24 September 2019 – Institute of Chartered Accountants of England & Wales
I took part in and presented at the first ICAEW Construction Community event at Moorgate last Tuesday. Ironically the great hall at Chartered Accountants Hall, where the event was planned to take place, was out of action due to the torrential rain that day causing a leaky roof. The Institute is need of some urgent construction support!
The audience for the session, which was open to all comers, consisted of a mix of external auditors, finance professionals and other professions such as project managers and quantity surveyors. The feedback we got on the night was excellent and members seemed very engaged and happy to stay and network over a drink.
I have provided the Delegate Pack and Audit Insights: Construction Report at the bottom of this post, however the key points from the session which I thought you might be interested in from a “client” perspective are:
Financial accounting and reporting
There are significant concerns over the quality of financial reporting and the effectiveness of audit given recent failures at Valerie Patisserie, Carillion, Tesco and Eddi Stobart Logistics. The recognition of accounting income by construction contractors requires significant judgement, as the factors which may affect it are many and complex and can lead to significant uncertainty. New financial reporting requirements under “IFRS15 – Revenue Reporting” should help to address this, and the government instigated Brydon review is currently underway to address concerns over audit effectiveness. In the meantime clients should pay particular attention to significant changes to supplier credit ratings and publicised events such as profit warning statements.
Sustainability of contracts
Sustainable profits for contractors are based on achieving the right price. Some companies price to reflect true cost, but some bid to win the job. Unforeseen changes can quickly turn small profits into losses, and make it difficult to return to profitability. Clients should do more to understand commercial drivers for their suppliers when they accept low tender prices.
Delivering for success
Contractors should invest in skills and technology to promote and “embed” good project management. Financial rigour should be applied consistently to key estimates and judgements made throughout the project as reliable and timely financial information and analysis can help determine a project’s success. It is critical that projects form strong delivery teams where project managers work closely with finance/commercial teams. Clients should not take this for granted. Many contractors mobilise individuals to new projects who have no previous experience of working together.
Rebuilding confidence through increased transparency
Poor or unexpected results are often caused by a lack of internal transparency or challenge. This can arise from a cultural issue or from a breakdown in project management. Executive management and boards need to ensure the tone from the top encourages transparency and consistency throughout the supply chain. Without early reporting of issues, projects are less likely to remain on track and problems will become more significant.
Getting fit for the future
Government can help to build confidence by committing to a pipeline of infrastructure works with specific and reliable procurement dates. To deal with shortages of workers caused by an ageing workforce and a reduction in the attractiveness of the UK for foreign workers, businesses need to create a pipeline of future young talent. The sector also needs to consider how it can attract more women and ethnic minorities. Clients should encourage competencies such as diversity and training development programmes within its tendering processes.
Underlying issues in the construction sector
Significant issues for the construction sector arise from reduced client knowledge, a fractured supply chain and difficulties in estimating and measurement. These issues can lead to unaligned objectives between the parties, confrontational relationships and the manipulation of the financial state of contracts. Clients and contractors should address these issues though more open and regular dialogue for example in annual commercial reviews.
Accounting and finance teams have a key role in delivering successful projects
Accounting and finance teams should be involved at the outset, to work closely with the QS teams to understand bidding margins, contract estimates and milestones, cashflows and key contract clauses. During the project they should have access to QS reports showing costs to complete, revenue to complete and variations together with potential upsides and downsides. Finance teams should familiarise themselves with projects and visit sites as well as tracking WIP, cashflows and unagreed variations. This will drive a more uniform understanding of cost and margin within contractors. Clients will see the benefit of this when costs are challenged as contractors will present information in a unified manor.
Structural sector risks
Construction firms typically have inadequate working capital and work on low margins. This can lead to main contractors using sub-contractors as a source of funding which in turn can increase the risk of insolvency. Potential solutions are the wider use of project bank accounts; holding retentions in trust; main contractors strengthening their balance sheets and bidding being restricted to good payers. In the longer term, clients should consider employing sub-contractors directly, where they see minimal value-add from contractors.
Delegate Pack – Construction Launch 2019
ICAEW Audit Insights: Construction
If you have the opportunity, I would recommend future Construction Community meetings. If you are unable to attend but have an interest, I would be happy to provide further feedback on the matters the group discusses.
