In this part 3 of the Accounting Principles and Procedures we'll be covering Audit and Ratio Analysis.
Audit in construction companies
As a Quantity surveyor, I have been audited by external auditors from the big 4 accounting firms. I think the only one I have not audited by was PwC. But the other three I do recognise them from the 15 years that I've been working.
Who is an auditor, and what qualifications does he have?
An auditor is a person who checks the accounts of a business to make sure they are accurate. An auditor must be qualified through the Institute of Chartered Accountants in England and Wales (ICAEW), which means they have passed exams and have practical experience.
What does an auditor do when they perform an audit on a business' account?
Auditors check that all transactions are recorded correctly, that all transactions are recorded within the correct period, and that transactions are recorded in accordance with legislation. They also check that employees are using proper procedures when making payments and recording expenses. Auditors also check that cash receipts match inventory levels and sales.
They do this because they want to make sure that the business is making good decisions with its money and that it's not doing anything illegal or improper with it.
As a quantity surveyor we are audited on the margin and values we take into account for our projects. They will check the validity of our changes (variations), the risks of losses, money receipts and procedures.
The majority of the questions are just "can you show me...." or "can I see proof for...". I usually spend 1-2 days but they are very quiet and there were no warning flags. It is an interesting process to ensure that the company I work for are reporting their figures correctly. Especially against FRS 102; on how to report the revenue of a long term project.
In the standard they cover what you can consider as a change, (must be agreed not assumed), and also consider loss now rather than later. So any potential risk of loss that you are aware of must be reported during your CVR to discuss its validity with your commercial director. The majority of the time they get removed, however, things such as re-works, or damages may be reported as loss on the revenue straight away.
Reason being is that the margins that you report on your CVR are reported to share holders and makes the stock of the business enticing for investors.
Why do you do an internal audit?
We also get audited internally, every 6 months and much more often than the external audits.
In order to ensure that your business is operating effectively internally, you will want to conduct an internal audit at least once a year. We can use this audit as a way to identify areas where the business could improve its operations or save money by cutting costs or avoiding wastefulness with resources like energy consumption or office supplies such as paper.
But the process also identifies and ensures we are doing the right thing for the external audit and we're reporting the right figures up the line in our CVR.
You can also use it as a springboard for implementing changes within your organization by showing employees how their actions have affected other departments or cost you money in lost revenue opportunities because certain processes aren't working as
GAAP
Something else you might want to know about when doing your studies is the GAAP, the generally accepted accounting principles. They are set of models/principles to follow to manage and maintain your account. It's just things you should consider and apply your work towards.
The GAAP are the standards that dictate how companies should measure and record their financial transactions, and how they should report them to the public.
As a QS or land surveyor we don't really have to do much with it but we just need to know of it for business purposes.
1. Principle of Regularity: It requires that accounting information be presented in a manner that is consistent, reliable and objective. It also states that the same principles and methods should be applied in similar circumstances.
2. Principle of Consistency: It requires that accounting information be prepared on the same basis throughout the period being reported on and any changes in accounting policies or methods are disclosed.
3. Principle of Sincerity: It requires that financial statements include all relevant information about a company's economic performance, financial position and cash flows.
4. Principle of Permanence of Method: It requires that companies use the same accounting principles consistently over time so that past decisions can be evaluated for their future implications.
5. Principle of Non-Compensation: Companies must include all costs associated with earning revenue and producing goods and services when calculating income from those activities (i.e., cost principle).
6. Principle of Prudence: It requires that companies act prudently when making business decisions, including those related to investing money in long-term assets such as property, plant and equipment because it may take years before those assets generate revenues (i.e., matching concept).
7. Principle of Continuity: The principle assumes that the business will continue its operations in the future.
8. Principle of Periodicity: Various entries are distributed across the appropriate time periods.
9. Principle of Full Disclosure: In creating the financial reports, accountants must be careful to include all relevant information.
10. Principle of Utmost Good Faith: This principle assumes that those involved in the transaction are honest.
While companies that are already subject to GAAP are required by law to report their financial information in accordance with the standard, if you believe the business you work for may eventually grow large enough for its financial statements be held up against GAAP guidelines, it's wise to start following them now.
Ratio Analysis
The definition of ratio analysis is the comparison of two amounts or numbers. Ratio analysis tells you how much a company earns relative to its assets or liabilities, which can help you determine the overall health of the company.
The three most common liquidity ratios include:
Liquidity ratios measure a company’s ability to pay its short-term debts.
Current Ratio is the ratio of a company’s current assets to its current liabilities. The higher the ratio, the better it is for a company. It indicates that the business has enough current assets to pay off its short-term debt. The Quick Ratio is similar to the current ratio, but it excludes inventory and prepaid expenses from both sides of the equation.
This is the simplest formula current ratio = asset/liability. An example can be found here.
Acid Test Ratio measures a company’s ability to pay its debt with its cash and liquid assets. It is calculated by adding a company’s cash, accounts receivable, and short-term investments together, then dividing that total by its current liabilities.
Profitability Ratios is a measure of the performance of a companies profit. The margin is calculated using:
profit ratio = turnover - (cost of sales/turnover); an example can be found here.