The general nature of the construction industry opens up opportunities for firms to fall victim to fraud. The Association of Certified Fraud Examiners (ACFE) reported the median fraud-related loss for construction firms at $200,000 for each incident between January 2018 and September 2019. In addition, 32% of survey respondents said they did not have internal controls in place, while 18% told the ACFE they regularly overrode existing internal controls.
Establishing internal controls is essential to prevent fraud and catch fraud attempts before too much damage is done to the construction firm. Here’s why construction firms see fraud and what controls owners and managers can put in place to protect their assets.
Construction firms can be easy targets for fraud
Construction firms can see a huge impact from fraudulent activity that goes undetected. This is often because of missing internal controls or a culture that has allowed the controls to be overridden or disregarded. In some cases, the accounting department is small, and separation of duties is difficult to maintain. But why are these internal controls so important in the first place?
There are a lot of involved parties and touchpoints in processes at construction firms that can have a significant impact financially. This opens more opportunities for fraud can take place. ACFE’s review showed the most common types of fraud in the construction industry result from corruption, financial statement fraud, billing fraud, and check and payment tampering.
Establishing and enforcing internal controls in the construction industry
Construction firm owners and operating managers can help protect their firms from fraud by creating a set of internal controls and ensuring the processes are followed without exception. Here are some areas to start:
- Accounts payable and receivables: Put someone who does not have access to incoming payments in charge of reconciling billing and receipts. When reviewing, they should look at each line item for irregularities in quantities or pricing, for overbilling and even underbilling of customers.
- Supplier and subcontractor disbursements: Establish a minimum threshold for requiring competitive bids from both suppliers and subcontractors to ensure competitive pricing. In addition, an employee outside of the project should be responsible for reviewing invoices and co-signing checks and electronic payments. When working with subcontractors, verify that surety bonds are in place and on file and that they are valid with the bonding agency before sending any payments.
- Payroll fraud: Regularly reconcile payroll reports, looking out for duplicate payments and fictitious employees. This should include reviewing W-2 and payroll tax reports by reconciling them with the general ledger system. Perform headcounts on job-site visits to compare against the numbers from time reports and payroll payments made for the project.
- Job-site controls: Managing materials is essential to control fraud in addition to the payroll checks mentioned above for each job site. Regularly compare materials and quantities delivered against the original bid and purchase orders. Require a second person to verify the delivery and sign off. Another precautionary measure to deter theft would be to install security cameras on-site.
- Bidding and change order processes: Require a secondary review before sending it to the client for every bid and change order. This should be done by someone not attached to the project. Require signatures from clients and firm managers on change orders and the scope of work before beginning or moving forward with the project.
- Conduct financial audits: Periodic audits of financial reports, processes, and even projects will allow someone to catch what might have been missed by those involved with the projects. This can be someone outside of the project team or even hired out through an external company.
While internal controls may seem like a lot of work to implement, they can save construction firms hundreds of thousands of dollars in the long run. If your firm needs assistance putting these processes into place or performing audits, reach out to our team of construction industry accounting experts.