1. Technical Guide on Internal Audit of Construction Industry
Technical Guide
on Internal Audit of
Construction Industry
ISBN : 978-81-8441-345-8
2010
Price : Rs. 150/-
The Institute of Chartered Accountants of India
(Set up by an Act of Parliament)
www.icai.org New Delhi
April / 2010

2. Technical Guide
on Internal Audit of
Construction Industry
DISCLAIMER:
The basic draft of the Technical Guide was prepared by CA. M.
Guruprasad. The views expressed in this Technical Guide are
those of the author and may not necessarily be the views of the
organisation he represents.
The Institute of Chartered Accountants of India
(Set up by an Act of Parliament)
New Delhi
i

3. © The Institute of Chartered Accountants of India
All rights reserved. No part of this publication may be reproduced,
stored in a retrieval system or transmitted, in any form or by any
means, electronic, mechanical, photocopying, recording or
otherwise, without prior permission, in writing, from the publisher.
Edition : April, 2010
Committee / : Internal Audit Standards Board
Department
Email : cia@icai.org
Website : www.icai.org
Price : Rs. 150/- (Including CD)
ISBN No. : 978-81-8441-345-8
Published by : The Publication Department on behalf of
The Institute of Chartered Accountants of
India, ICAI Bhawan, Post Box No. 7100,
Indraprastha Marg, New Delhi -110 002.
Printed by : Sahitya Bhawan Publications, Hospital
Road, Agra-3.
April/2010/1,000 Copies
ii

4. FOREWORD
The construction industry is a key indicator and driver of economic
activity and wealth creation. This industry has a profound impact
on the society and the products of this vital industry are of various
types like, buildings, roads and bridges, utility distributions
systems, railways, airports, harbours, etc. The future of this
investment laden industry depends upon its capacity to evolve on
business, technological and environmental fronts.
Internal auditors have a key role to play in construction industry
with respect to multi-dimensional challenges faced by this industry
like, project risk, funding strategies, cost reduction, project
monitoring, etc. This demands that internal auditors understand
the basic concepts and peculiarities of this industry and brace
them up to newer challenges.
I am happy to note that the Internal Audit Standards Board has
brought out this Technical Guide on Internal Audit of Construction
Industry. This Technical Guide provides the readers a crisp insight
into various technicalities arising in the operations of this industry
and covers the relevant issues which the internal auditors must be
aware of.
I congratulate CA. Shanti Lal Daga, Chairman, Internal Audit
Standards Board and the members of the Board on issuance of
this Technical Guide. This Technical Guide comprehensively deals
with the peculiar aspects of construction industry and provides a
step-wise approach for internal audit.
I am sure that this Technical Guide will assist the members and
others in efficiently discharging their responsibilities.
February 16, 2010 CA. Uttam Prakash Agarwal
New Delhi President, ICAI
iii

6. PREFACE
The construction industry in India accounts for more than 8% of
the GDP and has been on a high growth trajectory. Despite the
high growth potential, the industry is subjected to more risk and
uncertainty than many other industries. Many of the risks emerge
over time and are linked to the life cycle of the project. Thus, the
potential for improving the management for construction projects is
significant.
Internal auditors who understand the basic structure and
processes of construction project management and tailor their
internal audit work to the unique time and organisational
framework can play a meaningful role. They can assist in
implementing controls that provide reasonable assurance of
mitigating cost, schedule and technical risk to an immaterial level.
The Institute had in 1987 issued the Guidelines on Internal Audit-
Construction Industry. Since then the construction industry has
transformed in view of introduction of the new trades and work
practices, better safety and quality standards, productivity
benchmarks both by government organisations and by the
industry. The Guidelines have been thoroughly revised to reflect
these changes, especially, those arising out of the significant
developments in regulatory environment. This revised version of
Technical Guide on Internal Audit of Construction Industry is
aimed to help the readers in understanding not only the regulatory
framework and technical aspects of the construction industry but
also the procedures to be undertaken by the internal auditor. This
Guide has been divided into various chapters dealing with the
fundamental concepts in construction industry. These chapters
deal with the introduction, technical aspects, regulatory framework
of the construction industry, methodology for internal audit and
internal audit checklists of functional areas. The Appendix
containing flow charts regarding various processes carried out in
v

7. the industry and a glossary of terms used in the construction
industry provide valuable guidance to the readers.
At this juncture, I am grateful to CA. M. Guruprasad for sharing his
experiences and knowledge with us and preparing the draft of the
revised Guidelines and bringing them in line with the latest
developments in the field.
I also wish to thank CA. Uttam Prakash Agarwal, President and
CA. Amarjit Chopra, Vice President for their continuous support
and encouragement to the initiatives of the Board. I must also
thank my colleagues from the Council at the Internal Audit
Standards Board, viz., CA. Rajkumar S. Adukia, CA. Ved Jain,
CA. Abhijit Bandyopadhyay, CA. Bhavna G. Doshi, CA. Pankaj I.
Jain, CA. Sanjeev K. Maheshwari, CA. Mahesh P. Sarda, CA. S.
Santhanakrishnan, CA. Vijay K. Garg, Shri Krishna Kant, Shri
Manoj K. Sarkar and Shri K. P. Sasidharan for their vision and
support. I also wish to place on record my gratitude for the
coopted members on the Board, viz., CA. N. K. Aneja,
CA. Verendra Kalra, CA. Dilip Kumar Vadilal Shah and CA. K. S.
Sundara Raman as also special invitees on the Board, viz., CA. K.
P. Khandelwal, CA. S. Sundarraman, CA. Ravi H. Iyer, CA. Rajiv
Dave, CA. Pawan Chagti, CA. Ram Mohan Johri and CA. Arindam
Guha for their devotion in terms of time as well as views and
opinions to the cause of the professional development. I also wish
to place on record the efforts put in by CA. Jyoti Singh, Secretary,
Internal Audit Standards Board and her team of officers, viz., CA.
Arti Aggarwal and CA. Gurpreet Singh, Senior Executive Officers,
for finalising this publication.
I am certain that the readers, especially members of the Institute,
working as internal auditors in construction industry would find this
Technical Guide immensely useful.
February 10, 2010 CA. Shantilal Daga
Hyderabad Chairman
Internal Audit Standards Board
vi

8. GLOSSARY
Actionable Claim As defined in the “Transfer of Property
Act, 1882”.
Means a claim to any debt, other than a
debt secured by mortgage of
immovable property or by hypothecation
or pledge of moveable property, or to
any beneficial interest in immovable
property not in the possession, either
actual or construction, other claimant,
which the civil courts recognise as
affording grounds for relief, whether
such debt or beneficial interest be
existent accruing conditional or
contingent.
Bid Bond A debt secured by a bidder for a
construction job or similar type of bid-
based selection process for the purpose
of providing a guarantee to the project
owner that the bidder will take on the
job if selected. The existence of a bid
bond provides the owner with
assurance that the bidder has the
financial means to accept the job for the
price quoted in the bid.
Construction Sector engaged in preparation of land
Industry and construction, alteration and repair
of buildings, structures and any other
real property.
vii

9. Contingent It is an interest in property, which is
Interest available to a person only at a future
date on the happening or not happening
of an uncertain event.
Contract A written document which specifies the
terms for construction as agreed
between the parties.
Defects Liability It is a contingency period during which
Period (DLP) any modification, alterations, repairs or
rework to the scheduled premises is
performed by the entity as compliance
with the contract is liable to be
performed.
Entity Includes Companies, Partnership Firms,
Limited Liability Partnerships, Co-
operative societies, Trusts, Hindu
Undivided Families and any other legal
form under which business operates.
Final Acceptance It is the certificate given by the client at
Certificate (FAC) the completion of defects liability period.
Goods Goods as defined under Sales Tax
Laws.
Goods means all kinds of movable
property (other than newspaper,
actionable claims, stocks and shares
and securities) and includes livestock,
all materials, commodities, and articles
(including goods or in some other form)
involved in the execution of works
contract or those goods to be used in
the fitting out improvement or repairs of
viii

10. movable property and all growing crops,
grass, or things attached to or forming
part of the land which are agreed to be
severed before sale or under the
contract of sale.
Immovable As per the General Clauses Act, 1897
Property
“shall include land, benefits to arise out
of land, and things attached to the
earth, or permanently fastened to
anything attached to the earth”.
Inheritance Inheritance is an estate descended to
their heir immediately on the death of
the ancestor by virtue of his rights as a
descendant.
Interest It is a legal right in rem which becomes
an interest when it is attached to a land,
building, chattel, object, article or thing
and which is both recognised and
protected under law. It is both
inheritable and transferable in
accordance with law. It is basically of
two types:
• Vested Interest
• Contingent Interest.
Lease As defined under section 105 of the
“Transfer of Property Act, 1882”.
A Lease of immovable property is a
transfer of right to enjoy such property,
made for a certain time, express, or
implied, or in perpetuity, in
consideration of a price paid or
ix

11. promised, or of money, a share of
crops, service or any other thing of
value, to be rendered periodically or on
specified occasions to the transferor by
the transferee, who accepts the transfer
on such terms.
Movable Property As per the General Clauses Act, 1897
“Anything not a immovable property”.
Performance A bond issued to one party of a contract
Bond as a guarantee against the failure of the
other party to meet obligations specified
in the contract.
For example, a contractor may issue a
bond to a client for whom a building is
being constructed. If the contractor fails
to construct the building according to
the specifications laid out by the
contract, the client is guaranteed
compensation for any monetary loss.
Property Refers to the legal right and interest of a
person in and attached to land, building
or object, article or thing or in respect of
any intangible assets like, goodwill,
copyrights, etc, held and enjoyed by
him to the exclusion of others, which is
both recognised and protected under
the law. Such a right and interest is
transferable, inheritable and is capable
of being mortgaged, hypothecated or
otherwise encumbered.
Provisional It is the certificate given by the client at
Acceptance the time of the handover of the
x

12. Certificate (PAC) scheduled premises by the entity to the
client.
Real Estate or Denotes all lands, buildings, super
Real Property structures, infrastructures and all
improvements accretions thereto and all
rights, interest and titles attached to
them.
Right It is something, which enable a person
to do or not to do some act, deed or
thing, generally or in relation to a land,
building, chattel, object, article or thing.
The term ‘thing’ includes intangible
assets too.
An immovable property is the subject
matter of various rights like, the right to
posses, use, enjoy, alter, consume,
destroy, alienate, hypothecate, transfer,
bequeath, inherit, succeed to, etc.
Right in Rem A right against or in respect of a thing.
Spes Successions It is a mere right to succeed to a
property in the future.
Succession Succession is the transmission of rights
and obligations of deceased to their
heirs.
Title The title is the documentary base by
which the legal right and interest to
property is recorded, established and
evidenced.
xi

13. Transfer A transfer is an act or transaction by
which one person conveys a property in
favour of another person. The term has
been defined in various enactments
including tax laws with various meaning
and connotations to cover transactions
of wider nature.
Transfer of As defined under Section 5 of the
Property “Transfer of Property Act, 1882”.
Means “An act by which a living person
conveys property in present or in future,
to one or more other living persons, or
to himself, or to himself and one or
more other living persons, and “to
transfer property” is to perform such act.
In this section “living person” includes a
company, or association of persons or
body of individuals”.
Turnkey or a A turnkey is one in which a contractor
Package Contract undertakes to finance, design, construct
and commission a project in it entirety.
Vested Interest It is an interest in property, which is
available to a person at present or at a
future date on the happening of a
certain specified event which must
happen.
xii

14. CONTENTS
Foreword......................................................................................iii
Preface ..........................................................................................v
Glossary......................................................................................vii
Chapter 1: Introduction .................................................. 1-3
Objective and Scope of the Technical Guide ........................2
Chapter 2: About the Indian Construction
Industry ...................................................... 4-14
Evolution ...............................................................................4
History of the Indian Construction Industry ...........................4
Stages of a Construction Project...........................................6
Definition of the Project .............................................6
Planning for the Project ..............................................6
Execution Stage .........................................................7
Completion Stage.......................................................8
Post Completion Stage...............................................8
Benefits of the Construction Industry to the Society..............8
Special Features of the Indian Construction Industry............9
Business Process Related .........................................9
Contracts..................................................................10
Employee Related ....................................................11
Others ......................................................................11
xiii

15. Major Operational Challenges Faced by Entities ................12
Chapter 3: Legal Framework...................................... 15-20
Ministry of Commerce and Industry, GOI ............................15
Ministry of Finance, GOI .....................................................15
A Gist of Important Regulations that may be
Applicable to an Entity.........................................................16
The Transfer of Property Act, 1882 ..........................16
Special Economic Zone Act, 2006............................16
The Minimum Wages Act, 1948 ...............................17
The Factories Act, 1948 ...........................................17
The Industrial Disputes Act, 1947.............................17
Other Applicable Indian Acts to the Industry .......................18
Governance Laws ....................................................18
Economic Laws ........................................................19
Contract Laws .........................................................19
Labour Laws ............................................................19
Other Laws as applicable to the Industry .................20
Other Applicable International Acts to the
Construction Industry ..........................................................20
The Sarbanes-Oxley Act, 2002 ................................20
Chapter 4: A Reference to Statutory Laws
Applicable to Indian Construction
Industry .................................................... 21-26
Income Tax .........................................................................21
Service Tax .........................................................................22
xiv

16. Availing Input Credit .................................................23
Works Contract ...................................................................24
Input Credit Set-off Scheme .....................................24
Works Contract Tax Deducted at Source .................25
Deduction on the Rate of Works Contract Tax .........25
Special Economic Zone ......................................................25
SEZ Rules, 2006 ......................................................25
Chapter 5: Internal Audit ............................................ 27-39
Factors Contributing to the Evolution of Internal
Audit .................................................................................28
Increased Size and Complexity of Businesses.........29
Enhanced Compliance Requirements ......................29
Focus on Risk Management and Internal
Controls to Manage Them........................................29
Stringent Norms Mandated by Regulators to
Protect Investors ......................................................29
Unconventional Business Models.............................29
Intensive Use of Information Technology .................29
An Increasingly Competitive Environment................30
Methodology for Internal Audit ...........................................30
Standards on Internal Audit ......................................30
Terms of Internal Audit Engagement........................31
Knowledge of the Business .....................................32
Audit Planning, Materiality and Sampling .................33
Internal Control.........................................................33
xv

17. Internal Audit in an Information Technology
Environment .............................................................35
Overview of Compliance ..........................................36
Chapter 6: Major Areas of Internal Audit
Significance.............................................. 40-95
Selection of a Project ..........................................................40
Approvals for Registration...................................................43
Procurement .......................................................................45
Material Handling and Storage............................................58
Fixed Assets .......................................................................59
Total Fixed Cost ......................................................62
Asset Utilization ratio................................................62
Cash and Bank ...................................................................67
IOUS ........................................................................68
Revenue Recognition..........................................................72
Recognition of Contract Revenue and
Expenses .................................................................74
Payroll .................................................................................78
Operating Costs ..................................................................82
Hiring Expenses .......................................................82
Repair and Maintenance ..........................................83
Logistics ...................................................................83
Agreement with Collaborators.............................................86
Running Account Bill (RAB) ................................................87
Disputed Claims ..................................................................88
xvi

18. Measurement Sheets ..........................................................89
Risks Faced by an Entity Operating in the
Construction Industry ..........................................................89
Reduction of Risks ...................................................91
Maintenance of Books of Accounts and Documents...........92
Compliance with Standards and Regulations......................94
Appendix
Appendix 1
Process Flow Chart for Procurement of
Material and Services..........................................................97
Appendix 2
Process Flow Chart for the Purchase,
Transfer and Disposal of Fixed Assets................................99
Appendix 3
Process Flow Chart for General Payments .......................102
Appendix 4
Process Flow Chart for Recognition of Construction
Revenue, Service Revenue and Recognition of
Work in Progress ..............................................................103
Appendix 5
Process Flow Chart for Making Statutory
Deduction with Respect to Payroll, Month-end
Processing of Payroll and Payroll
Disbursement Process ......................................................106
xvii

19. xviii

20. CHAPTER 1
INTRODUCTION
1.1 Construction activity is an integral part of a country’s
infrastructure and industrial development. It includes hospitals,
schools, townships, offices, houses and other buildings, urban
infrastructure (including water supply, sewage, drainage),
highways, roads, ports, railways, airports, power systems,
irrigation and agriculture systems, telecommunications, etc.
Construction becomes the basic input for socio-economic
development as it covers such a wide spectrum. Besides, the
construction industry generates substantial employment and
provides a growth impetus to other sectors through backward and
forward linkages. It is, essential therefore, that, this vital activity is
nurtured for the healthy growth of the economy. Moreover, it is one
of the earners of foreign exchange as more and more
organisations have started to provide services outside India.
1.2 The construction industry has major linkages with the
building material industry since construction material accounts
for sizeable share of the construction costs. These include
cement, steel, bricks/tiles, sand/aggregates, fixtures/fittings,
paints and chemicals, construction equipment, petro-products,
timber, mineral products, aluminium, glass and plastics.
Construction activities also include civil, mechanical and
electrical engineering activities.
The construction industry is a capital intensive industry. It is
also labour predominant industry. In general, the construction
industry deals with development of real property. It involves
work to be performed at the specific location, where the
property is located. Only the administrative works are carried
out at the centralized location. It has become specialised in the
recent years which have lead to work to be performed on “turn-
key” basis. On the other hand, major projects have been
awarded to a consortium of contractors. Also, the role of sub-

21. Technical Guide on Internal Audit of Construction Industry
contracting has played a significant part, considering the trend
of hiring labour, transporters, electricians, plumbers, welders on
sub-contract has increased.
Objective and Scope of the Technical Guide
1.3 This Technical Guide is intended to assist internal
auditors in carrying out internal audit of entities operating in the
construction industry. The Technical Guide deals with
operational areas of entities operating in this industry with
emphasis on compliance mandated as per various regulations
applicable to the specific industry.
1.4 Today, the scope of internal audit has increased from
mere verification of financial transactions to reviewing of proper,
efficient and economical usage of resources by the entity.
Therefore, it is imperative that an internal auditor familiarises
with various management aspects and technical aspects of the
construction industry for performing internal audit in a more
efficient and effective manner.
This Technical Guide covers the following aspects:
(i) Glossary of terms peculiar to construction industry.
(ii) Scenario in the construction industry, special features
and challenges faced by entities operating in this
industry.
(iii) Discussion on Internal Audit and compliance related
issues.
(iv) Legal Framework for entities operating in the Indian
construction industry.
(v) Major areas of internal audit significance and risks faced
by an entity operating in this industry, procedures that an
internal auditor can perform.
(vi) Appendix
2

22. Introduction
1.5 This Technical Guide does not cover the following
aspects:
(a) Special audits
(b) Investigations
(c) Property Development Companies
(d) Construction of Specialised projects such as, airport,
dams, ports, railways, etc.
3

23. CHAPTER 2
ABOUT THE INDIAN
CONSTRUCTION INDUSTRY
2.1 It is important for an internal auditor to gain an
understanding of the Indian construction industry, its evolution,
special features of the construction industry and the challenges
faced by entities operating in the industry in order to understand
the critical areas, nuances and knowledge of the business
thereby helping him in framing internal audit procedures to
perform an efficient and effective internal audit.
Evolution
2.2 The evolution of Indian construction industry was almost
similar to the construction industry evolution in other countries,
i.e., founded by government and slowly taken over by private
enterprises. After independence the need for industrial and
infrastructural developments in India laid the foundation stone
of construction, architectural and engineering services. The
construction sector became organised since the 1950’s post
incentives taken by the government to develop these services.
History of the Indian Construction Industry
2.3 The history of the Indian construction industry dates
back to period from early 1950 to mid 60’s which witnessed the
government playing an active role in the development of these
services and most of construction activities during this period
were carried out by state owned enterprises and supported by
government departments. In the first five-year plan, construction
of civil works was allotted nearly 50 per cent of the total capital
outlay.
2.4 The first professional consultancy company, National
Industrial Development Corporation (NIDC), was set up in the

24. About The Indian Construction Industry
public sector in 1954. Subsequently, many architectural, design
engineering and construction companies were set up in the
public sector such as
• Indian Railways Construction Limited (IRCON)
• National Buildings Construction Corporation (NBCC)
• Rail India Transportation and Engineering Services
(RITES)
• Engineers India Limited (EIL), etc.
In the private sector, companies such as following were
incorporated:
• M. N. Dastur and Co.
• Hindustan Construction Company (HCC)
• Ansals.
2.5 In the late 1960s government started encouraging
foreign collaborations in these services. The Guidelines for
Foreign Collaboration, first issued in 1968, stated that local
consultant would be the prime contractor in such collaboration.
The objective of such an imposition was to develop local design
capabilities parallel with the inflow of imported technology and
skills. This measure encouraged international construction and
consultancy organisations to set up joint ventures and register
their presence in India.
2.6 The importance of this sector in India need not be over-
emphasized. In India, construction has accounted for around 40
per cent of the development investment during the past 50
years. Around 16 per cent of the nation's working population
depends on construction for its livelihood. The Indian
construction industry comprises 200 firms in the corporate
sector. In addition to these firms, there are about 1,20,000
Class A contractors registered with various government
construction bodies. There are thousands of small contractors,
which work as sub- contractors of prime or other contractors.
5

25. Technical Guide on Internal Audit of Construction Industry
The main reason for this is the increasing emphasis on
involving the private sector infrastructure development through
public-private partnerships (PPP) and mechanisms like, build-
operate-transfer (BOT).
Stages of a Construction Project
2.7 The construction industry has various stages. Based on
the nature of the construction to be performed, the following
may or may not be applicable in the same sequence:
Definition of the Project
2.8 In the project definition phase, objectives are developed
and the scope of the project is specified. This is the most
important phase of the project which determines the success or
failure of the project. This activity can be split in two broad
stages as described below:
(i) Site Investigation – This activity is performed at the initial
stages, say at the bidding stage. It involves processes like,
soil testing, ground landscape, structure, assessment of
ground quality, stability and other factors important for
ensuring sufficient life to the construction.
(ii) Feasibility Study Preparation – The feasibility of the
project is appraised apart from other processes like, cost
analysis, legal documentation, process of entering into
various contracts, etc.
Planning for the Project
2.9 Project planning involves marshalling the resources and
developing the systems and procedures necessary to control
activity during project execution. A successful planning effort
would result in development of following three distinct controls:
(i) Scope Controls - It ensures that the work performed is
within the overall scope of the project. It is also to ensure
that all parts of the projects are completed simultaneous
and appropriately.
6

26. About The Indian Construction Industry
(ii) Scheduled Controls - Controls should be in place to
ensure compliance with schedule of work. This is
extremely important to avoid project overruns and
compliance with scheduled time. These controls are
essential to avoid penalties & Charges for delay in
completion of contracted work as agreed by the parties.
(iii) Cost Controls - The importance of cost controls need not
be specifically stated. These controls are most important
for completion of project at the estimated cost. This is the
most important control to ensure profitability.
Execution Stage
2.10 In the execution stage, the following processes are
involved:
(i) Laying the Foundation – Once the materials are
procured, with the help of labour, the foundation for the
building is laid. The foundation is based on the strength of
the superstructure.
(ii) Brick and Masonary Work – In this stage, once the
foundation has been laid, the building starts rising by
construction of steel pillars and brick walls around them as
per the approved plan.
(iii) Laying Pipelines – At the time of construction of the
super-structure, various pipes for water, sewage, drainage,
& other disposal systems are laid apart from pipes laid for
electric wiring.
(iv) Steel and Wood Work – At the time of rising the building,
the wooden frames are made and grills for the windows are
also fixed. Wooden work includes work for doors, windows,
fixtures, partitions and such other furnishing required are
prepared.
(v) Completion of Construction – Once the above processes
are through, the painting/whitewashing process starts.
7

27. Technical Guide on Internal Audit of Construction Industry
It involves proper controls to ensure that the execution is as per
the planning. If there are any significant deviations, then
sufficiency of controls needs to be verified.
Completion Stage
2.11 After completion of the project, the project should be
reviewed and it is an invaluable tool for making sure that
lessons learned carry over to the next project. The level of effort
required in this phase varies with the size of the organization
and the frequency with which capital projects are undertaken. If
the organization is involved in a major expansion activity, with
more projects anticipated, a detailed review of each project by
management function is probably warranted. The formal reports
from the reviews should be compiled to provide a road map for
improving future performance.
Post Completion Stage
2.12 The entity might be required to provide fit outs, layouts in
accordance with the terms of the contract.Upon completion of
the Defects Liability Period, all liabilities with regard to the
contract cease.
Benefits of the Construction Industry to the
Society
2.13 The following are the benefits of the construction
industry to the society:
(i) Absorbs rural labour and unskilled workers (in addition to
semi-skilled and skilled);
(ii) Provides opportunity for seasonal employment thereby
supplementing workers’ income from farming;
(iii) Permits large-scale participation of women workers; and
(iv) Development of Infrastructure, thereby sustaining the
growth of economy.
8

28. About The Indian Construction Industry
Special Features of the Indian Construction
Industry
2.14 The construction industry is unique in certain respects
with respect to other industries. These can broadly be classified
as following:
(a) Business Process Related
The business of an entity operating in a construction industry
has certain unique characteristics, risks, nuances. Some of
them are as follows:
(i) The risks for a construction industry are different from
any other industry.
(ii) The construction industry is capital intensive in nature.
Huge investment needs to be made by the entity in
purchasing of specialised equipment for its construction
processes. In some cases, the entity hires specialised
equipment from external sources.
(iii) The entity might provide variety of services from building
houses, commercial complexes, factories, ports,
railways, roads, airports, etc. The risks for providing
each type of service are different.
(iv) The entity might be required to float tenders for projects,
which requires detailed estimation of the costs required
for the project.
(v) Construction services are required to be provided at the
respective sites. Significant part of the operations is at
the respective sites. Therefore, the need for proper
control procedures need not be over emphasized.
(vi) Requires high level of planning and execution to prevent
escalation of costs, timely completion of projects thereby
building brand.
9

29. Technical Guide on Internal Audit of Construction Industry
(vii) In case, construction companies provide services
outside India, they have to comply with foreign laws and
regulations.
(viii) Considering that this is a capital intense industry, and
money is received from client only on completion of a
certain percentage of work, in most cases, a high
working capital is required for proper functioning of the
industry.
(ix) The entity sub-contracts most part of its work such as,
welding, carpentry, transportation, plumbing to external
parties thereby ensuring professional involvement in the
performance of work, timely completion and also limiting
the liability for the entity.
(x) Certain projects such as, construction of highways,
bridges are provided by construction entities on a long
term basis and are in the nature of Build, Own and
Transfer (BOT) or Build, Own, Lease and Transfer
(BOLT) basis. The entity post constructing the said
infrastructure collects charges (toll) from the users of the
facility to cover its cost over a long period of time, say 20
years. During the period, they are responsible to
maintain them too. Post completion of the tenure, they
are required to transfer ownership to concerned
government department.
(b) Contracts
In general, contracts are entered for the work to be performed
to ensure proper determination of scope of work, nature of
work, fixation of responsibility, payment terms, escalation
clauses, and so on. Some important aspects are as follows:
(i) Different processes are handled for different clients and
billed as agreed specifically between parties. Contracts
are custom made and could be fixed price contracts or
cost plus contract.
10

30. About The Indian Construction Industry
(ii) Agreements are entered into between the client and the
entity as regards the scope of work to be performed, the
legalities involved, scheduled period of completion,
billing details, escalation clauses, penalties and other
charges.
(iii) Billing is done in accordance with the work completed
and as agreed between parties.
(c) Employee Related
The employee related area in a construction industry is usually
need based and the industry is also labour intense. Some
special features are as follows:
(i) Apart from being capital intensive, the industry is also
predominantly labour dependant. Cheap and
experienced labour is an important prerequisite for the
success of the industry.
(ii) Most workers who are involved in the construction
activity are not highly educated. Only the supervisors are
educated.
(iii) The requirement of labour for the construction site is not
constant and it keeps varying with level of specialisation,
deadlines, nature of work, percentage of completion
amongst other factors. In general, workers involved in
the construction activity are paid on the basis of per day
wages.
(d) Others
Data Security, reliance on external conditions are amongst the
other peculiar features of the construction industry:
(i) The level of construction activity is related to the
government policy towards construction industry,
importance given to infrastructure development,
economic activity and schemes providing benefit for both
individuals and entities.
11

31. Technical Guide on Internal Audit of Construction Industry
(ii) The importance of data security need not be over-
emphasized. Critical data such as plans, profitability
ratios, designs and unique strategies should be
sufficiently safeguarded.
It is therefore, extremely important for an internal auditor to
understand these special features for conducting the internal
audit of the entity.
Major Operational Challenges Faced by
Entities
2.15 The construction industry is a delivery based Industry.
The construction industry in India is not yet completely
organised. These service providers have unique challenges
faced by the industry and also the risks are unique in nature.
This section is intended to highlight some of the significant
challenges that the construction industry faces so as to enable
the internal auditor to plan and perform the internal audit
accordingly.
2.16 The internal auditor is required to perform such audit
procedures specific to the entity as deemed necessary to
ensure systematic evaluation of risk management, control and
governance processes. Some of these challenges are given
below:
(i) Challenges of meeting time schedules, cost schedules
and compliance with the scope of work has been key for
success and, thus,meeting them has been the greatest
challenge for any entity operating in the construction
industry.
The internal auditor can assess the business risk, and
also brand and reputation risk on not complying with
deadlines. The effectiveness of controls can also be
assessed by the internal auditor.
(ii) The biggest challenge faced by an entity operating in the
construction industry is availability of adequate
manpower with appropriate skill sets at a reasonable
12

32. About The Indian Construction Industry
cost. This is the most important factor to control for
sustained growth of the entity. The internal auditor might
analyse and assess the prospects of the business in
future, apart from business risk.
(iii) The client’s capacity to make payments as per the
contract agreed also poses a big challenge considering
that the funds get blocked up, increasing the working
capital requirements significantly. The management also
faces the challenge of managing the working capital
requirements for the projects considering that some
clients make the schedule payment only post completion
of certain percentage of work. It is the management
effectiveness in keeping the cost of borrowed funds as
low as possible thereby ensuring that the profitability is
not significantly affected. The internal auditor can assess
the effectiveness of management in assessing clients
and managing cost of borrowed funds before selecting
them.
(iv) The challenge of fair recognition of revenue and profit
ever exists in the construction industry owing to the
difficulty in estimating the exact percentage of work
completed. The internal auditor can assess financial risk
of recognition of revenue and incorrect billing apart from
the effectiveness of the accounting process.
(v) Material handling has been a major problem for the
industry. Improper handling and storage of materials
leads to significant storage costs, wastage, and non–
availability of critical materials at the appropriate time.
The internal auditor needs to assess the efficiency of
management with regards to handling of inventory.
(vi) The construction industry is more prone to accidents
than any other industry. Safety precautions of workers
are extremely important and have been extremely
difficult to achieve by most entities. The internal auditor
has to assess such types of risks and precautions taken
by management to avoid them.
13

33. Technical Guide on Internal Audit of Construction Industry
(vii) The costs of materials at the time of contract are
significantly different compared to cost at the time of
performance of the work. In cases where the cost of
materials required has escalated, the management might
be finding it difficult to maintain profitability. The internal
auditor should assess the process of making budgets
and whether management is effective in determining the
future costs.
(viii) Legal Compliance has been relatively high considering
many other Industries. Every contract entered by the
entity has unique terms and conditions to be complied
with, failing which may lead to penalties and other
arbitration. The internal auditor can assess operational
risks of business.
(ix) Some projects require minimum criteria such as
Minimum Turnover requirement/Minimum Net Worth
requirement for bidding of clients. If the entity does not
meet these criteria, they are not qualified to bid, thereby
hindering their growth. The internal auditor can assess
such types of business risk also.
(x) Certain regulatory requirements mandate the submission
of specific financial statements. For e.g., an entity might
be operating in SEZ and non-SEZ unit. In such a case, it
is required to maintain separate books of accounts in
order to ensure proper determination of profit for
claiming of deduction/exemption with respect to units
from these respective units from the perspective of
Income Tax and Service Tax. The internal auditor can
assess sufficiency of legal compliance.
(xi) As an entity grows, the balance between machinery and
manpower should be maintained at the optimum level. In
general, greater level of mechanizing is required as the
entity grows to sustain volumes and manage professionally
and cost effectively. The Internal auditor can verify whether
sufficient controls are in place for ensuring sustained
development and growth.
14

34. CHAPTER 3
LEGAL FRAMEWORK
3.1 This Chapter details the various acts applicable, and
also organisations that supervise and regulate the construction
industry in India.
Ministry of Commerce and Industry, GOI
3.2 The mandate of the Department of Commerce is
regulation, development and promotion of India’s international
trade and commerce through formulation of appropriate
international trade and commercial policy and implementation of
various provisions thereof. This Ministry formulates the
regulatory provisions pertaining to the Special Economic Zones
and EXIM Policy in India.
3.3 The Department of Industrial Policy and Promotion, set-
up under the Ministry of Commerce and Industry is responsible
for Intellectual Property Rights relating to Patents, Designs,
Trade Marks and Geographical Indication of Goods and
oversees the initiative relating to their promotion and protection.
This Department also formulates, promotes, approves and
facilitates the Foreign Direct Investment (FDI) Policy.
3.4 Director General of Foreign Trade (DGFT) is a
government organization in India responsible for the formulation
of Export – Import guidelines and principles for Indian importers
and Indian exporters of the country. The basic role of the
Department is to facilitate the creation of an enabling
environment and infrastructure for accelerated growth of
international trade.
Ministry of Finance, GOI
3.5 The Ministry of Finance, India looks after the various
financial affairs of the state of India. The Ministry of Finance,

35. Technical Guide on Internal Audit of Construction Industry
India is responsible for monitoring the various aspects of the
Indian economy and it operates through various departments.
• Department of Economic Affairs
• Department of Disinvestment
• Department of Expenditure
• Department of Financial Services
• Department of Revenue
Various statutes such as Customs Act, 1962, Foreign Exchange
Management Act, 1999, Income Tax, 1961 to name the
significant ones, as applicable to the construction industry are
formulated and governed by this Ministry.
A Gist of Important Regulations that may be
Applicable to an Entity
The Transfer of Property Act, 1882
3.6 The Transfer of Property Act, 1882 has been enacted for
• Enacting provision for transfer of property between living
persons;
• Supplementary to Law of Contract; and
• To support and compliment succession Laws.
The scope of the act deals with transfer of immovable property.
It does not include transfer operational by law.
Special Economic Zone Act, 2006
3.7 A Special Economic Zone (SEZ) is a trade capacity
development tool, with the goal to promote rapid economic
growth by using tax and business incentives to attract foreign
investment and technology. The Central Government has
framed the policy framework for SEZs through the SEZ Act. The
State Governments play a significant lead role in the
development of SEZs in their respective States by stipulating
the conditions to be adhered to by an SEZ and granting the
16

36. Legal Framework
necessary approvals. These supporting procedures are laid
down in SEZ Rules as framed by the State Governments.
The Minimum Wages Act, 1948
3.8 The Minimum Wages Act, 1948, extends to the whole of
India and applies to scheduled employments in respect of which
minimum rates of wages have been fixed under this act. The
objective of this Act is to fix minimum rates of wages in certain
employments. The appropriate government (State Government
or Central Government as the case may be) shall fix the
minimum rates of wages payable to employees employed in a
scheduled employment.
The Factories Act, 1948
3.9 The Factories Act, 1948 is a social legislation which deals
with following aspects:
(i) Health;
(ii) Safety;
(iii) Welfare facilities;
(iv) Working hours;
(v) Employment of young persons;
(vi) Annual leave with wages;
(vii) Contract employees and so on.
It requires compliance for enterprises which employ more than 10
employees.
The Industrial Disputes Act, 1947
3.10 The Industrial Disputes Act, 1947, extends to whole of
India and applies to every industrial establishment carrying on
any business, trade, manufacture or distribution of goods and
services irrespective of the number of workmen employed
therein. Every person employed in an establishment for hire or
reward including contract labour, apprentices and part time
17

37. Technical Guide on Internal Audit of Construction Industry
employees to do any manual, clerical, skilled, unskilled,
technical, operational or supervisory work, is covered by the
Act. The objective of the Act is to secure industrial peace and
harmony by providing machinery and procedure for the
investigation and settlement of industrial disputes by
negotiations.
3.11 The Industrial Disputes Act also lays down following:
(i) The provision for payment of compensation to the
Workman on account of closure or lay off or
retrenchment.
(ii) The procedure for prior permission of appropriate
Government for laying off or retrenching the workers or
closing down industrial establishments.
(iii) Unfair labour practices on part of an employer or a trade
union or workers.
Other Applicable Indian Acts to the Industry
Governance Laws
3.12 The various acts enacted by the Government to govern
any industry and so also applicable to the construction industry are
as follows:
(i) The Companies Act, 1956
(ii) Partnership Act, 1932
(iii) The Benami Transactions (Prohibition) Act, 1988
(iv) The General Clauses Act, 1897
(v) The Land Acquisition Act, 1894
(vi) The Indian Easements Act, 1882
(vii) The Indian Stamp Act, 1899
(viii) The Negotiable Instruments Act, 1888
(ix) Land Reform Regulation of the respective states.
(x) The Indian Penal Code.
18

38. Legal Framework
Economic Laws
3.13 The various economic laws to which the construction
industry may be subject to include:
(i) The Income Tax Act, 1961
(ii) Central Excise Act, 1944
(iii) The Customs Act, 1965
(iv) Chapter V of the Finance Act, 1994 relating to Service Tax
(v) Value Added Tax and Sales Tax Act
Contract Laws
3.14 The various contract laws to which the construction
industry may be subject to include:
(i) The Indian Contract Act, 1872
(ii) Securities Contracts Regulation Act, 1956
Labour Laws
3.15 There are a number of labour laws governing the
construction industry. A few of the important ones are as follows:
(i) Employees Provident Fund Scheme, 1952
(ii) Employee State Insurance Act, 1948
(iii) Payment of Gratuity Act, 1972
(iv) Payment of Bonus Act, 1965
(v) Professional Tax enacted by the respective states
(vi) Shops and Establishment Act enacted by the respective
states
(vii) The Trade Union Act, 1926
(viii) Factory Rules of respective states.
19

39. Technical Guide on Internal Audit of Construction Industry
Other Laws as applicable to the Industry
(i) Securities Exchange Board of India Act, 1992
(ii) Foreign Exchange Management Act, 1999
(iii) Arbitration and Conciliation Act, 1996
The internal auditor is also expected to be aware of various
circulars Issued by the RBI towards foreign currency transactions.
Other Applicable International Acts to the
Construction Industry
3.16 Apart from the above, regulations of the respective country
in which construction and related services are provided by the
entity are also applicable to the entity. In such cases the
agreement between the parties specifies the jurisdiction in case of
arbitration, if any. In cases where the entity is listed in a stock
exchange other than India, there might be regulatory requirements
from the respective governing body of the company.
The Sarbanes-Oxley Act, 2002
3.17 This Act is applicable for Companies, wherein the
Company or its holding company is incorporated and listed in the
United States. The legislation has been enacted to set new or
enhanced standards for all U.S. public company boards,
management and public accounting firms. It does not apply to
privately held companies. The act contains 11 titles, or sections,
ranging from additional corporate board responsibilities to criminal
penalties, and requires the Securities and Exchange Commission
(SEC) to implement rulings on requirements to comply with the
new law.
20

40. CHAPTER 4
A REFERENCE TO STATUTORY
LAWS APPLICABLE TO INDIAN
CONSTRUCTION INDUSTRY
4.1 This section is intended to provide broad guidelines of
various laws, compliances required for entities opting for special
status such as STPI, SEZ or EOU status. The internal auditor
should refer to bare act of these laws and regulations and study
the different cases and judgements by competent authorities.
4.2 Considering that these regulations undergo frequent
amendment/changes, a detailed checklist has not been
prepared. The internal auditor must update himself with the
amendments, pronouncements and any new regulations
enacted from time to time to ensure effective performance of
internal audit.
Income Tax
4.3 Companies might have deduction either under Section
10A or Section 10B of the Income Tax Act, 1961. These
provisions offer tax sops to SEZs (Special Economic Zones). As
such, most units registered as STP or SEZ need not pay any
corporate tax except MAT (minimum alternative tax). However,
it is important that the business profits are determined using
‘arm’s length pricing’. This aspect is generally in the purview of
the statutory auditor but it is advisable that the internal auditor
understands the various requirements and compliances under
these statutes/ regulations and conducts internal audit of the
same.
4.4 The Income Tax Act, 1961 provides presumptive
taxation for small construction entities. The Income Tax Act,
1961 also provides for deduction as a percentage of profits for
entities operating in the Infrastructure Development.

41. Technical Guide on Internal Audit of Construction Industry
Service Tax
4.5 The definition of construction service given under clause
(30A) of Section 65 is as follows:
“Construction service" means,
• Construction of new building or civil structure or a part
thereof; or
• Repair, alteration or restoration of, or similar services in
relation to, building or civil structure,
which is -
• Used, or to be used, primarily for; or
• Occupied, or to be occupied, primarily with; or
• Engaged, or to be engaged, primarily in,
commerce or industry, or work intended for commerce or
industry, but does not include road, airport, railway, transport
terminal, bridge, tunnel, long distance pipeline and dam.
4.6 The definition of construction services is quite wide. It
not only covers construction of new building/civil structure or
part thereof but also includes repair, alteration or restoration of
building. However, service tax will be applicable when such
construction services are rendered in respect of the
building/civil structure for the commerce and industry. In other
words, construction services in respect of commercial building
are taxable whereas construction services for residential
premises/ building or non-commercial buildings are not covered
under the ambit of service tax.
However, construction services for following are excluded from
ambit of service tax, namely, -
• road;
• airport;
• railway;
• transport terminal;
22

42. A Reference to Statutory Laws Applicable to Indian Construction Industry
• bridge;
• tunnel;
• long distance pipeline and
• dam.
Availing Input Credit
4.7 The following is an illustrative list of major capital goods,
inputs and input services on which CENVAT can be availed:
• CED/ Additional Duty of Customs (CVD) on machinery or
equipments
• CED on office equipment and computers
• CED on consumable tools and packing materials
• CED on chemicals used or consumed
• Construction of office or factory
• Transportation of goods by road service
• Internet charges
• Market research and market survey
• Recruitment and supply of manpower service
• Rental and insurance for premises and goods
• Telecommunications
• Consulting engineering
• Designing
• Other services used for providing the business auxiliary
service
• Other services used in business.
4.8 The input credit can be availed only on payments made
and it cannot be availed on accrual basis. However, in case
there is excess credit during the month, the same can be
23

43. Technical Guide on Internal Audit of Construction Industry
carried forward to the following month and can be set-off,
whenever service tax liability arises. Abatement may be
prescribed from time to time on the total value of contract on
satisfaction of certain conditions such as, no credit of duty paid
on inputs or capital goods has been taken under the provisions
of the CENVAT Credit Rules, 2004.
Works Contract
4.9 Works Contract comes under the preview of Sales
Tax/Value Added Tax as applicable to the respective States.
The definition of “Sale” under the respective Sales Tax/Value
Added Tax of the respective states includes Works Contract.
Works Contract includes any agreement for carrying out for
cash, deferred payment or other valuable consideration, the
building, construction, manufacture, processing, fabrication,
erection, installation, fitting out, improvement, modification,
repair or commissioning of any movable or immovable property.
4.10 The entity needs to verify applicability of provision of
Works Contract in accordance with the respective governing
Sales tax/Value Added Tax. Works Contract can be broadly
classified as:
• Works Contract including transfer of property in Goods–
Covered under Sales Tax/Value Added Tax.
• Works Contract Not including transfer of property in
Goods–Covered under Service Tax and other applicable
acts as the case may be.
The rate of tax for Work Contract Tax varies from State to
State.
Input Credit Set-off Scheme
4.11 “Input” means any goods, including capital goods
purchased by a dealer in the course of his business for re-sale
or for use in the manufacture or processing or packing or
storing of other goods or any other use in business.
24

44. A Reference to Statutory Laws Applicable to Indian Construction Industry
As there is no need to pay VAT on the services provided by the
construction entity, they are not eligible to take input credit on
purchases made by them.
Works Contract Tax Deducted at Source
4.12 The client shall deduct out of the amounts payable by
them to a dealer in respect of any works contract executed for
them in the State, an amount equivalent to the tax payable by
such dealer under the Act.
Deduction on the Rate of Works Contract Tax
4.13 The Act provides for deduction on the value of contract,
computed with respect to the provisions of the respective Sales
Tax/Value Added Tax. The respective regulations provide for
the basis for deduction based on the percentage of labour
involved in the overall scope.
Special Economic Zone
4.14 For an entity providing construction service in a Special
Economic Zone (SEZ), these regulations are applicable. Legal
Framework for setting up SEZ is defined under SEZ Act and
State SEZ Policy:
SEZ Rules, 2006
4.15 The main provisions of the Indian SEZ Rules, 2006 can
be summarized as promotion of industrialization and economic
25

45. Technical Guide on Internal Audit of Construction Industry
growth through sustainable development of Indian industries.
The main essence of the Indian SEZ Rules, 2006, states that
these Special Economic Zones of India shall be offered tax
rebates, fiscal incentives and lands at subsidized rates.
4.16 Some of the key provisions of the Indian SEZ Rules,
2006 applicable to an entity operating in the construction
industry are given below:
• It should be exempted from excise/VAT on domestic
sourcing of capital goods for project development.
• Freedom to develop township in the SEZ with residential
areas, markets, play grounds, clubs and recreation
centers without any restrictions on foreign ownership.
• It should be exempted from taxation on business
income.
• It should be exempted from import duty, VAT and other
taxes.
26

46. CHAPTER 5
INTERNAL AUDIT
5.1 Most entities operating in construction industry are
unorganised as related to its operations and a significant
percentage of players operating in this sector are small in
nature. Effective internal audit provides a tool to ease out all
complexities, ensures that systems and processes are
adequate to support the growth and are adapted to the changes
in various applicable regulations, thereby ensuring sustained
growth and development.
5.2 Preface to the Standards on Internal Audit, issued by the
Institute of Chartered Accountants of India defines the term
Internal Audit as follows:
“Internal Audit is an independent management function, which
involves a continuous and critical appraisal of the functioning of
an entity with a view to suggest improvements thereto and add
value to and strengthen the overall governance mechanism of
the entity, including the entity’s strategic risk management and
internal control system.”
The abovementioned definition highlights the following facets of
an internal audit:
• Internal auditor should be independent of the activities
they audit. The internal audit function is, generally,
considered independent when it can carry out its work
freely and objectively. Independence permits internal
auditors to render impartial and unbiased judgment
essential to the proper conduct of audits.
• Internal audit is a management function, thus, it has the
high-level objective of serving management's needs

47. Technical Guide on Internal Audit of Construction Industry
through constructive recommendations in areas such as,
internal control, risk, utilization of resources, compliance
with laws, management information system, etc.
• Internal audit's role should be a dynamic one, continually
changing to meet the needs of the organization. There is
often a need to change audit plans as circumstances
warrant. These changes may include coverage of new
areas, assistance to management in solving problems,
and the development of new internal audit techniques.
• An effective internal audit function plays a key role in
assisting the board to discharge its governance
responsibilities. Thus, it contributes in accomplishment
of objectives and goals of the organization through
ethical and effective governance.
• Risk management enables management to effectively
deal with risk, associated uncertainty and enhancing the
capacity to build value to the entity or enterprise and its
stakeholders. Internal auditor plays an important role in
providing assurance to management on the
effectiveness of risk management.
• Internal audit function constitutes a separate component
of internal control with the objective of determining
whether other internal controls are well designed and
properly operated. Thus, the examination and appraisal
of controls are normally components, either directly or
indirectly, of every type of internal auditing assignment.
Factors Contributing to the Evolution of
Internal Audit
5.3 General Guidelines on Internal Audit, issued by the
Institute of Chartered Accountants of India, describes the
28

48. Internal Audit
factors contributing the evolution of Internal Audit in India,
which are as follows:
(i) Increased Size and Complexity of Businesses
Increased size and business spread dilutes direct management
oversight on various functions, necessitating the need for a full
time, independent and dedicated team to review and appraise
operations.
(ii) Enhanced Compliance Requirements
Increase in the geographical spread of the businesses has also
led to crossing of political frontiers by businesses in a bid to tap
global capital. This has thrown up compliance with the laws of
the home country as well as the laws of that land as a critical
factor for existence of businesses abroad.
(iii) Focus on Risk Management and Internal
Controls to Manage Them
Internal auditors can carry out their job in a more focused manner
by directing their efforts in the areas where there is a greater risk,
thereby enhancing the overall efficiency of the process and adding
greater value with the same set of resources.
(iv) Stringent Norms Mandated by Regulators to
Protect Investors
The regulators are coming up in a big way to protect the
interests of the investors. The focus of the latest regulations
being ethical conduct of business, and enhanced corporate
governance and financial reporting requirements, etc.
(v) Unconventional Business Models
Businesses today use unconventional models and practices, for
example, outsourcing of non-core areas, such as accounting.
(vi) Intensive Use of Information Technology
Information technology (IT) is invariably embedded in all spheres
of activities of a modern business enterprise today, from data
29

49. Technical Guide on Internal Audit of Construction Industry
processing to resource planning to online sales and e-commerce.
Use of IT has, however, increased the threat of data thefts or
losses on account of systems failure or hacking/espionage, as well
as the need to comply with the cyber laws, etc.
(vii) An Increasingly Competitive Environment
Whereas deregulation and globalization have melted the
political as well as other barriers to entry in the markets for
goods and services, free flow of capital, technology and know-
how among the countries as well as strong infrastructure has
helped in bringing down the costs of production and better
access to the existing and potential consumers. This in turn,
has lured more and more players in the existing markets,
thereby, stiffening the competition.
Methodology for Internal Audit
Standards on Internal Audit
5.4 The Institute of Chartered Accountants of India has till
date issued seventeen Standards on Internal Audit (SIAs),
which aim to codify the best practices in the area of internal
audit and also serve to provide a benchmark of the performance
of the internal audit services. While formulating SIAs, the Board
takes into consideration the applicable laws, customs, usages,
business environment and generally accepted internal auditing
practices in India. The list of Standards on Internal Audit (SIAs)
is given below:
SIA 1 Planning an Internal Audit
SIA 2 Basic Principles Governing Internal Audit
SIA 3 Documentation
SIA 4 Reporting
SIA 5 Sampling
SIA 6 Analytical Procedures
SIA 7 Quality Assurance in Internal Audit
SIA 8 Terms of Internal Audit Engagement
30

50. Internal Audit
SIA 9 Communication with Management
SIA 10 Internal Audit Evidence
SIA 11 Consideration of Fraud in an Internal Audit
SIA 12 Internal Control Evaluation
SIA 13 Enterprise Risk Management
SIA 14 Internal Audit in an Information Technology
Environment
SIA 15 Knowledge of the Entity and its Environment
SIA 16 Using the Work of an Expert
SIA 17 Consideration of Laws and Regulations in an Internal
Audit
Some important aspects on internal audit has been discussed in
the following paragraphs:
Terms of Internal Audit Engagement
5.5 The client is expected to formally communicate the
appointment to the internal auditor. Upon receiving the
communication, the internal auditor should send an
engagement letter, preferably before the commencement of
engagement so as to avoid any misunderstandings. The internal
auditor and the client/auditee should record the terms of
engagement in the letter or other suitable form of contract and it
shall also confirm objective and scope of internal audit with the
client.
5.6 The engagement letter should generally include
reference to the following aspects:
• Objective of the internal audit
• Management’s responsibilities
• Scope of internal audit (including reference to the
applicable legislation, regulation and various
pronouncement of ICAI)
31

51. Technical Guide on Internal Audit of Construction Industry
• Access to records, documents and information required
in connection with the internal audit
• Expectation to receive management’s written
confirmation in respect to representation made in
connection with the audit
• Basis on which fees shall be computed and the billing
arrangements thereof.
Any changes in the terms of the appointment should be
communicated in written form. Moreover, the internal audit may
be on a continuous basis, monthly, quarterly or even annual. It
is important for the internal auditor to ensure that the periodicity
of the internal audit is sufficient in the light of overall business
condition.
Knowledge of the Business
5.7 Prior to commencement of internal audit assignment, the
internal auditor should have or obtain the knowledge of the
business. The internal auditor should acquire sufficient
knowledge to enable him to identify and understand the events,
transactions and practices that can have significant effect on
the internal audit process. Such knowledge shall be helpful to
the internal auditor in assessing the inherent risk and control
risk and in determining the nature, timing and extent of the
internal audit procedures. Knowledge of the business assists
the internal auditor in:
• Assessing the risk and identifying the problems;
• Planning and performing the internal audit effectively
and efficiently;
• Evaluating audit evidence; and
• Providing better service to the client.
The internal auditor should prepare the flow of events,
transactions, processes and practices within the organisation.
This will help him in gaining better understanding of the process
32

52. Internal Audit
and the existence of the internal controls. Illustrative flowchart
of the business process is given as Appendix.
Audit Planning, Materiality and Sampling
5.8 After acquiring the knowledge of business and various
laws and regulation applicable to the construction industry the
internal auditor should plan out the internal audit activity.
Planning helps in achieving the objectives of internal audit
function. Adequate planning ensures that:
• Appropriate attention is devoted to significant areas of
audit
• Potential problems are identified
• Skills and time of the staff are appropriately utilised
• Work is carried out in accordance with the applicable
pronouncements of ICAI
• Work is carried out in conformity with the applicable laws
and regulation.
5.9 In preparing an internal audit program, an internal
auditor should obtain an understanding of the accounting and
internal control system prevalent within the entity, exercise
preliminary judgement regarding the critical areas to be
considered during the internal audit. It also helps the internal
auditor in determining the audit materiality, nature and extent of
audit procedures to be adopted. While designing an audit
sample the internal auditor should consider the specific audit
objectives, materiality, population from which the internal
auditor wishes to select the sample, area of audit significance
and the sample size.
Internal Control
5.10 Internal controls are a system consisting of specific
policies and procedures designed to provide management with
reasonable assurance that the goals and objectives it believes
important to the entity will be met.
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53. Technical Guide on Internal Audit of Construction Industry
"Internal Control System" means all the policies and procedures
(internal controls) adopted by the management of an entity to
assist in achieving management's objective of ensuring, as far
as practicable, the orderly and efficient conduct of its business,
including adherence to management policies, the safeguarding
of assets, the prevention and detection of fraud and error, the
accuracy and completeness of the accounting records, and the
timely preparation of reliable financial information. The internal
audit function constitutes a separate component of internal
control with the objective of determining whether other internal
controls are well designed and properly operated.
5.11 Internal control system consists of following inter-related
components:
• Control (Or Operating) Environment
• Risk Assessment
• Control Objectivity Setting
• Event Identification
• Control Activities
• Information and Communication
• Monitoring
• Risk Response.
5.12 The system of internal control must be under continuous
supervision by management to determine that it is functioning
as prescribed and is modified, as appropriate, for changes in
environment. The internal control system extends beyond those
matters which relate directly to the functions of the accounting
system.
5.13 The internal auditor should obtain an understanding of
the significant processes and internal control systems sufficient
to plan the internal audit engagement and develop an effective
internal audit approach. The internal auditor should use
professional judgment to assess and evaluate the maturity of
the entity’s internal control. The auditor should obtain an
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54. Internal Audit
understanding of the control environment sufficient to assess
management's attitudes, awareness and actions regarding
internal controls and their importance in the entity.
5.14 The internal auditor should examine the continued
effectiveness of the internal control system through evaluation
and make recommendations, if any, for improving that
effectiveness.
The importance of internal controls in a construction entity need
not be over-emphasized. Internal audit plays a major role in
determining the effectiveness of internal controls and highlights
areas for improvement. The Internal auditor may also refer to
Standard on Internal Audit (SIA) 12, “Internal Control
Evaluation” for a detailed discussion on internal control.
Internal Audit in an Information Technology
Environment
5.15 Computer Information System (CIS) environment exists
when one or more computer(s) of any type or size is
(are)involved in the processing of financial information,
including quantitative data and the significance in relation to the
audit, whether those computers are operated by the entity or
third party.
5.16 The overall objective and scope of internal audit does
not change in a CIS environment. However, the use of
computer changes the processing, storage, retrieval and
communication of financial information and may affect the
accounting and internal control systems employed by the entity.
Moreover, the risks involved in an internal audit may too
undergo a change. The internal auditor should have sufficient
knowledge of the CIS environment to plan, direct, supervise,
control and review the work performed.
5.17 The data in an Entity operating in CIS environment is,
generally, voluminous. The CIS automatically generates
material transaction or entries and exchanges transaction
automatically with other organisation as in electronic data
interface (EDI) systems. Source documents, computer files and
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55. Technical Guide on Internal Audit of Construction Industry
other evidential matter exist only for short period and in
machine readable form. The use of the computer Assisted Audit
Technique (CAAT) shall increase the efficiency in the
performance and enable the internal auditor to economically
apply certain procedures to the entire population or accounts
transaction.
5.18 The internal auditor should understand the CIS
Environment in designing audit procedures to reduce the audit
risk to an acceptable low level. The internal auditor should also
document the audit plan, the nature, the timing and the extent
of audit procedures performed and the conclusions drawn from
the evidence obtained which may be in the electronic form. The
internal auditor should ensure that such electronic evidence is
adequately and safely stored and is retrievable in its entirety, as
and when required.
5.19 The internal auditor may refer to Standard on Internal
Audit (SIA) 14, “Internal Audit in an Information Technology
Environment” for guidance on procedures to be followed when
an audit is conducted in a computer information systems (CIS)
environment.
Overview of Compliance
What is Compliance?
5.20 Compliance means ensuring conformity and adherence
to regulatory acts, rules, procedures, laws, regulation, directives
and circulars. Standard on Internal Audit (SIA) 17 issued by the
ICAI relating to “Consideration of Laws and Regulations in an
Internal Audit“ states that when planning and performing audit
procedures and in evaluating and reporting the results thereof,
the internal auditor should recognize that non compliance by the
entity with laws and regulation may materially affect the
financial statements. However, an audit cannot be expected to
detect non compliance with all laws and regulations. Detection
of non compliance, regardless of materiality, requires
consideration of the implications for the integrity of
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56. Internal Audit
management or employees and the possible affect on the other
aspect of the audit.
5.21 Non-compliance with laws and regulations could result in
financial consequences for the entity such as, fines, litigation,
etc. Internal auditor cannot be expected to detect non-
compliance with all laws and regulations; however this
argument shall not apply to engagements where the internal
auditor is specifically engaged to test and report separately on
compliance with specific law and regulations.
The management is responsible to ensure that the entity’s
operations are conducted in accordance with laws and
regulations. The responsibility for prevention and detection of
non-compliance shall be that of the management; however the
internal auditor should plan and perform the internal audit
recognising that the internal audit may reveal conditions or
events that would lead to questioning whether an entity is
complying with laws and regulations.
5.22 The term “Non-compliance “refers to acts of omission or
commission by the entity being audited, either intentional or
unintentional, which are contrary to the prevailing laws and
regulations. Such acts include transactions entered into by, or
in name of the entity or on its behalf by the management or
employees. However, non compliance does not include
personal misconduct (unrelated to the business activity of the
entity) by the entity’s management or employees.
Understanding of Laws and Regulations
5.23 Laws and regulation vary considerably in their relation to
the financial statements. Some laws or regulations determine
the form or content of an entity’s financial statement or the
amounts to be recorded or disclosures to be made in financial
statements. Other laws or regulation are to be complied with by
management or prescribed by the provisions under which the
entity is allowed to conduct its business. Non-compliance with
laws and regulation could result in financial consequences for
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57. Technical Guide on Internal Audit of Construction Industry
the entity such as, fines, litigation, etc. It also has a potential
effect on going concern as an entity.
5.24 The internal auditor should plan and perform the audit
recognizing that the audit may reveal conditions or events that
would lead to questioning whether an entity is complying with
laws and regulations. In order to plan the internal audit, the
internal auditor should obtain understanding of the legal and
regulatory framework applicable to the entity and how the entity
is complying with that framework.
5.25 To obtain this understanding, the internal auditor would
particularly recognize that non-compliance of some laws and
regulations may have a fundamental effect on the operations of
the entity and may even cause the entity to cease operation, or
call into question the entity’s continuance as going concern. To
obtain the understanding of laws and regulations, the internal
auditor would ordinarily:
• Use the existing knowledge of the entity’s industry and
business.
• Inquire with management as to the laws or regulations
that may be expected to have a fundamental effect on
the operations of the entity.
• Inquire with management concerning the entity’s policies
and procedures regarding compliance with laws and
regulations.
• Discuss with management the policies or procedures
adopted for identifying, evaluating and accounting for
litigation claims and assessments.
After obtaining the understanding, the internal auditor should
perform procedures to identify instances of non-compliance with
those laws and regulations where non-compliance should be
considered while preparing financial statements, specifically:
• Inquiring with management as to whether the entity is in
compliance with such laws and regulations.
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58. Internal Audit
• Inspecting correspondence with the relevant licensing or
regulatory authorities.
Significance of Compliance
5.26 The significance of compliance is:
(a) The benefits to the Industry are:
• Helps in compliance with legal terms and
covenants and thereby reduces penalties and
charges
• Increased Internal Control
• Reduction of internal frauds and losses
• More time available for other core activities
• Increases efficiency in operations
• Customer satisfaction.
(b) The benefits to the stakeholder are:
• Ensures risk containment and safer market place
• Better investor confidence
• Uniform practices
• Better image, hence, better value for the investor.
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59. CHAPTER 6
MAJOR AREAS OF INTERNAL
AUDIT SIGNIFICANCE
6.1 Internal audit procedures that apply to any industry also
apply to an entity operating in the construction industry. In this
technical guide, specific internal auditing procedures pertaining
to construction industry have been specified. These audit
procedures are illustrative in nature which can be performed, in
addition, to the regular internal audit procedures performed by
an internal auditor.
6.2 The internal auditor needs to assess the work performed
at the location and the centralised office. Based on the
operations performed by the entity, the internal auditor needs to
plan his audit procedures.
Selection of a Project
6.3 Incredibly, many construction projects are initiated
without even the most basic cost-benefit analysis or feasibility
study. Documented evidence justifying the project should be
submitted, even though proceeding with a project that will not
result in an increase in revenue or financial position can be
acceptable in some instances. Sometimes projects are
undertaken to maintain market share in a competitive industry
or to provide a service or product line that will complement
another.
6.4 Internal auditors should determine whether the project
has been evaluated before being accepted by the entity,
appropriate approvals have been obtained and ensure that the
risk on accepting the project has been properly evaluated by the
management.

60. Major Areas of Internal Audit Significance
A few Analytical Procedures that can be performed by the
internal auditor include:
• Evaluation of project wise profitability ratio of projects
completed during the period.
• Evaluation of budgeted profitability of all new projects
approved.
These ratios should be compared to the previous periods and
explanations for any significant fluctuations needs to be
obtained. The following is a model checklist related to bidding
and selection of a project:
S. No. Particulars Yes No N/A
1. Bidding Process and Selection of a Project
1.1 Is there a written policy with the
entity as regards its bidding
process?
1.2 Is the policy complete in all regards
including obtaining bid bonds and
performance bonds?
1.3 Is the written policy updated at
frequent intervals by the entity
based on its previous experience?
1.4 Has the entity performed site
investigation before entering the
bidding process?
1.5 Has the entity obtained sufficient
approvals at the appropriate level of
authority before accepting the
process?
1.6 Has the entity prepared budgets of
the estimated cost of the project in
detail with respect to all costs and
considered the escalation of costs
on a reasonable basis in the case of
fixed price contracts?
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61. Technical Guide on Internal Audit of Construction Industry
S. No. Particulars Yes No N/A
1.7 Are the bids approved by the
appropriate level of authority?
1.8 Are there written policies/processes
for placing bids by the entity?
1.9 Does the entity enter into contracts
for all parties? Are the terms of the
contract complete in all aspects
such as term of the contract,
specifications if any, escalation
clauses as agreed, responsibilities,
penalties, etc?
1.10 Does the entity ensure compliance
with the terms of the contract?
1.11 Is the agreement entered into with
clients signed by both the parties at
the appropriate level before
commencement of work?
1.12 Does the entity provides services to
Related Parties?
1.13 Are there proper systems in place to
ensure that there is unbiased pricing
in the case of Related Parties so as
to ensure that the pricing is done at
arm’s length price?
1.14 Does the entity have the process of
evaluating the credit worthiness of
the customer?
1.15 Does the entity requests for a bid
bond? If a bid bond is not obtained,
does the written policy specifies
alternative procedures?
1.16 On a sample basis, has the internal
auditor verified the compliance of
this policy?
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62. Major Areas of Internal Audit Significance
S. No. Particulars Yes No N/A
1.17 Does the internal auditor need to
verify the risk involved if the entity
does not obtain performance bonds?
1.18 Is the minimum limit to obtain these
bonds fixed in relation to the risk
taking ability by the entity and is it
frequently reviewed?
1.19 Are there any exceptions in
complying with the procedures
related to performance bonds? Has
appropriate approvals for such
cases obtained and what are the
reasons for not obtaining
performance bonds?
Approvals for Registration
6.5 The entity needs to liaison from various government
authorities for approvals right from the start of the construction
project. The building constructed without sanctions or deviated
more than 5 per cent from approved plan attracts penalty, and
authorities have right to demolish the building without any prior
notice. The following are the approvals or sanctions required for
builder for any construction activity.
(i) Building Plan: A builder should submit building plan
before starting the construction activities. Building plans
are a graphical representation of what a building will look
like after construction. Building plan ensures that
building complies with building laws. Once the building
plan is approved, builder should commence construction
work within two years and there should be no deviation
from the sanctioned plan.
(ii) Layout Approval: The builder has to get approval of
layout plan from concerned authorities before starting
construction of residential or commercial building.
Constructing building in unapproved layout will not be
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