A Construction Accounting Team’s Guide to Financial Audit Preparation

Construction accounting is hectic enough during ordinary times. It gets even more so when the subcontractor you work for has to prepare for an audit. Just the mention of audits can create stress, especially if you’ve never been through one before. 

A well-defined audit preparation plan can help your construction accounting team navigate a financial audit without losing sleep—which is precisely why we've put together this guide. Keep reading to learn:

• The basics of financial audits
• The purpose and types of financial audits 
• Proven audit preparation strategies 
• Documents to compile for an audit
• Tips for implementing audit findings

The Basics of Financial Audits 

Financial audits, different from construction project audits, are detailed reviews of a subcontractor’s financial records to ensure they accurately represent the company’s financial standing. 

Audits are almost always conducted by an external party like a Certified Public Accountant (CPA) firm. The auditor’s job is to methodically examine your financial statements—including income statements, balance sheets, cash flow statements, and work-in-progress reports—to verify that they fairly and accurately represent every transaction that occurred during the audit period. 

Types and Purposes of Audits Subcontractors Face

There are a few types of financial audits you should be prepared to deal with. Each has a different purpose.

Internal Audits

Internal audits are initiated internally for the purpose of improving financial processes. An external firm typically conducts the audit, but the findings are for internal use only.

Some subs only order an audit if the company is struggling financially. For those working to create healthier financial outlooks, it’s beneficial to conduct internal audits more proactively. We talk to a lot of subs with more rigorous accounting processes that make it a best practice to complete financial audits annually. 

Regular internal audits help you:

• Assess and improve internal financial processes
• Promote transparency across the organization 
• Instill confidence in stakeholders
• Identity compliance and security issues

External Audits

External audits are requested by and prepared for a third party. Sureties and lenders often require them to verify a subcontractor’s financial data before they issue a bond or loan. Property owners and general contractors may also request an audit before they award a contract.  

When doing an external audit, auditors are looking to make sure:

• Clients are real and valid entities
• Contracts are an accurate representation of projects
• Lower-tier subs and materials suppliers have all been paid
• You don’t have any significant over- or under-billings
• There aren’t any outliers or wide variances in your profit margins
• You follow Generally Accepted Accounting Principles (GAAP)
• Your business is trustworthy

IRS Audits

IRS audits are ordered and conducted by the IRS. They can be triggered by the inclusion of specific tax credits, deductions, or certain types of income, or by random statistical analyses comparing your business returns to those from other companies with similar profiles.

When the IRS conducts an audit, it reviews tax returns, supporting schedules, and all other supporting documentation. An IRS audit is usually just for the previous year, although it can cover multiple years. 

The IRS’s primary objectives are to ensure:

• You’re reporting all the income your company generates
• Your expenses and deductions are accounted for and properly categorized
• Expense and revenue dates line up with the tax period in question

5 General Audit Preparation Strategies

Don’t wait until you get a notice that an audit is coming up. Proactively preparing for an audit helps minimize stress across your team and ensures the process goes as smoothly as possible. 

Consider these six audit preparation strategies. 

1. Establishing an Audit Preparedness Plan

Consider incorporating an audit preparedness plan into your year-end business schedule. Your plan should include:

• A documented process for compiling all the necessary financial statements 
• Roles and responsibilities across the team 
• A timeline and schedule for when you’ll complete each activity

2. Conducting Regular Assessments and Self-Evaluations

You don’t need to wait for an official audit to review and evaluate financial records. Many subs audit every project as part of their closeout process. Others implement monthly audits of their work in progress schedules to ensure WIP reports are error-free.  

3. Implementing Robust Record-Keeping Practices

Auditors often review day-to-day financial documents like payroll reports, job costing schedules, etc. They don’t typically review every document. Rather, they pick a couple at random to make sure everything lines up. The more methodical your record-keeping processes, the less likely auditors are to uncover errors in your records.  

Make sure you’re using accounting software that tracks information like job costs, time card entries, and budget variances. 

4. Training Employees on Audit Protocols

Even though external parties typically conduct audits, staff members play a big role in how smoothly the process goes. Develop training for all teams—not just finance and accounting—that could play a role in an audit. This might include projects, purchasing, human resources, information technology, etc. 

Make sure everyone:

• Knows that getting audited is a normal part of business
• Understands what the audit process looks like
• Gets training on the audit preparedness plan
• Commits to responsible record-keeping

5. Engaging a Tax Professional or Consultant if Needed

If your team isn’t prepared, your numbers are a mess, or you know an auditor would uncover some serious issues, you may want to get help beforehand. Consider hiring a construction accounting firm to help you assess the problem, implement better processes, and clean up your records so your documents accurately represent your financial details.      

Documents to Compile for an Audit

The most time-intensive step on your part is pulling all the documentation that the auditor will request. The exact documents they want will depend on their objectives for the audit. 

Be prepared to submit the following:

• An up-to-date general ledger that covers the entire audit period
• A/R aging reports
• Contract schedules and WIP reports
• Schedule of inventory and storage fees
• Fixed assets and depreciation schedules
• Vendor invoices and pay apps from lower-tier subs
• Bank statements and canceled checks
• Proof of prepaid expenses
• Schedules of loans and other liabilities with lenders and creditors

Note that this list is not exhaustive. Ask your auditor for a list of documents and materials they’ll need before they start the audit.  

Tips to Implement Audit Findings

Once the audit is complete, the auditor will provide a formal written report documenting their findings. It will include any issues or discrepancies in your internal controls, along with any instances of noncompliance. 

The last thing you want to do is ignore this report. It’s important to resolve your audit findings. We recommend following these four steps: 

1. Reviewing and analyzing audit findings: Make sure your team fully understands the findings. If there are areas where you have questions, reach out to the auditor. 
2. Developing corrective action plans: You should identify a solution for each issue. Outline all the steps you’ll complete, assign responsibilities, and set dates for resolution.  
3. Documentation any evidence of compliance: Record any actions you take and changes you make to address audit findings. Regularly document progress.
4. Follow-up and monitoring: Stay on top of your corrective action plans. Make sure everyone follows through with their responsibilities. And remember to communicate your progress with the auditor. 

Staying Calm Before, During, and After the Audit

Audits are an inevitable part of business, especially as your subcontractor company grows. Instead of worrying about them, we encourage you to embrace them, prepare for them, and learn from them. Build a culture of continuous improvement and compliance. And check out tools like Siteline that centralize all your billing data and give you quick, organized access to your A/R.

Subcontractors across all trades use Siteline to consolidate billing operations, automate compliance, and deliver back-office efficiency. Plus, it helps them get paid weeks faster. If you’re ready to organize your billing chaos, request a demo today.