CONSTRUCTION

INDUSTRY
The construction industry is defined by the Standards
Industrial Classification as the branch of manufacture and
trade based on the building, maintaining, and repairing
structures.
• The CONSTRUCTION INDUSTRY is divided into two sectors: 
• Non-residential, which has three sub-sectors (heavy industrial,
institutional and commercial, engineering), and
• Residential.
• In general, there are three sectors of construction:
• Buildings
• Infrastructure
• industrial
• The Construction Industry Authority of the
Philippines (CIAP) promotes, accelerates, and
regulates the construction industry through its various
implementing boards.
• The CIAP is an attached agency of the Department of
Trade and Industry (DTI).
Top Construction Companies in the Phils.
• EEI Corporation
• Megawide Construction Corporation
• DDT Konstract Inc
• SMCC Philippines Inc
• Metro Stonerich Corporation
• Foundation Specialists Inc
• D.M. Consunji Inc
• Momentum Construction and Development Corporation
• Metro Construction Inc
• Spes Construction Inc
• Vinnell-Belvoir Corporation
Construction Accounting
• Construction accounting is a form of project accounting in which costs are
assigned to specific contracts. A separate job is set up in the accounting system
for each construction project, and costs are assigned to the project by coding
costs to the unique job number as the costs are incurred.
• Construction accounting is a unique form of bookkeeping and financial
management. It's designed specially to help contractors track each job and how
it affects the company as a whole. While it draws on all the same basic principles
of general accounting, it also has several important and distinct features.
• Contract Revenue Recognition (CCM, PCM, etc.)
• Contract Retainage
• Specialized Construction Billing
• Construction Payroll
Auditing Construction Entities
• The methods and the bases of measurement used in accounting for
contracts affects the independent auditor's procedures performed with
respect to costs incurred to date, estimated contract costs to complete,
measures of extent of progress toward completion, revenues, and
gross profit to form a conclusion on the reasonableness of costs,
revenue, and gross profit allocated to the period being audited.
• The auditor should identify and assess the risks of material
misstatement at the financial statement level and the relevant
assertion level for classes of transactions, account balances, and
disclosures to provide a basis for designing and performing further
audit procedures.
Risk-based audits in the Construction
Industry *
• Audits are an essential part of risk management. They provide the feedback
loop to help identify improvements. But too many audits can be counter-
productive or wasteful. Large and complex construction projects are often
subjected to numerous external audits or surveys, each focusing on a
specific topic to meet a specific requirement of a particular project
stakeholder, whether regulator, partner, insurer or third-party inspector.
• The sheer volume of audits places a significant resource burden on the main
contractor. This may be acceptable where recommendations arising from the
audits truly add value, but all too often they make little or no contribution to
reducing risk. This happens frequently when a prescriptive, checklist-based
approach is taken to the auditing. The “one-size-fits-all” approach rarely fits
anyone.

*Taken from TUV Rheinland Risktec

Risk-based audits in the Construction
Industry *

*Taken from TUV Rheinland Risktec

Risk-based audits in the Construction
Industry *
• The overriding objective is to provide comfort to stakeholders
that risks are being properly managed, at all times, and not just
when the auditor is on site. Furthermore, the approach means
that any recommendations equate to tangible benefits to the
project.
• For large construction projects the risks will change as the
project progresses through its various phases. Therefore audits
are timed to coincide with major changes on the project, for
example, prior to enclosing structures which would change the
fire risk, or prior to heavy lifts which introduce an additional risk.

*Taken from TUV Rheinland Risktec

Risk-based audits in the Construction
Industry *

*Taken from TUV Rheinland Risktec

Risk-based audits in the Construction
Industry *
• Firstly, the project program is reviewed with the project senior management who explain
how risks are identified, what the key risks are and how they are managed for each phase.
• Documentation is then reviewed, starting with the risk register and moving on to the health,
safety, environment and quality system manuals and procedures, fire control procedures,
method statements, etc.
• A specific high-risk activity is selected and interviews are held with key personnel to
understand how the risks are being managed, especially where more than one sub-
contractor is involved. Follow-on audits are targeted on other high-risk activities or on
specific sub-contractors.
• This is followed by a site walk-down to find evidence that what is being preached is actually
being practiced on the ground.
• Any shortfalls are highlighted during the walk-down and reported shortly after, together with
proposed recommendations for improvement.

*Taken from TUV Rheinland Risktec

Benefits of risk-based audits in the
Construction Industry *
• Focus on root causes rather than last ditch defenses.
• Provide evidence that a professional approach to managing all
risks is in place throughout the project lifecycle.
• Deliver fewer but more value-adding recommendations, which
reduces cost, time and effort that may otherwise be wasted.
• Provide lasting benefits throughout the project organization,
from the principal contractor to all sub-contractors.

*Taken from TUV Rheinland Risktec

Checklist-based audits of major construction projects
can be an ineffective way of confirming that risks are
being properly managed. Risk-based audits focus on
what really matters – the risks and how effectively they
are being controlled.
Risks of material misstatement:
Construction Contractors
• Understanding the Entity and Its Environment and Assessing the Risks of Material
Misstatement, requires that the auditor identify and assess the risks of material
misstatement (RMM) at the financial statement level and relevant assertion level for
classes of transactions, individual account balances, and disclosures to provide a
basis for performing further audit procedures. RMM includes both inherent risk and
control risk.
• When obtaining an understanding of controls that are relevant to the audit, the
auditor should evaluate the design of those controls and determine whether they
have been implemented by performing procedures in addition to inquiry of the
entity’s personnel. Areas of focus in the construction industry are:
• contract revenues
• costs
• gross profit or loss
• related contract receivables and payables
Risks of material misstatement:
Construction Contractors
• Although not all the controls identified are found in every construction entity,
considerations for adequate controls for a contractor must be considered in the
following areas:
• Estimating and bidding
• Project administration and contract evaluation
• Job site accounting and controls
• Billing procedures (including determination of reimbursable costs under cost-plus contracts)
• Contract costs
• Contract revenues
• Construction equipment
• Claims, extras, and back charges
• Joint ventures
• Internal audit function
Increased Audit Risk
For audits of construction contractors, a major area of risks of
misstatements is in the area of contracts. Contracts have a
pervasive effect at the account balance, class of transactions,
and disclosure level. Construction contract factors that normally
indicate an increased audit risk include:
• Percent of contract complete – 10% to 90%
• Size of project – Relatively large job
• Type of project
• Complex, one of a kind
• Not within contractor’s expertise
Increased Audit Risk
• Timing and scheduling
• Long-term project
• Work is falling behind schedule
• Accelerated time frame
• Significant penalties for late completion
• Location
• New area
• Remote area – materials and labor are not readily available
• Weather – High susceptibility to adverse weather
• Owner/investor
• Very few previous contracts with contractor
• Weak financial position
Increased Audit Risk
• Subcontractors
• Small portion of work performed by subcontractors
• Very few previous contracts with contractor
• Weak financial position
• Majority of significant subcontract agreements not finalized
• Big spread – Significant variances in bid amounts among competing contractors
• Profit fade – Significant profit fade
• Underbilling – Unusual/significant underbilling
• Type of contract
• Fixed-price
• Cost-type, difficult to determine reimbursable costs
• Claims – significant claims
• Material costs – High susceptibility to price escalations during performance of contract
Significant Risk
As part of the assessment of the risks of material misstatement, the auditor
should determine whether any of the risks identified are, in the auditor’s
professional judgment, a significant risk, those that require special audit
consideration.

In the construction industry, auditors may find that a significant risk exists with
regards to:
• the accuracy of management’s estimates f costs to complete for contracts in progress.
• contract revenues due to the possible effects of unsigned or unpriced change orders
and claims
• the significant measurement uncertainty associated with the application of the
percentage-of-completion method of accounting for contracts.
Things to consider when auditing
Construction Entities
1. Keep in mind volatility of the construction industries. In boom periods the entities may be
confronted with excessive construction work and consequent inadequate working capital, In
recession, entities may be subject to going concern problem.
2. Ascertain general level of competence of management.
3. Discuss with management future prospects.
4. Ascertain accounting and internal control system.
5. Assess inherent and control risk and set materiality level.
6. Obtain a list of contracts awarded during the year and a list of incomplete contracts end of last
year.
7. Verify major contract accounts
8. Check contract price with signed contracts.
9. Ensure that variations in contract work, claims and incentive payments are recognized only to
the extent that is probable that they will result in revenues and they re capable of being
reliably measured.
Things to consider when auditing
Construction Entities
10.Ensure that contract costs comprise costs that relate directly to the specific contract and costs
that are attributable to the contract activity in general and can be allocated to contract. Selling
and administrative costs should not be allocated to contracts.
11. If the outcome of the contract can be estimated reliably, contract
revenues and contract costs should be recognized by reference to stage of completion of the
contract activity at the balance sheet date.
12.Determine how the stage of completion has been estimated. The two acceptable ways are:
• The proportion that contract costs incurred to date bear to the
estimated total cost
• Surveys of work performed.
13.Ensure that when stage of completion is determined by reference to the contract costs to date,
only those contract costs that reflect work performed are included in costs incurred to date.
14.If the outcome of the contract cannot be estimated reliably, revenues should be recognized
only to the extent of contract costs incurred that it is probable will be recoverable and contract
costs should be recognized as an expense.
Things to consider when auditing
Construction Entities
15.Ensure that in case of a contract it is probable that total contract
costs will exceed total contract revenue, the expected loss
should be recognized in full.
16.Reviews reasonableness of estimated further costs.
17.Verify estimated future costs with subsequent events to date of
audit report.
18.Ensure that the changes in estimates are recorded in the year
of change and in future years if they affect future years.
19.Ensure that presentation and disclosure is in accordance with
PFRS/IFRS 15.
PFRS 15
Under PFRS 15, an entity recognizes revenue to depict the transfer of
promised goods or services to customers in an amount that reflects the
consideration to which the entity expects to be entitled to. An entity must apply
the five-step model to comply with the new revenue recognition standard:
• Step 1: Identify the contract(s) with customers
• Step 2: Define the performance obligations in each contract
• Step 3: Determine the transaction price
• Step 4: Allocate the transaction price to the performance obligations in the
contract
• Step 5: Recognize revenue when (or as) the entity satisfies a performance
obligation
Challenges under PFRS 15
Entities in varying degrees are conducting assessments on the impact
of PFRS 15 and are finding that implementing PFRS 15 is challenging.
It requires more effort than what was originally anticipated, as they have
to reconsider not only its accounting implications, but also its impact on
multiple workstreams such as processes, information technology, legal,
sales, human resources and investor relations. These areas include:
• Project Team and Planning
• Setting the Scope
• Significant Judgments and Estimates
• Variable Considerations
• Allocating the Transaction Price
• Process Flows and Internal Control
Project Team and Planning
Entities need to form adequate project teams equipped and enabled with the
requirements of PFRS 15, since effective project management is crucial to
implementation. The assigned project team needs to obtain input from its business
functions and stakeholders to plan and implement the PFRS 15 requirements to the
various workstreams. Entities need to also ascertain that the conversion project
team has adequate and appropriate governance to ensure that key judgments and
decisions are appropriately vetted. Some entities find creating project teams to be
particularly challenging as they need to confirm that project team members are:
1) competent on PFRS 15 requirements;
2) knowledgeable about the current revenue recognition policy and;
3) well-informed on the business functions and practices.
Setting the Scope

To determine the initial impact of PFRS 15, entities need to establish its effect on its
revenue streams, including a review of its relevant contracts. Some entities have a large
volume of non-homogenous contracts. Reviewing them takes a lot of time; thus,
entities need to first agree on the scope for the review of these contracts (i.e., by
selecting representative contracts for similar product and service offerings) and
applying the five-step model to determine the revenue accounting for such contracts.
Entities also need to consider additional factors such as geography, sales channels and
customer types that could impact revenue streams and related contract provisions.
Once the scope is set, entities can apply the requirements of PFRS 15 while considering
its impact on their business functions. Thus, entities need to ensure that the scope is
appropriate and complete as the assessment of the representative contracts will be the
basis of the design and implementation of solutions across workstreams.
Significant Judgments and Estimates
PFRS 15 involves significant judgments and estimates since the new
model uses broad principles rather than specific guidelines. Examples of
areas requiring significant judgments and estimates include:
• Identifying a contract with customer
Entities need to identify when an arrangement will create enforceable rights and
obligations as they cannot directly conclude that their current arrangements will
pass the criteria of a contract in accordance with PFRS 15. Entities, along with
their respective legal teams, will have to revisit the enforceability of other forms
of arrangements (e.g., written, oral and implied contracts).
• Identifying performance obligations
Entities cannot directly assume that the deliverables identified in the current
revenue standards will be the same as the performance obligations under PFRS
15.
Significant Judgments and Estimates
An example of this is the recognition of bundled goods or services. Entities
need to identify the promised goods or services within the contract and
determine whether these goods or services should be considered
collectively within the context of the contract as a single performance
obligation. Otherwise, the promised goods or services will have to be
treated as distinct and separate performance obligations. Typical questions
considered by entities include:
• Is the entity fulfilling a single promise to the customer?
• Do one or more goods or services significantly modify or customize one or more of
the other goods or services in the contract?
• Do two or more promised goods or services each significantly affect the other
goods or services (i.e., two-way dependency between the promised goods or
services)?
Significant Judgments and Estimates
Entities will need to understand the facts and circumstances and apply
significant judgment to determine whether goods or services are to be combined
into one or treated as separate performance obligations.
Another example is the recognition of free goods or services, since PFRS 15
does not limit performance obligations that are explicitly stated in the contract.
Implied promises from an entity’s customary business practice (e.g., free goods
or services) can be considered performance obligations if these will create a
valid expectation that an entity will transfer a good or service to the customer.
Entities will need to evaluate whether these free goods or services which were
previously treated as marketing incentives may qualify as identified performance
obligations in the contract.
Variable Consideration
Examples of variable considerations are discounts, rebates, refunds, performance
bonuses and penalties. Entities that simply recognized these amounts when cash
is received will most likely be affected since PFRS 15 requires entities to estimate
and update such estimate throughout the term of the contract. Under PFRS 15,
recognizing revenue until the product is sold to the customer may no longer be
acceptable if the only uncertainty is the variability in pricing; that is, the estimated
variable consideration may now be recognized as part of the transaction price.
However, there may be cases that the impact under PFRS 15 and legacy guidance
(i.e., current revenue standards) will be the same if the estimated revenue will be
constrained. Constraining variable consideration prevents over-recognition of
revenue (i.e., significant reversal of cumulative revenue will not occur in future
periods). Entities need to use significant judgment in constraining variable
consideration by considering both the probability and materiality of revenue
reversal.
Allocating the Transaction Price
PFRS 15 requires entities to determine the stand-alone selling
price of all the performance obligations and allocate the
transaction price based on their standalone selling prices.
Entities that determined bundled goods or services which should
be treated as separate performance obligations under PFRS 15,
may find allocating the transaction prices challenging, particularly
when the price is not currently observable.
Process Flows and Internal Control
Entities need to revisit whether they will require new/revised
process flows and adjust their transaction-level controls to make
sure the information used is accurate and built around the
framework of sound internal control policies. Entities also need to
pinpoint significant assumptions and assess their estimation
methods in applying the requirements of PFRS 15. It is also
critical that the new/revised processes and controls, significant
assumptions and chosen methods are appropriately
documented. Documentation may provide sufficient and reliable
evidence to regulators and stakeholders that the management
has already taken steps to consider the impact of PFRS 15.
Audit Insights: Construction (based on the 2019
report of the top 9 auditing firms)
• Procuring and bidding responsibly and delivering consistently
across the lifetime of a contract
• Shortage of skilled labor
• Transparency in reporting
• Provision of more investment in commercial and operational
technology advances and R&D

This may impact the financial statements and the subsequent audit,
at the same time alerting the auditors to some of the issues they
should consider when planning their audits.