schedule, tie contract revenue and cost to the income statement, and tie over and under billings to the balance sheet.
• Prepare retainage receivable and payable aging by job.
• Schedule a year-end meeting with the auditor to walk through the five largest jobs before fieldwork.

Documents to have ready

• Year-end WIP schedule with original contract, approved change orders, revised contract value, estimated total cost, cost to date, percent complete, revenue earned, billings, and over or under billings.
• Signed contracts and change orders for jobs the auditor selects, plus customer pay applications.
• Subcontract agreements, subcontractor pay applications, and lien waivers for the selected jobs.
• Completed contracts schedule for the year, with final gross profit compared with the prior estimate.
• Backlog schedule for signed work not started.
• Equipment fixed asset rollforward with additions, disposals and depreciation.
• Lease agreements and the ASC 842 calculations.
• Bank and loan statements, covenant calculations, and surety correspondence.
• Payroll reports, certified payroll for public jobs, and union benefit remittance reports.

Pull these into one shared folder per job. Auditors sample jobs, so a folder that holds everything for job 2417 saves a week of emails.

Common first-year problems and adjustments

Revenue booked on billings. Many contractors on review-level reporting book revenue when they invoice. The first audit converts that to cost to cost, which moves revenue between years and often creates a large opening equity adjustment.

Optimistic estimates. Estimates that have not moved since bid day are the most common finding. When cost to date approaches the original budget on a job that is 70% done, the auditor will push for a higher estimate and lower margin.

Missing subcontractor accruals. Late pay applications for December work understate cost and, under cost to cost, also understate revenue. The net effect is often small but the balance sheet impact is not.

Uninstalled materials. Materials delivered to site but not yet installed can overstate progress if they are counted as cost incurred without adjustment.

Loss jobs. A job expected to lose $80,000 with $30,000 of loss already recognized needs another $50,000 accrued now.

Opening balances. If prior years were reviewed or compiled, the auditor still needs comfort on opening WIP, retainage and equity. Expect requests for prior-year job files. The process is described in first-year audits and opening balances.

How to work with the auditor

Put your project managers in front of the auditor early. The audit team is not trying to second-guess construction judgment, but it must document why your estimates are reasonable, and nobody explains a job better than the person running it. Give one person ownership of the PBC tracker and answer requests within two business days.

Agree on the job selection approach at planning. Many auditors visit one or two active sites; a short walk-through with the superintendent is worth more than a stack of photos.

When the auditor proposes adjustments, ask for the reasoning and the entry in writing, and decide with your controller whether to book it. Post agreed entries to the books so next year starts from audited balances.

CORAA prepares ready-to-review audit files for US CPA firms; see /us.

Sources

• FASB ASC 606-10-25-27 through 25-37, Revenue from Contracts with Customers (performance obligations satisfied over time and measuring progress)
• FASB ASC 606-10-32-11 and 32-12, Revenue from Contracts with Customers (constraining estimates of variable consideration)
• FASB ASC 605-35-25-45 through 25-49, Construction-Type and Production-Type Contracts (provision for losses)
• FASB ASC 360, Property, Plant, and Equipment, and ASC 842, Leases
• AICPA, AU-C Section 510, Opening Balances: Initial Audit Engagements, Including Reaudit Engagements

AU-C references are to AICPA Professional Standards, paraphrased here; read the standard itself before relying on a requirement. This page is guidance, not professional advice. Report an error