In regards to the aerospace and defense industry, the primary focus of the audit is on the profit centers, such as individual contracts, for recognizing revenues, accumulating costs, and measuring income. Evaluation of the profitability of contracts is essential to the total audit process. Much of the audit work done in this area involves evaluating subjective estimates relating to future events. The auditor's objective when auditing accounting estimates is to provide reasonable assurance that all material accounting estimates have been developed, that the accounting estimates are reasonable in the circumstances, and that the accounting estimates are in accordance with applicable accounting principles.
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 detection risk. The less the inherent and control risk, the higher detection risk the auditor can accept. The auditor should now assess control risk to determine the nature, timing, and extent of substantive tests to be performed to restrict detection risk to an acceptable level.
Revenues.
Regarding contracts, the auditor should evaluate the acceptability of the income recognition methods being used. Since many contracts use the percentage of completion method to recognize income, certain audit procedures should be performed to evaluate the acceptability of this method. The objective in investigating this type of contract is to determine that income recognized during the current period is based on the total gross profit projected for the contract on completion and on the work performed to date.