Going through a financial statement audit can sound like a daunting task, especially if your company has never been audited before. Why are we being audited? What does the process entail? What do we do once the audit is complete?
These are all valid and common questions asked by first-time audited companies. The process may seem intimidating, but it doesn’t need to be. The tips below can not only make having an audit seem more manageable, but they can also help you maximize the potential benefits to your company after the audit.
A financial statement audit provides reasonable, but not absolute, assurance that the financial balances your entity is reporting for the period are materially correct.
There are various reasons you may need an audit, the most common of which is to provide assurance to an external debtor or investor. If this is your first audit, odds are your company took on debt or an investment from a third party within the last year. Debtors often request financial statements so they can be confident your company will be able to pay back the money you borrowed. Investors also often require financial statements to keep tabs on the profitability of their investment.
While taking on debt or investors are the two most common reasons for an audit, they aren’t the only ones. Companies can also request an audit without any external requirement. Management may want to improve the company’s credibility with customers and vendors, assess the health of internal controls, or simply get an outsider’s perspective on the company’s operations.
In all scenarios, it is vital for the users of the financial statements to be able to trust those statements are materially accurate. An audit provides that assurance.
Ok, you have been told — or decided — you will be audited. What’s next?
There are various characteristics that can define what you are looking for in an auditor, and these are prioritized differently for every company, depending on preferences. Consider these initial questions when conducting your search:
It is important to find the right audit firm for you, as the relationship should be a cooperative one rather than simply transactional or, even, worse, adversarial. You should be able to consider your auditor one of your advisers, helping to provide advice to and best practice recommendations for your business.
Once you have selected your audit firm, you can begin preparing. When you think of the audit process, you may have an image of one, sometimes frantic, month of communication back and forth with auditors after year-end, but that should not be the case. Ongoing and strategic communication between your company and the audit firm, before the audit starts and throughout the year, will make for a much smoother and valuable process for both parties.
Planning and Risk Assessment
Your audit starts with the planning and risk assessment phase, usually performed prior to year-end. During this phase, your audit firm will perform inquiries and walk through various processes to best understand your company’s operations — namely its financial control environment — and the areas of the balance sheet and income statement most susceptible to risk of a material misstatement (an error or omission that can impact information for those who use your statements to make decisions).
Audit Testing/Fieldwork
Your auditors will use the findings from the planning and risk assessment phase to develop their audit plan. The plan will detail the testing they will need to perform during the year-end testing phase, often called “fieldwork.”
The year-end testing, or fieldwork, phase will be the heaviest lift for both parties. If your company has a material amount of inventory, the audit team will likely want to observe your year-end physical inventory count. The remaining bulk of the testing will consist of the audit team requesting schedules and listings to support the balances of your various general ledger accounts that the team deems to be material to the financial statements. From there, the team will make sample selections, requesting invoices, check copies and other supporting documentation and test them in a variety of ways. The depth of samples and testing is dependent on the determined risk of material misstatement and materiality of the related financial statement item.
Below are examples of common audit procedures for common audit areas:
| Audit Area | Audit Procedure Example |
|---|---|
| Cash |
Confirming balance directly with financial institution at year-end |
| Accounts Receivable |
Confirming balance directly with customers at year-end Obtaining proof of cash receipt relating to balances owed at year-end Obtaining proof of sale documents, such as invoices and any applicable shipping documentation (if the two procedures above aren’t possible) |
| Inventory |
Comparing cost of items on inventory listing to most recent vendor invoice Determining reasonableness of any inventory obsolescence reserve |
| Accounts Payable |
Testing cash disbursements to ensure they are accrued for at year-end (if related to the fiscal year under audit) OR to ensure they are not accrued for (if related to the next fiscal year) |
| Income Statement |
Obtaining explanations for large income statement account fluctuations from the previous year Reviewing invoices and purchase orders for sales that occurred during the period to ensure revenue is being properly recognized |
It’s best to stay organized during the year, maintaining these supporting documents in a manner that makes it easy to find them when it comes time for the audit. It will save you both time and frustration later. During testing, the audit team should let you know if there are any material discrepancies or errors noted and discuss the reasoning with you.
Preparing Final Financial Statements
Once the testing is complete, the next, and consequently last, step relates to the financial statements. Depending on the audit firm and your preferences, auditors can assist with preparing these statements, if your company is not publicly traded. Although the auditors may assist with preparing the financial statements, your management team ultimately takes full responsibility. As such, it is important to ask any clarifying questions to obtain a complete grasp on what the financial statements are showing.
Issuing the Auditor Opinion
Once the statements are prepared, your auditors will review them and issue one of the four following opinions:
The unqualified is the most desirable opinion, as it means the audit firm believes the financial statements present fairly, in all material respects, your company’s financial position. The remaining three all represent decreasing levels of assurance. Whatever the result, the final opinion issued should not come as a surprise, as your auditor should discuss this with you prior to issuing the statements.
While many companies breathe a sigh of relief once the audit is over (understandably so!), it is important to realize there are still often critical steps to take post audit:
This background on the financial statement audit process should help you feel at ease as you face your first audit, making it seem less like a daunting task and more like an opportunity for improvement and growth.
Contact Ryan Hochberg or a member of your service team to discuss this topic further.
Cohen & Company is not rendering legal, accounting or other professional advice. Information contained in this post is considered accurate as of the date of publishing. Any action taken based on information in this blog should be taken only after a detailed review of the specific facts, circumstances and current law with your professional advisers.