A professional services firm sells people's time. Consultancies, engineering practices, law and architecture firms, and staffing-adjacent advisory shops all carry the same audit shape: a large payroll cost base, revenue built from timesheets, and a balance sheet where the biggest judgment sits in receivables and unbilled work. The balance of "work done but not yet invoiced" is where revenue cutoff, collectibility and management bias meet.
How revenue is recognized
Services contracts transfer value as the work is performed, so revenue is recognized over time. What changes is the measure of progress.
Time and materials. When the customer is billed a fixed rate per hour, ASC 606-10-55-18 allows the entity to recognize revenue in the amount it has a right to invoice, provided that amount corresponds directly with the value transferred to the customer to date. FASB TRG staff gave as the example a service contract billed at a fixed amount per hour. The staff paper also states that an agreed invoice schedule does not automatically qualify, because payment timing is sometimes set for cash flow or credit reasons rather than to track value. Rates can change during the contract if the changes reflect value to the customer, and that takes judgment.
Fixed fee. A fixed fee billed on milestones that do not track effort fails the expedient. Revenue is measured with an input method (hours or cost incurred against total expected hours or cost) or an output method. This is the same mechanics as construction cost-to-cost, covered in construction contractor audits.
Retainers, success fees and not-to-exceed caps. Retainers for standing readiness are recognized ratably when the customer benefits evenly over the period. Success fees and bonuses are variable consideration, constrained to the amount that is probable of not reversing. Caps limit the price and require reassessment as hours accumulate.
An entity that applies the right-to-invoice expedient is not required to disclose the remaining performance obligation for those contracts (ASC 606-10-50-14(b)). If the entity uses it, the auditor should see the policy stated in the revenue note.
Unbilled revenue, contract assets and receivables
Revenue recognized ahead of invoicing creates an asset. The classification matters:
- A receivable exists when the right to consideration is unconditional, meaning only the passage of time is needed before payment is due. Work that has been performed and is waiting for the monthly invoice run belongs here.
- A contract asset exists when the right still depends on something other than time, such as completing a later milestone or client acceptance.
Many firms label both "unbilled revenue" or "WIP." The audit file should split the balance, because presentation, aging and the contract balance disclosures differ for each.
Risk areas
- Cutoff. Hours worked in the last days of the period but entered late. Invoices issued after year-end for work done before year-end.
- Realization. Standard billing rates are not the transaction price. Write-downs, discounts and unbillable time reduce what the firm will actually collect. A WIP balance carried at full rate when history shows 80 cents on the dollar is overstated.
- Stale WIP. Unbilled time more than a few months old needs investigation for disputes, scope creep or lost client relationships.
- Fixed-fee estimates. Total hours to complete are management's estimate, and overruns surface late.
- Loss contracts. When expected cost exceeds the fixed fee, the shortfall needs evaluation for accrual.
- Pass-through costs. Whether the firm is principal or agent for reimbursable expenses. See principal versus agent.
- Management override. Partners compensated on revenue or collections have an incentive to hold WIP up. See management override of controls.
Audit procedures
- Obtain the WIP and unbilled aging by client and engagement. Test it for completeness and accuracy against the time and billing system before relying on it.
- Reperform the rollforward: opening WIP plus time and expenses recorded, less billings, less write-offs, equals closing WIP.
- Select engagements and agree hours to timesheets, and timesheets to approved rates in the engagement letter. Confirm that employee cost per hour is reasonable against payroll.
- For subsequent billings, trace the invoice issued after year-end to the unbilled balance and compare billed amount to the carried amount. The difference is realization evidence.
- For fixed-fee contracts, recompute percent complete, challenge estimated hours to complete against the project manager's latest forecast, and look for contracts where actual hours already exceed budget.
- Confirm significant receivables. See audit confirmations.
- Test cutoff using timesheets entered in the first weeks after year-end, and invoices issued in the same window.
- Assess the allowance and any WIP write-down against history of write-offs.
Worked example
Example: Harbor Advisory has two engagements at year-end.
- Engagement A is time and materials at $200 an hour. Staff logged 150 hours in December, none invoiced. The right-to-invoice amount is $30,000, recognized and presented as a receivable because only time stands between the work and the invoice.
- Engagement B is a $240,000 fixed fee billed in three equal $80,000 milestones. Budget is 1,200 hours. Management reports 600 hours incurred and projects 1,200 total, so 50% complete and $120,000 of revenue. Billings to date are $80,000. A $40,000 contract asset is recorded, because the next milestone is not yet earned.
The auditor reads the project manager's forecast and finds the team expects 1,500 hours to finish. Percent complete falls to 40%, revenue to $96,000 and the contract asset to $16,000, a $24,000 reduction in revenue. The same forecast also shows expected cost has risen, so the contract is checked for loss.
PBC items to request
- WIP and unbilled aging by client, tied to the general ledger
- Time and billing system reports, with a population completeness report
- Engagement letters and change orders for the top engagements by revenue
- Fixed-fee budgets, hours to date and latest estimate to complete
- Write-off and discount history for the past several years
- Subsequent billing and cash receipts listing
- Policy for rate cards, billable utilization and write-down approval
Use the PBC list guide to structure the request.
Red flags
- Unbilled balance growing faster than revenue
- Realization rates falling while WIP is held at standard rates
- Large manual journal entries to unbilled revenue at quarter-end
- Engagements with revenue recognized but no signed scope document
- Hours logged on closed projects
Sources
- FASB Transition Resource Group staff paper on the practical expedient in ASC 606-10-55-18, as reproduced by PwC Viewpoint: https://viewpoint.pwc.com/dt/us/en/fasb_financial_accou/trg_revenue/trg_revenue_US/practical_expedient___1_US.html
CORAA prepares ready-to-review audit files for US CPA firms; see /us.
Part of CORAA University · Specialized engagements: related guides, calculators and templates.
AU-C references are to AICPA Professional Standards, paraphrased here; read the standard itself before relying on a requirement. This page is guidance, not professional advice. Report an error