CPA Exam — AUDPerforming Further Procedures and Obtaining EvidenceMedium
A client produces custom-engineered industrial machinery. The auditor is reviewing the client's long-term construction contracts. To test the recognition of revenue over time, which of the following audit procedures would be most appropriate?
- AConfirming contract terms and progress billings with customers.
- BComparing current year's revenue to prior year's revenue for similar contracts.
- CInspecting completed machinery in the client's warehouse for existence.
- DRecalculating the percentage of completion based on costs incurred and estimated total costs.
Show answer & explanationAnswer & explanation
Correct answer: D. Recalculating the percentage of completion based on costs incurred and estimated total costs.
Revenue recognition for long-term contracts often relies on the percentage-of-completion method. Recalculating this percentage based on objective data (costs incurred and estimated total costs) directly tests the accuracy and valuation of revenue recognized.
Why the other options are wrong
- A. Confirmations provide evidence about contract existence and terms but not directly about the accuracy of revenue recognized over time.
- B. Analytical procedures are useful but less direct for testing specific revenue recognition accuracy than recalculation.
- C. Inspecting machinery tests existence of assets, not the accuracy of revenue recognition.
Revenue Recognition for Long-Term Contracts
Auditing the process by which revenue is recognized over time for contracts where control of goods or services transfers continuously to the customer, often using methods like percentage of completion.
- Requires careful estimation of costs and progress.
- Auditor must test the underlying inputs and calculations.
- Focuses on accuracy, valuation, and cutoff assertions.
Memory trick: CONTRACT: Costs, Revenue, Accuracy, New estimates, Timely recognition.