Once beginning the actual audit, the auditor should review the terms of a sample of contracts currently in process in order to acquire a general understanding of a contractor’s operations. Next, n order to determine the amount of testing needed, the auditor must first obtain an understanding of internal control by performing procedures to understand the design of controls relevant to the audit of the financial statements. Inherent risk and control risk should be evaluated and assessed inversely with detect

Once the auditor is satisfied with the income recognition methods for various contracts, he can review the earned revenue. The auditor should review the contract and related correspondence files to assess the reasonableness of management’s current estimate of contract revenues. The auditor should obtain and review workpaper schedules that summarize contract information from the contractor’s books and records together with audit data arising from the audit of contract activity. The auditor should perform procedures to test the contractor’s contract status report. For these procedures, the auditor could trace the data to their sources, such as contract cost records or project manager’s status reports. Or the auditor could compare current results to prior reports for unusual trends. Also, the auditor could physically observe the status of the project by visiting the project site.

Unbilled receivables occur when revenues have been recorded, but the amount cannot be billed under the terms of the contract until a later date. Alternative procedures must be applied since direct confirmation of an unbilled receivable is usually not possible. For example, the auditor should examine subsequent billing and collection of receivables and evaluate the billing information on the basis of accumulated cost data. The auditor should also consider the length of time the receivable has remained unbilled, and check for other matters affecting ultimate collectibility.

The auditor should also test the financial viability of hired subcontractors. Tests performed could be confirming billings to date and balances due and reviewing the accuracy of the cutoff of subcontractors’ billings to determine that all billings for work performed have been included in contract costs.

The second area of auditing contract costs is estimated-cost-to-complete. This part of the audit can be very complex since it involves estimates of future performance, and is therefore highly subjective. The auditor should first assess the relative risk factors of the contracts by assessing performance risk and the risk associated with the contract terms. Next, the auditor should consider the accuracy of the contractor estimates-to-complete for the current and similar previous contracts.

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