The construction industry is a delivery based Industry. The construction industry in India is not yet completely organised. These service providers have unique challenges faced by the industry and also the risks are unique in nature. This section is intended to highlight some of the significant challenges that the construction industry faces so as to enable the internal auditor to plan and perform the internal audit accordingly.
The internal auditor is required to perform such audit procedures specific to the entity as deemed necessary to ensure systematic evaluation of risk management, control and governance processes. Some of these challenges are given below:
(i) Challenges of meeting time schedules, cost schedules and compliance with the scope of work has been key for success and, thus, meeting them has been the greatest challenge for any entity operating in the construction industry. The internal auditor can assess the business risk, and also brand and reputation risk of not complying with deadlines. The effectiveness of controls can also be assessed by the internal auditor
(ii) The biggest challenge faced by an entity operating in the construction industry is availability of adequate manpower with appropriate skill sets at a reasonable cost. This is the most important factor to control for sustained growth of the entity. The internal auditor might analyse and assess the prospects of the business in future, apart from business risk.
(iii) The client’s capacity to make payments as per the contract agreed also poses a big challenge considering that the funds get blocked up, increasing the working capital requirements significantly. The management also faces the challenge of managing the working capital requirements for the projects considering that some clients make the schedule payment only post completion of certain percentage of work. It is the management effectiveness in keeping the cost of borrowed funds as low as possible thereby ensuring that the profitability is not significantly affected. The internal auditor can assess the effectiveness of management in assessing clients and managing cost of borrowed funds before selecting them.
(iv) The challenge of fair recognition of revenue and profit ever exists in the construction industry owing to the difficulty in estimating the exact percentage of work completed. The internal auditor can assess financial risk of recognition of revenue and incorrect billing apart from the effectiveness of the accounting process.
(v) Material handling has been a major problem for the industry. Improper handling and storage of materials lead to significant storage costs, wastage, and non–availability of critical materials at the appropriate time. The internal auditor needs to assess the efficiency of management with regards to handling of inventory.
(vi) The construction industry is more prone to accidents than any other industry. Safety precautions of workers are extremely important and have been extremely difficult to achieve by most entities. The internal auditor has to assess such types of risks and precautions taken by management to avoid them.
(vii) The costs of materials at the time of contract are significantly different compared to cost at the time of performance of the work. In cases where the cost of materials required has escalated, the management might be finding it difficult to maintain profitability. The internal auditor should assess the process of making budgets and whether management is effective in determining the future costs.
(viii) Legal Compliance has been relatively high considering many other Industries. Every contract entered by the entity has unique terms and conditions to be complied with, failing which may lead to penalties and other arbitration. The internal auditor can assess operational risks of business.
(ix) Some projects require minimum criteria such as Minimum Turnover requirement/Minimum Net Worth requirement/ Minimum quantities executed requirement for bidding of clients. If the entity does not meet these criteria, they are not qualified to bid, thereby hindering their growth. The internal auditor can assess such types of business risk also.
(x) Certain regulatory requirements mandate the submission of specific financial statements. For e.g., an entity might be operating in SEZ and non-SEZ unit. In such a case, it is required to maintain separate books of accounts in order to ensure proper determination of profit for claiming of deduction/exemption with respect to units from these respective units from the perspective of Income Tax and Service Tax. The internal auditor can assess sufficiency of legal compliance.
(xi) As an entity grows, the balance between machinery and manpower should be maintained at the optimum level. In general, greater level of mechanizing is required as the entity grows to sustain volumes and manage professionally and cost effectively. The Internal auditor can verify whether sufficient controls are in place for ensuring sustained development and growth.
(xii) Even the risks of Force Majeure such as Natural calamities / labour unrest etc needs to be factored into at the time of taking up the project.