What’s your reaction? Apprehension? Dread? Fear? All of these would be appropriate. An audit is a major task that requires time and attention to detail. Probably your resources are already stretched thin and an announcement of the audit to your staff will most likely be less-than-warmly received.

 

You may be wondering why executive management has decided to add this extra burden to an already hectic schedule. Your company may be gearing up to go public. The company’s bank may have requested audited financials in regards to lending. The company may be for sale and an interested buyer would like to see audited financials. Whatever the case may be, the company is preparing for its first audit and relying on the accounting department to make sure it runs smoothly.

 

Your first concern would most likely be that your company reports its current financials by using an “other comprehensive basis of accounting” (OCBOA). The most common are reporting on a cash basis or tax basis. You will need to translate your financials into generally accepted accounting principles (GAAP).

 

You will have to think about assets that need to be included on your books. Receivables include monies loaned to outside parties, sales completed but not collected and employee advances. Prepaid expenses for services, equipment and inventory are expenses you’ve paid for but haven’t yet received.

 

The company’s additional liabilities will also need to be considered. They consist of monies the company owes but hasn’t yet paid. These can be payables due to vendors for services rendered or goods received, salaries due to employees for work completed in the current period to be paid in a future period or loans the company has taken.

 

You will also have to review prior expensing of assets. These can include intangibles like patents and trademarks, or fixed assets like property, plant and equipment. You will need to determine the useful lives of these classes of assets. You will need to go back through your records for as many years as the useful life is determined and review your accounting records to collect information on these prior expensed assets. Assets expensed beyond the useful life timeframe are already fully depreciated.

 

Small and mid-sized companies often miss the area of disposals of assets. So, fixed assets should be reviewed for accuracy. Often disposals have no way of making their way back to the accounting department. A physical count should be completed prior to the audit to ensure that what is listed on the books is actually physically available for review.

 

The company will need to account for loss contingencies. These are items where the company may owe monies in the future. Two conditions must be met: The event must be probable or likely to occur and the amount of the loss can be reasonably estimated.

 

Any items that may influence the company’s fiscal situation must be disclosed in the notes of the financial statements. These generally include a summary of significant accounting policies; property, plant and equipment; comprehensive income; long-term debt; fair value measurements; and income taxes. They may include such items as goodwill and intangibles, investments, hedging and derivatives, commitments and contingencies, stock option plans and pensions.

 

Once the books are translated from OCBOA to GAAP, you will then need to comply with the Sarbanes-Oxley Act (SOX). With the implementation of SOX, focus increased from testing account balances and transactions to processes and testing controls surrounding transactions. Your auditors are going to want narratives documenting your various processes and controls surrounding financial reporting (e.g. inventory, payroll, revenue and cash). You may also want to create flowcharts of your controls and/or a control matrix.

 

You will want to interview the process owners to get an understanding of the narratives you will need to write. The idea here is to follow one transaction from its inception through all the stops along the way to the transaction hitting the general ledger. After interviewing the process owner you will want to perform a walkthrough. These are particularly good to do so that you can see which controls may have been left out. In addition, you can see where you may have gaps in your processes. Is there an issue with segregation of duties, security over assets or having a formal review process?

 

Once you’ve documented your controls, it’s time to prepare for the auditors. Make sure you have a clear understanding of the audit process and what the auditors will expect. This can be accomplished through the audit letter, which the auditors will provide. Obtain the “provided by client” (PBC) list, as it will outline all the documents the auditors will need. Make sure to have these items available at the start of the audit. Often the auditors will need to make selections of documents from the lists provided.

 

The auditors will want to meet and will have questions for you and possibly your staff. Prepare your staff to answer questions as if they were on the stand in court. They should focus only on answering the questions the auditors have asked. Additionally, you should prep your staff as to what they should and shouldn’t talk about. Any areas you do not want your staff to discuss should be referred back to you. If possible, ask the auditors to provide written questions. This way you are not thrown off guard and will have time to prepare accurate and responsive answers.

 

You should expect to run into some bumps along the way. Most auditors will find some mistakes. Don’t panic. Auditors expect this to happen. If the errors do not materially affect the financial statements, then they will most likely not be communicated to you.

 

With some hard work and planning the audit process can run fairly smoothly and your company can receive an unqualified opinion, which is the ultimate goal of a successful audit.

 

 

Source: Reprinted with permission from the Virgina Society of CPAs.