Blueprint for Success: Strengthen Your Construction Firm with 3 Pillars of Internal Controls

At a glance

• The main takeaway: Internal controls are policies and procedures designed to improve the reliability of information and prohibit the misappropriation, or theft, of company assets.
• Impact on your business: Strengthening them is a blueprint for accurate financial reporting and protection of your company’s assets.
• Next steps: Reach out to Aprio’s Real Estate & Construction group for proactive guidance and help with evaluating your internal controls and determining the best next steps.

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The full story:

If you are a business owner in the construction industry, a critical area you may inadvertently overlook is your internal controls process.

Internal controls are policies and procedures designed to improve the reliability of information and prohibit the misappropriation, or theft, of company assets. Strengthening them is a blueprint for accurate financial reporting and protection of your company’s assets.

Below, we discuss actionable steps you can take to improve your internal controls and better protect your business.

Main components of internal control

There are five main components of internal control that need to be functioning and working together for the system to be effective:

• Control environment: Emphasizes the importance of upholding integrity and commitment within the company to recognize errors and identify solutions.
• Risk assessment: A regular risk assessment can help identify risk or loss.
• Information and communication: There should be a practice to keep communication and sharing information within the company running smoothly.
• Control activities: These are policies and procedures that are in place to make sure proper directives from the leaders and management team are implemented.
• Monitoring: Regular monitoring of internal controls highlights the need for constant check-ins and updates to assure a sound internal control system.

Separation of duties

A sound internal control system starts with the segregation of duties. Identifying different individuals to handle different tasks so no one person has control over an entire transaction is a significant step. The three primary areas to focus on are:

• Authorization: The process of delegating the authority to someone in the organization to perform and approve a task. A treasurer approving a wire transfer or signing a check is one example.
• Recordkeeping: The process of recording transactions in the accounting system. An example is an accounts payable clerk, a controller, or some other personnel in the accounting department.
• Custody: The process of having control of an asset related to a transaction. An example from the cash disbursement cycle includes having custody of blank-check stock or having the ability to access bank portals to initiate a wire transfer.

When these three functions are segregated, the internal control system is well-designed, which helps reduce the chances of theft or fraud. Additionally, these measures help detect and rule out inadvertent errors.

Reduce the risk of internal fraud

Internal fraud is something for which all businesses should be on guard. One common fraud scheme includes utilizing ghost vendors. For instance, if an accounts payable clerk has the ability to add vendors to an approved vendors list, the payables clerk could potentially create a ghost vendor and set up unauthorized payments.

With sound internal controls in place, the payables clerk would not be authorized to access or modify the approved vendors list. Similarly, a payroll department employee might add a ghost employee to direct payments to themselves through payroll runs if proper checks and balances are not in place.

Why is cost-benefit measurement considered a challenge in implementing internal controls?

This is the process of measuring the benefits of a decision by comparing them with the projected costs to determine whether it is feasible to implement. In smaller organizations with two or three employees, owners might hesitate to expand accounting staff to segregate duties. And while segregating duties is not a guarantee that fraud or errors will not occur (since employee collusion and overrides of control are always a threat), it does serve as a solid foundation. We recommend consulting with a professional advisor to determine the best next steps for your organization when implementing internal controls.

The bottom line

Separating the three pillars — authorization, recordkeeping, and custody — is vital for effective internal controls. Consult with a CPA about your current accounting practices and needs; they can help spot critical gaps and identify areas to improve your internal controls.

If you need help evaluating your internal controls and determining next best steps, contact Aprio’s Real Estate & Construction group today.

This article first appeared in the October 2024 issue of Construction News.

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