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Audit of contracts

Learning plan

1. What is contract audit2. Need for contract audit3. Qualities and attributes of a contract

auditor4. Issues to be considered by a contract

auditor (IAS 11)5. Performance of audit work6. Stages of contract auditing

What is contract audit Long-term contract are those projects of which

completion falls into 2 or more acc periods More associated with audits of major construction

and maintenance contracts And in particular with the audits of schemes, which

are financed by capital expenditure. Mostly:

Building works Civil engineering works Mechanical and engineering works

Auditing principles are the same to all types of contract (minor or major works)

Need for contract audit

The need for this audit is due to:1. The value and importance of

contractual expenditure2. The high turnover and diversity of

contract (from supply of stationery to construction of roads)

3. The inherent risk of loss, waste and fraud from such expenditure levels.

Qualities and attributes of a contract auditor

The auditor is primarily expected to be able to examine and interpret financial information pertaining to contracts

but should ideally also possess a working appreciation of technical and legal matters connected with such contracts.

This additional knowledge will: add depth to investigations, allow meaningful discussions with staff from

other disciplines and provide for a more management-type of

approach to the audits.

Issues to consider as per IAS 11

The following issues need to be considered in an audit of a long-term contract:

1. Conformance of disclosure with the requirement of IAS 11

2. Accuracy of costs recorded3. Accuracy of revenues recorded4. Recognition of contract revenues and

expenses 5. Recognition of expected losses6. Changes in estimates

1: Disclosure Requirements of IAS 11

The auditor must check that the disclosure is sufficiently informative to include:

1. The amount of contract revenue recognised as revenue in the period;

2. The methods used to determine the contract revenue recognised in the period;

3. And the methods used to determine the stage of completion of contracts in progress.

1: Disclosure Requirements of IAS 11

For each of the contracts in progress at the balance sheet date:

1. the aggregate amount of costs incurred and recognised profits (less recognised losses) to date;

2. the amount of advances received; and

3. the amount of retentions.

2: Accuracy of costs recorded

IAS 11 stipulates that contract costs shall comprise:

1. Costs that relate directly to the specific contract;

2. Costs that are attributable to contract activity in general and can be allocated to the contract; and

3. Such other costs as are specifically chargeable to the customer under the terms of the contract.

3: Accuracy of contract revenue

According to IAS 11 contract revenue shall comprise:

1. the initial amount of revenue agreed in the contract; and

2. variations in contract work, claims and incentive payments:

(i) to the extent that it is probable that they will result in revenue; and

(ii) they are capable of being reliably measured.

4: Recognition of Contract Revenue and Expenses

It is stated that contract revenue and contract costs shall be recognised as revenue and expenses respectively by reference to the stage of completion at the balance sheet date.

An expected loss on the construction contract shall be recognised as an expense immediately in accordance with paragraph 36.

When it is probable that total contract costs will exceed total contract revenue, the expected loss shall be recognised as an expense immediately.

The amount of such a loss is determined irrespective of:

(a) whether work has commenced on the contract; (b) the stage of completion of contract activity; or (c) the amount of profits expected to arise on other

contracts which are not treated as a single construction contract

5: Recognition of Expected Losses

6: Changes in estimates

The percentage of completion method is applied on a cumulative basis in each accounting period to the current estimates of contract revenue and contract costs.

Therefore, the effect of a change in the estimate of contract revenue or contract costs, or

the effect of a change in the estimate of the outcome of a contract, is accounted for as a change in accounting estimate

(see IAS 8 Accounting Policies, Changes in Accounting Estimates and Errors)

Stages of contract auditing

Contract auditing embraces five distinct areas, namely:

A. Pre-contract investigations

B. Currency of contract investigations

C. Final contract investigations

D. Post completion investigation

E. General investigations

A: Pre-contract investigations

At this stage the auditor conducts the examination and assessment of documents pertaining to the contract

and of decisions taken by the mgt team in respect of that contract.

It may also make possible the detection of bribery and corruption,

The tendering procedures and the acceptance of tenders are areas susceptible to illegal or immoral practices and

the operation of a weak system of control could result in considerable loss to the organization

A: Pre-contract investigations

The auditor should pay attention to whether:

1. The system for and effectiveness of project appraisal within the Organization

2. The systems for admitting contractors to the approved list and for reviewing their performance and current viability

3. The methods for the selection of contractors invited to tender

A: Pre-contract investigations

4. The system for regulating the tendering procedures and the letting of contracts

5. The system for reviewing the suitability of Conditions of Contract and Tender documents

6. Insurance and Bonding procedures

B: Currency of contract investigations

The continued development of interim or current audits is an attempt to prevent loss, waste and extravagance,

and hence encourage savings or improved controls throughout the construction period of the contract under investigation, as well as future contracts of a similar nature.

the auditor is not involved on a continuous basis but independently examines, assesses and reports

on the mgt controls and procedures by employing sampling techniques, spot checks, system

appraisal techniques and risk analysis.

B: Currency of contract investigations

The following should be checked:1. The system and documentation for providing

financial information to enable costs to be adequately controlled

2. The system of on- site control regulating valuations of work for Interim payments

3. The system for the examination and control of price fluctuations

4. The system for the control and issue of variations5. The system for the receipt and evaluation of

contractual claims

C: Final contract investigations

The final contract audit is easier to conduct and has more of an accounting format.

Where the auditor is in disagreement with the officials responsible for drawing up the account, any relevant matters should be brought to their attention at the time of the audit and

should also be pointed out in an appropriate minute or report to management.

C: Final contract investigations

The auditor’s role at this stage is independently to examine the account in order to detect weaknesses, error or fraud in the contract system.

He should check: The system for ensuring that when the final

account is produced, it is complete and accurate

The system to ensure that damages have been recovered where appropriate

D: Post completion investigation

The post completion investigation would include: 1. Re-appraising the project to examine whether the

benefits expected at the outset have been achieved 2. Assessing the performance of the contractor to

determine if the he provided good VFM3. Reviewing the consultant’s performance in a similar

manner, for example, fees charged, ability, competence, etc.

4. Reviewing the organization’s own departmental costs and the performance of the departmental staff involved in the project.

Relationship with other Professions

Although primarily financed based, the contract auditor must be capable of liaising with persons from other disciplines and professions, which would include: architects, engineers, quantity surveyors, clerks

of the works, legal officials, consultants and contractors.

The auditor is an observer of matters that are managed by these persons and therefore takes no responsibility in the running of such projects.

Relationship with other Professions

It is essential that a strong working relationship between audit and other professions be established,

that access to contracts matters is readily offered to the auditor by these professional persons and that they are not offered grounds for scepticism.

Working without assistance of other professions would be detrimental to the effectiveness of the contract auditor and would in fact be unprofessional and short-sighted.

The end!