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How does the justification of hours worked on a FP7 project to be documented? Are time sheets required?

Answer: 

Not necessarily. When you have a consistent, high-quality documentation system you can convince your auditor to take this instead of time-sheets.
But time sheets are default for most of the organisations, because they are easy to handle. The time recording needs to be signed and countersigned by either the project leader or the hierarchical supervisor. If the time recording system of your organisation is able to do this (e.g. by electronic signatures) then there are no time sheets needed. As the most organisations do not have such a system it is best to print out and sign and have counter-signed the time sheets on paper.