CCA Construction Internal Controls and Financial Reporting 2 — Questions and Answers
Question 1: An 'overbilled' condition on a construction WIP schedule indicates that:
- The contractor has billed less than the value of work completed to date
- The contractor has billed more than the value of work earned based on completion (Correct answer)
- The project is behind the contractual schedule
- Total costs have exceeded the original contract budget
Correct answer: The contractor has billed more than the value of work earned based on completion
Overbilling, also called 'billings in excess of costs and estimated earnings,' occurs when a contractor has invoiced the owner for more than the revenue earned based on actual work progress.
Question 2: In construction auditing, 'retainage' refers to:
- A penalty clause assessed for project schedule delays
- A portion of each progress payment withheld by the owner until project completion (Correct answer)
- The contractor's retained profit margin on a completed project
- Equipment rental costs placed in a reserve escrow account
Correct answer: A portion of each progress payment withheld by the owner until project completion
Retainage is a percentage (typically 5–10%) of each progress payment withheld by the owner until the project reaches substantial completion, providing performance assurance.
Question 3: A 'Schedule of Values' in a construction contract primarily serves as:
- A list of all subcontractor bid amounts submitted during procurement
- A breakdown of the contract price by work components used as the basis for progress billing (Correct answer)
- An itemized inventory of equipment values currently on the project site
- A historical record of material prices at the time of original purchase
Correct answer: A breakdown of the contract price by work components used as the basis for progress billing
A Schedule of Values allocates the total contract sum across individual work components and serves as the agreed basis for calculating each progress payment application submitted by the contractor.
Question 4: When auditing construction disbursements, 'joint checks' are primarily used to:
- Verify that subcontractors carry the required bonding and insurance
- Ensure material suppliers are paid directly alongside the subcontractor from the same payment (Correct answer)
- Confirm that labor rates comply with prevailing wage requirements
- Document that change orders were approved by multiple authorized parties
Correct answer: Ensure material suppliers are paid directly alongside the subcontractor from the same payment
Joint checks are made payable to both the subcontractor and their material supplier, ensuring the supplier receives payment and reducing the risk of mechanic's lien claims against the project.
Question 5: Which metric best measures a construction company's efficiency in converting project billings into cash receipts?
- Debt-to-equity ratio
- Days Sales Outstanding (DSO) (Correct answer)
- Gross profit margin percentage
- Current ratio
Correct answer: Days Sales Outstanding (DSO)
Days Sales Outstanding (DSO) measures the average number of days it takes to collect payment after billing, directly indicating how efficiently the company manages its accounts receivable.
Question 6: The 'underbilled' condition in a WIP schedule, also known as 'costs in excess of billings,' is classified on the balance sheet as:
- A current liability
- A current asset (Correct answer)
- A contra-revenue account reducing net revenue
- An off-balance-sheet contingent liability
Correct answer: A current asset
Costs in excess of billings (underbilling) represents revenue earned but not yet billed to the owner, and is classified as a current asset because the owner owes the contractor for work already performed.
Question 7: When auditing a construction company's financial statements, the auditor identifies that estimated costs to complete a project have significantly increased. The primary audit concern is:
- Whether the bonding company has been notified of the cost increase
- Whether contract revenue and gross profit have been appropriately revised under the percentage-of-completion method (Correct answer)
- Whether the project manager has been disciplined for cost overruns
- Whether subcontractors have been issued formal notices to cure
Correct answer: Whether contract revenue and gross profit have been appropriately revised under the percentage-of-completion method
Under the percentage-of-completion method, changes in estimated total costs require the auditor to verify that cumulative revenue, gross profit, and WIP balances have been recalculated to reflect the revised estimate.
CCA Construction Internal Controls and Financial Reporting 2
An 'overbilled' condition on a construction WIP schedule indicates that: