Part 1: Top Reasons for Capital Project Audits/Benefits of Audits

Introduction

Capital projects often face several common challenges during the project's lifecycle, leading to project delays and cost overruns.

Common Challenges

• Overbilling arises from inaccurate progress reporting, improper billing rates, and unallowable costs per the contract.
• Schedule delays caused by unforeseen permitting issues, labor shortages, supply chain disruptions, and frequent design changes — among other impacts.
• Change orders due to design modifications, rising material costs, and inadequate warranty management contribute to cost overruns and can impact project completion.
• Lack of proper documentation, including receipts and warranties, often leads to inefficiencies and disputes, while frequent scope changes add complexity and uncertainty.
• Liens — from subcontractors filing claims due to non-payment despite the general contractor or construction manager being paid — usually resulting from mismanagement of funds.

Strategies for Addressing Challenges

To effectively tackle challenges in capital projects:

• Establish standard policies and procedures for managing a capital project from procurement through close-out.
• Conduct regular audits to ensure compliance with established procedures.
• Implement stringent financial management and oversight, including timely payments, accuracy, and compliance measures.
• Develop accurate reporting systems to prevent over-billing.
• Enhance project planning and risk management to mitigate schedule delays.
• Improve change management processes and communication to manage pending change orders efficiently.
• Monitor expenditure closely to control costs.
• Ensure transparent management processes to maintain accountability with vendors and contractors.
• Maintain proper documentation — including accurate receipts and warranties — to avoid disputes and inefficiencies.
• Structure change management to address frequent scope changes and ensure stakeholder alignment, preventing miscommunication.
• Implement these practices to enhance the likelihood of successful project completion within the terms of the underlying contract and the owner’s audit plan.

How Can Capital Projects Audit Help?

Internal audits are vital in addressing the challenges encountered on a capital project by independently assessing project controls and processes. They identify weaknesses in financial management, documentation, and compliance, and provide recommendations for improvement. Regular audits facilitate early non-compliance detection and promote accurate reporting, enhancing stakeholder alignment. Various factors — such as contractual or government requirements, the desire for transparency, risk mitigation, process improvement, issue resolution, or vendor integrity — can drive capital projects and process audits.

1. Deterrence and Transparency

Proactive monitoring ensures that relevant parties know the comprehensive review process for submitted costs. Regular audits serve as a deterrent to claimants from submitting inflated or non-compliant costs. Capital project audits emphasize that each party's cost submissions, guaranteed maximum price (GMP), or cost-reimbursable payment applications will be evaluated consistently according to established guidelines and requirements.

2. Risk Mitigation

Capital project audits bring problem areas to light earlier in the project lifecycle to address and mitigate them adequately. Audits can also reveal warning signs that a project may not go well. For example, general conditions are billed at 75%, but the overall project may be only 50% complete. This can mean a delay; the contractor has increased staff or is just billing ahead of overall project completion and may run out of general conditions and, therefore, require an increase.

Focusing on changes and impacts on project/program completion and goals can identify the root cause of the issues and create and implement mitigation strategies based on best practices.

3. Issue Resolution

Often, an audit is performed related to a specific change order request, request for equitable adjustment (REA), or claim. The audit process brings relevant information forward for both sides to conduct informed settlement discussions or decisions to proceed to litigation.

Contractors and subcontractors often submit loss of productivity claims, and they may use generic loss of productivity factors, such as 50% loss of labor and equipment, or they may use published factors from publications such as the Mechanical Contractors Association of America (MCAA). The claimed productivity losses should always be compared to actual labor and equipment overruns, especially in the areas claimed. One can obtain the documentation required to perform this overrun analysis through an audit.

4. Vendor Integrity

Owners, contractors, and subcontractors must continuously test and refine their list of acceptable contractors, subcontractors, and vendors. If there are suspicions of malfeasance on the part of subcontractors or sub-tiers, audits and cost reviews allow owners, contractors, and subcontractors to make informed decisions about continuing certain business relationships.

What is a Capital Project Audit?

First, let us define the word “audit.” This is not a traditional financial statement audit, nor limited to verifying construction costs. A capital project audit is quite broad and depends on the needs and the audit program established by the owner. In some situations, the governing board may appoint an auditor/advisor to monitor the project for the board.

Capital project audits assure the organization’s C-suite, controllers, governing boards, funding sources, and stakeholders that cost, compliance, and performance risks are monitored and addressed at every stage of a capital project. An owner may conduct different types of audits tailored to the specific contract structure, the project risk areas that need particular attention, and the phase within the project lifecycle.

^{Exhibit 1: Ankura’s approach to capital project audits and risk management.}

1. Audit Clauses in Public Contracts

Most contracts involving the expenditure of public funds will have audit clauses. At the state level, Washington State, for example, has laws requiring audits on specific types of contracts.

There may be contractual requirements to perform audits, separate from or in addition to legal requirements. The following excerpts are from Washington State University's public contracts requiring audits of contracts based on a Design-Builder contract with a GMP or a target final cost to be substantiated by recorded project costs:

• … The Designer-Builder and its Subcontractors will keep complete and detailed records and accounts related to the Cost of the Work, exercise such controls as necessary for proper financial management under the Design-Build Contract, and substantiate all costs incurred. The accounting and control systems will be satisfactory to the Owner. The owner will usually conduct, at a minimum, a pre-construction audit conference, an interim audit, and a final audit of the Project. However, the Owner reserves the right to conduct an audit at any time…
• The design-builder will keep complete and detailed records and accounts related to the Chargeable Costs and, as necessary, substantiate all costs incurred. The Owner and the Owner’s auditors will, during regular business hours and upon 7 days’ notice, be afforded access to and will be permitted to audit and copy, including an electronic copy, the design-builders' original records and accounts, including complete documentation supporting all Chargeable Costs.

2. Audit Clauses in Private Contracts

Private owners with significant capital budgets — be they companies, private colleges/universities, or healthcare facilities — may have internal audit or risk compliance offices. An esteemed private research university built two hospitals simultaneously, each with a budget of over one billion dollars. Internal Audit audited each project during each construction year and conducted audits (discussed below) during construction. The university also identifies projects with high dollar amounts or construction risk to audit annually.

Types of Audits

The types of audits conducted — along with the corresponding stages in the capital project lifecycle shown in Exhibit 1 — are detailed below:

Current State Assessments:

The internal control environment can be evaluated through project and organizational assessments. Current state audits or assessments identify control gaps, weaknesses, and business improvement opportunities. They verify compliance with written policies and procedures, determine weak or absent control functions, and identify opportunities to improve business processes and efficiency. Implementing improvements should consider recommended project management practices specifically for the construction industry.

The audit work plan must include an analysis of performance metrics against key business objectives. For instance, comparing final costs for a selection of projects to the original and revised budgets — including approved amendments — measures cost performance and provides insights into the adequacy of contingency reserves. Another standard analysis compares cycle times for invoice payments against contractual terms and identifies impediments, which often involve multiple units within an organization.

Planning, design, and construction/facilities departments play a vital role for owners such as universities, healthcare, retail, and other entities with extensive capital programs. Project managers frequently oversee multiple projects, which can strain resources. An outside auditor/consultant can offer these owners valuable opportunities to improve overall project monitoring, oversight, and contract terms, address any loopholes or ambiguities, and support the project management team. A sample audit work plan, aimed at assessing a university's construction costs incurred and compliance with policies and state regulations, examines several internal areas across various project stages, including:

• Adequacy of written policies and procedures (governance and oversight),
• Allowable costs under the GMP agreement,
• Review and approval of payment applications,
• Budgeting and funding approvals,
• Procurement and award of construction contracts,
• Change orders and management processes,
• Forecasting costs and scheduling milestones,
• Scheduling and schedule management, and
• Adequacy and accuracy of cost accounting systems and reporting.

Additionally, the assessment should evaluate the Management Action Plan to ensure it mitigates any risks identified in audit findings, often requiring input from project stakeholders and other business units involved in the workflow.

Pre-Construction Audits:

Pre-construction audits are conducted during the planning phase to ensure cost accuracy and compliance with construction projects.

• Rate Audits: Verify labor, equipment, and overhead costs across contract types to ensure accurate budgeting and foster stakeholder trust.
• Key Project Records: Job cost transaction detail reports are crucial for a comprehensive financial picture and require auditors for accurate analysis.
• Contract Clauses: Provisions like the right to audit and access to information ensure transparency and accountability in construction projects.

Construction Audits:

Conducting various construction audits during the execution and protection phases is crucial to ensuring financial integrity, regulatory compliance, and successful project completion.

• Cost audits: To verify costs under GMP and cost-plus contracts to prevent overbilling and ensure legitimate expenses.
• Compliance audits: Assess adherence to laws, regulations, and policies, evaluate compliance programs, and mitigate risks.
• Close-out audits: Ensure all terms are met post-project, verifying deliverables and final payments are justified.

An active audit program that includes the types of audits listed above during the construction phase will result in a project that is more likely than not to mitigate cost and schedule risk to the owner for the reasons set out below.

The Capital Project Auditor's Background and Qualifications 

The background and qualifications of the auditor(s) assigned to conduct an audit of a capital project depend on the type of audit and the defined objectives. Since capital project audits require accounting and construction management expertise, the owner may want to consider augmenting its internal audit team to include third-party capital projects expert(s) in capital project accounting and auditing, schedule and productivity analysis, architects/engineers, and claims management/resolution experts.

Conclusion

Capital projects can face significant delays and cost overruns if not managed well. Regular audits throughout the project lifecycle are essential to identify and address issues early. Audits promote transparency and accountability and provide insights for better project controls and compliance. Focusing on risk management and vendor integrity is crucial for stakeholders to ensure projects are completed on time and within budget. In our next article, we will explore different types of audits and their roles in overcoming the challenges of capital projects.

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^{© Copyright 2025. The views expressed herein are those of the author(s) and not necessarily the views of Ankura Consulting Group, LLC., its management, its subsidiaries, its affiliates, or its other professionals. Ankura is not a law firm and cannot provide legal advice.}