The contract underpins the Department for Work and Pensions' (DWP) efforts to move people from sick benefits into work.
But a BBC report found the National Audit Office said the DWP had failed to penalise Atos for "underperformance", and had not set "sufficiently challenging" targets.
French firm Atos was paid more than £112 million in the last year to carry out 738,000 face-to-face medical tests on benefit claimants.
The DWP used the test results, known as work capability assessments, to decide whether people were fit to work or eligible for Employment and Support Allowance (ESA).
The assessments were first introduced on a pilot basis by Labour in 2008 and rolled out across the country by the coalition government.
The DWP had previously admitted that Atos had not carried out some fitness testing within the agreed time limits, and performance had been "below the standard" since mid-2011.
According to the BBC the NAO criticised the DWP for not seeking "financial redress" for these delays, saying just 10% of the penalties triggered by poor performance had been applied.
The spending watchdog added that the DWP's negotiating position has been undermined by "inaccurate forecasting" of the number of people likely to need a medical test.
Major changes to the tests were recommended in 2010 by independent adviser Malcolm Harrington. Last month he told the BBC the system had improved but was still "patchy".
