A construction joint venture can be incredibly beneficial for construction companies working together on a large project. However, there are a variety of auditing, reporting, and compliance challenges to be aware of.
Having processes and controls in place from the beginning, such as defining cost of work definitions and consistent labor rates among parties, and real time project reporting aligned with key performance indicators (KPIs), could help improve transparency, maintain compliance, and increase accountability between the contractors and owner.
Why Do Contractors Enter into a Construction Joint Venture?
A joint venture entity made up of two or more construction companies provides individual members of the entity a variety of benefits and opportunities. This includes resources, capital, transparency, and relationships.
One of the biggest reasons why contractors enter a joint venture is to gain access to resources, such as equipment, knowledge, experience, and projects outside a company’s typical geographical footprint.
Combining resources with one or multiple construction companies, along with the successful completion of a project, provides an opportunity for each party to bid on larger, higher visibility projects in the future. A successfully completed project can also earn companies a reputation of doing quality work.
Given the continued labor shortage and because the construction industry is so competitive, labor is one resource that’s especially important. A joint venture provides the opportunity for each company to share talent and reduces the burden of hiring additional skilled labor.
An individual construction company may not have the equity to handle a large project or to meet bonding company requirements. A joint venture allows multiple companies to come together with their respective balance sheets, which can show bonding companies they’re in a key position to successfully complete a project.
With proper planning and controls established, organizations can see first-hand what other joint venture members are doing. This allows all involved members to implement best practices they’ve learned or to see how certain processes could be done differently within their respective companies.
Entering a construction joint venture is an opportunity for construction companies and owners to network and build relationships with each other. When the joint venture is structured correctly with solid agreements and strong communication between all parties, there’s greater potential for future collaboration.
Increase Financial Compliance and Reduce Risk in a Joint Venture with an Audit
Financial statement audits provide assurance for the joint venture entity and its members, helping all parties maintain financial compliance, strengthen financial reporting, and reduce risk.
What Are the Basics of a Joint Venture Audit?
Financial statement audits are typically completed for banks or bonding companies. Construction contract audits, on the other hand, are generally required by state law or regularly conducted by project owners to support transparency and accountability to key stakeholders.
Project owners may require financial statement audits of the joint venture, an audit of the individual joint venture parties, or they may also require construction contract audits of specific construction costs.
Joint Venture Audit Versus Individual Member Audit
Construction joint venture entities often don’t have lines of credit; however, individual members of the joint venture typically do for bonding purposes. If there’s capital that needs to be contributed into the joint venture, the members would do it with their cash flow.
Financial statement audits of the joint venture entity benefits the individual members who need to roll in financial reporting of the joint venture into their company’s financial statements through consolidation or equity method of accounting for the joint venture, especially when the joint venture is of a material size.
If joint venture financial statements aren’t audited each joint venture member would potentially experience increased audit fees from their respective auditor who would likely have to perform similar audit procedures on the joint venture as part of each member’s financial statement audit.
Establish Audit Requirements
Before contractors enter a construction joint venture project it’s critical to be proactive, understand the audit requirements, and engage with project owners and auditors early on with objectives for how to approach the various audit requirement.
Engaging a qualified construction auditor at the start of a project can help create transparency about audit requirements as well as help all joint venture members remain compliant with the applicable requirements, which may include details such as cost of work definitions, to prevent potential contract audit findings at the end of a project.
It’s important for the construction joint venture entity and individual members to understand reporting requirements and common key performance indicators (KPIs) that should be measured to help identify challenges and mitigate risk.
Consider reporting requirements for the following areas:
- Budget forecasts
- Expenditures to date
- Flux analysis
- Pending change orders
- Billing collections
Joint venture projects often benefit from technology-based dashboards, visualizations and other reporting solutions that can be built with tools such as Tableau. These technologies provide real-time reporting and data analytic capability to support accountability and transparency between the joint venture, its members and the construction project owner.
Internal Control Environment
As part of completing a financial statement audit in accordance with auditing standards issued by the American Institute of Certified Public Accountants (AICPA), the organization’s internal controls affecting financial reporting must be understood and assessed from a design and implementation perspective as part of the auditor’s risk assessment.
Risk assessment generally includes gaining an understanding of the processes and controls involved in estimating remaining construction costs, cash disbursements, and cash receipts, among. other processes determined to be relevant to the financial statement audit.
In an AICPA financial statement audit, the auditor does not specifically report on the design, implementation, or operating effectiveness of an entity’s internal controls, unless specifically engaged to do so—which is not common.
Control deficiencies can be addressed through designing better controls or by strict adherence to existing well-designed controls that aren’t properly implemented or not operating effectively.
For example, a company including pending change orders in the contract value should have a control requiring members of both operations and finance review an assessment of the pending change order to determine if it’s appropriate to include in accordance with Accounting Standards Codification (ASC) Topic 606, Revenue Recognition.
Schedule Regular Financial Meetings
All joint venture members could consider scheduling a monthly meeting to assess the financial status of the project in conjunction with overall progress. Look at what’s been done, what’s left to do, and analyze the budget to compare the actual costs to the original estimated budget.
After assessing various aspects of the project, look for areas that are going poorly to tackle potential challenges early on. If building materials go over budget, for example, it’s critical to plan how to address it, rather than waiting until the end of the job. This can help mitigate reporting errors and reduce the risk of auditing challenges and potential contention between joint venture members and its subcontractors as well as project owners.
What Are Common Challenges of a Construction Joint Venture?
Even though construction joint ventures can be incredibly beneficial, there are a few common areas where challenges could arise:
- Communication around scheduling and purchasing
- Labor billable rates
- Contractor-owned equipment rates
Communication Around Scheduling and Purchasing
Managing the schedule for materials and labor is a significant risk area that was magnified on many joint venture projects due to COVID-19 and the global supply chain. Disconnects with scheduling work crews or ordering building materials could impact the overall cost and efficiency of the project.
From an operational perspective, daily communication among the different members, strong reporting controls around supply chain and contingency plans for key materials, and scheduling labor can help keep the project moving, reduce downtime, and increase efficiency. Creating a work schedule at the beginning of the project can also help track performance, create transparency, and catch potential supply chain challenges early on.
Labor Billable Rates
When personnel work together from different companies, there’s a risk of workers learning others’ salaries, which could create contention and possibly result in personnel wanting to move to a higher paying company. The construction industry is highly competitive and finding skilled workers can be difficult, especially with the current labor shortage.
Establish consistent labor rates at the beginning of the project so that personnel types are paid the same market competitive billable rate.
Contractor-Owned Equipment Rates
Similar to labor rates, there could be disputes when each joint venture party has a different rate for the same type of equipment. Varying equipment rates could potentially result in a construction contract audit finding if such varying rates aren’t in compliance rates allowable in the construction contract with the project owner.
Defining equipment rates as a joint venture and setting caps if applicable can help keep everyone on the same page in terms of what’s an allowable cost. This allows contractors to focus on the project and not be concerned about the construction contract audit at the end of the job.
We’re Here to Help
For audit and compliance support for a construction joint venture or your construction company, contact your Moss Adams professional. You can also visit our Construction Practice page for additional resources.