Auditing contract balances for building clients
How to audit a contractor's contract assets and liabilities, retainage and loss-making contracts, from the WIP schedule to the quantity surveyor.
By Achekam · · 5 min read · For Accountants & audit firms in South Africa, Nigeria, Kenya
A building contractor's profit for the year is mostly an estimate. It depends on how far each contract has progressed, what it will cost to finish, and whether a project that looked profitable at tender has quietly turned into a loss. The cash in the bank tells you little: the client may have billed ahead on one job and behind on another, and the customer may be holding back a slice of every certificate until the defects period ends.
For audit firms with construction clients in South Africa, Nigeria and Kenya, the contract balances are where the risk sits. This article covers how to test contract assets and liabilities, the work-in-progress schedule, loss-making contracts and retainage, and what to ask the client's quantity surveyor.
Contract assets and liabilities under IFRS 15
ACCA quotes IFRS 15's definition of a contract asset: an entity's right to consideration for goods or services it has transferred to a customer, where that right depends on something other than the passage of time, such as the entity's future performance. A contract liability, in the same article, is the obligation to transfer goods or services to a customer for which the entity has already received consideration, or the amount is due.
ACCA explains that the balance is calculated simply as revenue recognised to date less amounts invoiced to date. If revenue is ahead of billing, there is a contract asset; if billing is ahead, a contract liability. So the audit of the balance is really two audits: of revenue recognised to date, and of billing to date.
The work-in-progress schedule
Most contractors run a work-in-progress schedule. AccountingTools describes it as tracking each project's percentage of completion, revenue earned to date and over- or under-billing, calculated as the difference between actual billings and recognised revenue.
That schedule is the auditor's main working document. Test it in this order:
- Agree the list of contracts to the contracts register and to revenue in the ledger, to confirm no project is missing.
- Agree contract values to signed contracts and approved variations.
- Agree billing to date to invoices and payment certificates.
- Test costs to date to supplier invoices, subcontractor certificates and payroll.
- Test the stage of completion and the resulting revenue (below).
- Recompute the over- or under-billing and agree the total to the contract asset and liability balances in the trial balance.
Stage of completion and loss-making contracts
ACCA explains that for performance obligations satisfied over time, the stage of completion is needed to calculate revenue to date, but IFRS 15 does not require the estimated profit or loss on the contract to be calculated, except to determine whether the contract is onerous.
That exception is where the audit effort should go. A contractor that measures progress by costs incurred will report revenue in line with spending; if the estimate of cost to complete is too low, the contract looks profitable when it is not. AccountingTools states that when revised estimates show an overall loss on a construction contract, the contractor recognises the entire expected loss immediately.
For each significant contract, obtain:
- the original budget and the current estimate of total cost;
- the cost to complete, with the basis for it;
- disputed variations and claims, and whether they are included in contract value;
- penalties for late completion.
Compare this year's estimates with how last year's turned out. A contractor whose cost-to-complete estimates were consistently low last year needs more challenge now. Our guide to auditing accounting estimates gives a fuller approach.
Retainage as a separate receivable
Customers commonly withhold a percentage of each payment until practical completion or the end of the defects period. AccountingTools states that contractors must record retainage as a separate receivable, since it has been earned but not yet collected, and that it may be classified as a long-term receivable if the customer can hold it for more than a year.
AccountingTools also says a contractor should disclose the billed but unpaid amounts held under retainage, the amount expected to be collected within one year, and the years in which further retainage will be collected.
Test retainage by agreeing it to payment certificates, checking the release conditions in each contract, and assessing whether amounts held on troubled projects will be recovered at all. Old retainage on a project that finished years ago is a recoverability question, not a timing one.
Confirmations and lead schedules in Achekam
In Achekam, staff plan external confirmations and prepare requests that a different person approves, and each customer answers through a single-use link. Achekam does not send the requests itself; staff send them and record how. For a contractor, confirming billing to date and retainage held with the main customers is often the most persuasive evidence available.
The contract asset, contract liability and retainage lines in the lead schedules are built from the engagement's trial balance and trace back to its lines. Where testing of the work-in-progress schedule shows revenue or a loss provision is misstated, staff record an audit adjustment on the line with a reason, and raise a finding from the working paper to close or withdraw later. Our article on revenue recognition policies helps check that the policy matches what the schedule does.
Questions for the client's quantity surveyor
The quantity surveyor usually knows more about the true state of each project than anyone in the finance team. Meet them, and ask:
- Which contracts are behind programme, and why?
- Which variations are agreed with the customer, and which are only claimed?
- Are any contracts expected to make a loss, even if the schedule shows a profit?
- Are there disputes, penalties or defects that could reduce what the customer pays?
- How is the cost to complete estimated, and when was it last updated?
- Has any customer withheld payment beyond normal retainage?
Write down the answers and compare them with the schedule. Differences between what the surveyor says and what the schedule shows are the audit's best leads.
AccountingTools' overview of construction accounting covers the work-in-progress schedule, retainage and loss recognition in practical terms, and is a useful primer for staff new to construction clients.
Before fieldwork on your next contractor audit, ask for the work-in-progress schedule, the contracts register and a meeting with the quantity surveyor. Those three tell you where to spend the time.
General guidance only, not advice on your own circumstances. Tax and payroll rules change: check the current position with the authority or your adviser.
