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10 CONSTRUCTION ACCOUNTING AND TAXATION SEPTEMBER/OCTOBER 2020

Dur ing per iods o f peak con-s t ruc t ion and s ign i f i cantbacklog, you need good inter-na l contro l s to sa feguardyour assets and hard-earned

profits. That is a given. But what happensduring an economic downturn, when per-sonnel start turning over, or worse, when apandemic occurs and your account ingdepartment becomes lean and may need towork from home? It is easy to get distractedor to make compromises dur ing suchtimes. And it is during such times that youcan be vulnerable.There are basic internal controls that

must be in place, regardless of whether youare se t t ing monthly revenue records ornervously watching jobs and productivityslow down while owners, developers, andcontractors address the need to continuebuilding safely and profitabil i ty . Respon-s ib i l i t y for deve lop ing and moni tor ingthese internal controls fa l l s to manage-ment.Most contractors who are reading this

art ic le probably do not have an internalaudit department or internal audit function.Most do not have a treasury department

tha t i s s epa ra t e f rom the i r a c count ingdepartment. As you move down the orga-n i za t iona l complex i t y cha r t t o a morerealistic representation of what you see inyour own company , a sk your se l f wha tin t e rna l con t ro l s you shou ld have tosafeguard your assets. The following internalcontrols are recommended for this pur-pose.

Segregation of dutiesSegregation of duties is fundamental in anycontrol environment. Many of the controlsdiscussed later have roots solidly in segre-gation of duties. The basic principle: Indi-viduals who have access to assets shouldnot have access to the related accountingrecords. It sounds simple, but in practicethere are challenges, mostly related to havingsufficient personnel to achieve segregationof duties.

Check signorsI f individuals who can s ign checks haveaccess to the financial accounting system,there is an inadequate segregation of duties.

DO YOU HAVEYOUR INTERNALCONTROLS UNDERCONTROL? M A R K E . L U N D

MARK E. LUND, CPA, CCIFP, is a partner-in-charge of construction industry services at Weaver, a national accounting f irm. Thefirm’s cl ients range from locally owned specialty contractors and prime subcontractors with revenues starting at $10 mill ion annuallyto large industrial contractors and general contractors with revenues in excess of $1 billion. Mark can be contacted [email protected].

Safeguard assets and hard-earned profi ts byimplementing mitigating controls or oversightwhere weaknesses exist .

JCA-20-09-04-LUND.qxp_JCA 06-06-04-Ruby 10/14/20 10:49 AM Page 10

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11INTERNAL CONTROLS SEPTEMBER/OCTOBER 2020 CONSTRUCTION ACCOUNTING AND TAXATION

SIGNED CHECKSREPRESENT ANASSET OF THECOMPANY, SUBJECTTO DEFALCATION IF RETURNED TO THE INDIVIDUALWHO HAS ACCESSTO ACCOUNTINGRECORDS.

The ability to sign a check provides accessto a s se t s . Any ind iv idua l who can s i gnchecks should not have the ability to enterjourna l en t r i e s o r t o a cce s s r e l a t edaccount ing records , inc luding accountspayable subledgers, payroll journals, andthe general ledger.A t many compan ie s , t he CFO or

controller is responsible for signing checks,which is often a fundamental mistake. ACFO or contro l ler who can s ign checkssingly and also has access to the accountingrecords and system is in a position to divertcash from the company and hide or maskthe transaction in the accounting records.Depending on whether there are other

mitigating controls, inadequate segregationof duties can result in a significant deficiencyor material weakness in internal controls.This weakness in internal controls can beaddressed by taking the following steps: 1. Require that checks be signed by some-

one outside the accounting function. Inmany companies, this responsibilityfalls to the owner, CEO, or COO,where such individuals do not haveaccess to the financial records or sys-tem. In essence, they are serving thetreasury function for the company.

2. Limit the dollar amount of checks thatcan be issued singly with only one sig-nature. This applies in situationswhere, due to a l imited number of per-sonnel in upper management, the CFOor controller must have access to theaccounting records and also retain theability to sign checks. The dollaramount l imit can be set anywherebased on management’s evaluation ofthe risk and other controls. As anexample, checks higher than $5,000could require two signatures, one ofwhich belongs to the owner, CEO, orCOO. The second signature require-ment l imits the company’s risk expo-sure to less than $5,000 if the CFO orcontroller writes a check to themselvesor cashes and then hides the disburse-ment in the accounting records. Man-agement should implement otheroversight controls to mitigate the riskof unauthorized disbursements under$5,000 (or whatever amount they haveset for their company).

3. Give check signors read-only access tofinancial records. If managementdeems it necessary for the CFO or con-troller to sign checks, segregation ofduties can be achieved by giving thesepositions read-only access throughoutthe financial accounting system, sothat they do not have the ability tomake original entries into the system(e.g. , post vendor invoices, set up per-sonnel for payroll) or make journalentries.The th i rd s t ep r equ i r e s a su f f i c i en t

number of other accounting personnel whohave the ski l ls and knowledge to handletheir responsibilities and to recognize anddecline a request to post irregular accountingentries. Require a second authorization orreview for any such requests, which mayinclude a request to post an inappropriatejournal entry, a credit memo or debit memoto a subledger , or a request to set up anunauthorized vendor.

Accounts payable disbursementsAccounts payable checks (checks to sub-contractors , mater ia l suppl iers , renta ls ,overhead, etc.) should not be returned tothe a ccount s payab l e c l e rk , CFO, o rcontro l ler once they are s igned . S ignedchecks represent an asset of the company,subject to defa lcat ion i f returned to theindividual who has access to accountingrecords. Separate the s igned check fromthe voucher package and return only a copyof the check and the voucher package tothe accounting department. Have the checkmailed or distributed by someone outsidethe accounting department. If the payablesclerk has access to the signature stamp forcomputer-genera ted or pr inted checks ,require a second signature and review beforemailing.

Payroll disbursementsThe same internal control principles applyto the payroll disbursement function. Oncethe payroll checks are signed, they shouldnot be returned to the payroll clerk or theCFO, controller, or assistant controller ifthey have access to the payroll accountingsystem or records . Al though i t can be acha l lenge in the construct ion industry ,

NOTE


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12 CONSTRUCTION ACCOUNTING AND TAXATION SEPTEMBER/OCTOBER 2020 INTERNAL CONTROLS

direct depos i t o f payrol l i s an exce l lentcontrol as there are no accessible signedchecks to be controlled. But remember, theabi l i ty to s ign checks or to prepare andelectronically sign checks (as a payroll clerkdoes) means access to an asset , even i f aphysical check is not issued. Implementmi t iga t ing contro l s or over s ight whereweaknesses exist . Also, review the payrolld isbursements records per iodica l ly andlook for “ghost employees.”

Physical distribution of payroll checkPaper checks are sti l l common in the con-struction industry, with payrolls to laborersoccurring weekly. While the normal processmight be for the project manager or super-intendent to d i sburse the checks in thefield, it is a good control to have someoneelse periodically deliver and hand out thosechecks on a surprise basis to look for fic-titious employees. It is also a good controlprocedure to check for field laborers whoare being shaken down to pay the superin-tendent an amount out of each paycheckor r i sk be ing f i r ed . Imag ine a concre telaborer approaching a surprise managementrepresentative, who is handing out checks,and saying, “Here is your $20.” When askedwhat the $20 is for, the laborer says, “Wealways give the superintendent $20 eachweek.”

Wire transfersSegregation of duties is even more criticalwhen it comes to wire transfers , and thesame rules for segregation of duties applyto initiating and sending wire transfers ofcompany funds. Accounting personnel whohave the ability to initiate a wire transferfrom the company should not have accessto the general ledger and accounting system.You may be preventing fraudulent activitiesof less than $5,000 with controls over paperchecks, but higher amounts may be at riskwithout controls over wire transfers.Idea l l y , on ly ind iv idua l s out s ide the

accounting department should be authorizedto initiate a wire transfer. Treasury initiatesand con t ro l s the t r ans f e r ; a c count ingaccounts for it . As noted previously, withl imited personnel , you may need to addmitigat ing controls . Mit igat ing controls

could include dual participation to initiatea transfer, with a follow-up reconciliationof the transfer log per management to theactua l t rans fers on the bank s ta tement .Some banks will execute the control of con-tacting management first to verify or approvethe wire transfer.Wire t ransfers can pose a higher r i sk

than computerized or paper checks. Wiretransfers invite fraudulent activities, suchas when an emai l , purportedly from theCEO or CFO, is sent to the controller oraccount ing depar tment au thor i z ing atransfer of funds to a specific bank routingnumber. The emails may look legitimate,but it is only after such transfers are madetha t compan ie s r e a l i z e they have beenscammed . Cons ider r equ i r ing the two-person authorization of wire transfers.

Positive payAlmost al l major and most regional banksoffer positive pay, and if you are not alreadyusing i t , you should. Approved disburse-ments for each check run are forwardedto the bank, and the bank only clears checksincluded on the posi t ive pay detai l s . Thisp rov ide s ano the r de t e r r en t t o p r even taccounting personnel from issuing a checkouts ide the normal r ev iew and contro lp ro c e s s . Th e po s i t i v e p a y p r o c e s s o fuploading approved checks to the bank(access to assets) should not be performedby personnel that have access to the relatedaccounting records or general ledger orhave the abi l i ty to make journal entr ies .Discuss posi t ive pay controls with yourbank.

Cash receiptsCus tomer o r owner check s shou ld b edepos i t ed by someone ou t s ide t h eaccounting department. Only the depositinformation or copies should be forwardedto a c coun t ing . A l t e rna t i v e l y , t h e c a shreceipts (checks) should be restr ict ivelyendorsed to the benefit of the company bysomeone ou t s ide t h e a c coun t ingdepartment, and then the checks shouldbe sent to accounting for deposit ing andrecording. Checks that are restr ict ivelyendorsed (e .g . , For Deposi t Only . ABCConstruction Inc. Acct. #458723) are much

SEGREGATION OF DUTIES IS

EVEN MORECRITICAL WHEN

IT COMES TOWIRE TRANSFERS,

AND THE SAMERULES FOR

SEGREGATION OFDUTIES APPLY TO

INITIATING ANDSENDING WIRETRANSFERS OF

COMPANYFUNDS.


THE THREAT OF AN ONGOINGMONTHLYMANAGEMENTREVIEW IS OFTENA SUFFICIENTDETERRENT TO DISSUADEACCOUNTINGPERSONNELFROMATTEMPTING ANUNAUTHORIZEDDISBURSEMENT.

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more dif f icult to divert to another bankaccount or turn into cash.

Electronic receiptsSetting customers or owners up to use wireor electronic transfers to make paymentson monthly billings or draws on the projecteliminates the need for multiple companypersonnel to handle owner receipts beforedepositing under the normal segregationof dut ies . This way , funds are companyproperty and secure in the bank accountwithout any personnel having access tothem. Your internal controls over cash arenow limited primarily to the cash disburse-ments function, and you greatly reduce therisk related to handling owner remittancesbefore they are recorded.

Bank account reconciliations and other cash controls Bank a c coun t s shou ld b e r e conc i l edmonthly on a timely basis. Ideally, the rec-onciliation should be completed by an indi-v idua l who does not handle the re la tedaccounting records or related assets . Forexample, the accounts payable disbursementbank account could be reconciled by theaccounts receivable accountant. All bankreconciliations should be reviewed by some-one o ther than the p repare r , and the i rreview should be documented by initialingand dating the review.An excellent internal control procedure

over cash is to have an individual in man-agement who is not in the accounting depart-ment review the electronic bank statementactivity each month before accounting doesits bank reconcil iation. For smaller con-tractors, the best person may be the owneror a shareholder who is familiar with theoperations of the company. Spending 15minutes to review the electronic copies ofchecks clearing the bank each month (aswell as wire transfers out) provides a wealthof information on where the cash goes eachmonth and brings to l ight unusual vendoror subcontractor names on checks.Larger contractors may assign monthly

r ev i ew o f bank a c t i v i t y t o the COO oranother shareholder. The key point is thatall accounting personnel know managementis conducting a monthly review of bank

activity. In reality, the threat of an ongoingmonthly management review is often a suf-f icient deterrent to dissuade accountingpersonnel from attempting an unauthorizeddisbursement. Therefore, missing a monthof review is not a critical failure. The factthat personnel believe there is a monthlymanagement review is in i tse l f a type ofcontrol.

Cost shifting by project managersWhen a project is going badly, project man-agers may have an incentive to shift coststo another job. This could be a one-timeshift in which the costs are permanentlyhidden in the second job and not discovered,leaving the contractor with two jobs withincorrect costs and gross profit numbers.On the other hand, the shift could be tem-porary. Costs from Job A are moved to JobB; when Job B starts running over budget,those costs are moved to Job C, and so on.To control the shifting of costs, require

that materials purchases del ivered to anaddress other than the stated project numberaddress are pulled and questioned. Addi-tionally, have a second sign-off or reviewfor requests by project management to movecosts from one job to another, veri fyingthe supporting documentation or evidenceof the incorrect initial coding.

Kickbacks from subcontractors and suppliersOne of the most difficult fraudulent actsto uncover occurs in the field, when a projectmanager arranges for a kickback or favorsfrom a subcontractor in exchange for beingawarded the subcontract. To keep projectmanagers from getting too cozy with sub-contractors, require a minimum of threebids for al l the prime subcontracted areas.Maintain bids in the bid file, with supportingdetails about each subcontractor. Continualselection of a subcontractor who is not thelowest bidder should give rise to questionsby upper management or the COO. Addi-t iona l l y , an unusua l amount o f changeorders to that subcontractor on a continuingbasis over several projects may indicate arevenue recovery facil itated by the projectmanager on the subcontractor’s initial lowbids.



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Internal project auditsS ince the p ro j e c t manage r con t ro l s s omuch of a project ’s activity , from bid dateto subs tant i a l comple t ion , an e f f ec t ivecontrol is to have another project managerconduc t pe r iod ic in t e rna l aud i t s . Theother project manager reviews bid f i les ,subcontract ing act iv i ty , job cost deta i l ,change order activity, areas with cost over-runs , areas with s ignif icant savings , andfinal gross prof i t margin. Any i tems thatappear abnormal or outs ide expectat ionsshou ld b e i n v e s t i g a t ed f u r t h e r . S u chreviews by a second project manager shoulddissuade primary project managers fromabusing their authority over project expen-ditures , change orders , and f inal contractamount and margin. The second projectmanage r c an a l so r ev i ew in de t a i l andques t ion cos t over runs on a par t i cu la rphase of a project .

BudgetsBudgets are an effective tool for controllingoverhead expenses. Established by uppermanagement at the beginning of the year,any overhead accounts that are over budgetshould t r igger a management rev iew ofdeta i l s o f the expenses . The rev iew wi l lprevent project managers from trying tomake their project look better by movingcosts out of their project and into overhead.Many times, these cost overruns show upin payroll-related accounts, supplies, andother contracted services normally reservedfor the general office overhead.

Vacation policy and rotation of responsibilitiesA vacation policy that requires all employeesto take time off each year is another goodinternal control for contractors. Fraud isoften exposed when the perpetrator is notthere to cover it up. Even if a loyal employeeclaims not to need a vacation, it is a goodinternal control procedure to require al lemployees to take at least two weeks vaca-tion.Vacations should be taken for two con-

secut ive weeks and over lap with severalpayables , payrol l , and bi l l ing/receivableperiods. Having another employee managingthese tasks dur ing a regular employee ’ s

vacation may be a sufficient control to detersomeone from embezzling company funds.A manda tory vaca t ion po l i cy i s a l so

important from a f irm risk managementper spec t i ve . You need to have ano theraccountant in the department cross-trainedfor each function. Should a key employeeleave for health or other unexpected reasons,you do not want to be without someonewho can take over that position and continueto process payables, payroll , or bill ings. Besure to turn software access controls onand off as appropriate.

Simple internal audit proceduresMost a ccount ing s y s t ems w i l l e a s i l ydownload details from the accounts payablesub l edge r in to Exce l . A ve ry s imp leprocedure that is effective for smaller con-tractors to give management a quick viewis to download all cash disbursement fromthe payables subledger. Sort the downloadby the following criteria: 1. Check number. Look for missing checknumbers or gaps in check numbers.Compare checks to the bank statementto be sure none of those missingchecks cleared the bank, indicatingdisbursement fraud or masking anunauthorized cash disbursement.

2. Highest to lowest amount. Scan the l istfor larger checks paid to a vendor orsubcontractor that you are not famil-iar with.

3. Payee or vendor name, ranked largestto smallest . Scan the l ist for unusuallylarge amounts paid to someone out-side their normal volume. Look forhigher amounts paid to someone youdo not recognize.Lastly, sort or search checks for checks

payable to either cash or to the names ofemployees in the accounting department.Employees should not be receiving checksexcept for expense check reimbursementsand normal payrol l amounts , and thereshould not be checks payable to cash. Oncethese detai ls are downloaded into Excel ,the management review process takes justa few minutes each month. A similar exercisecan be done for the payroll disbursementaccount and the job cost subledger.

14 CONSTRUCTION ACCOUNTING AND TAXATION SEPTEMBER/OCTOBER 2020 INTERNAL CONTROLS

ESTABLISHED BY UPPER

MANAGEMENT AT THE

BEGINNING OFTHE YEAR, ANY

OVERHEADACCOUNTS THAT

ARE OVERBUDGET SHOULD

TRIGGER AMANAGEMENT

REVIEW OFDETAILS OF THE

EXPENSES.


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ConclusionThe aforementioned controls are some ofthe mos t common con t ro l s f o r anycontractor, even those that do not have aninternal audit department. Obviously, therea re co s t bene f i t cons ide ra t ions to anycontrol, but the basic segregation of dutieson cash disbursements and cash receipts isfundamental and should be implementedwhenever possible.

Some of the procedures discussed canbe implemented at the same time or overtime as you fine-tune segregation of duties.Procedures such as internal audit disburse-ment tests can be rotated on a monthly orquarterly basis. The element of uncertaintyin applying internal control procedures isa great control as well .You have worked hard to earn those profits.

Implement controls to protect them! n



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