While an approaching audit can be intimidating, proper planning can make for a smooth and successful audit experience. Whether your organization already participates in annual audits or is approaching the audit requirement threshold for the first time, there are best practices to consider when preparing for a financial statement audit.
There are several steps your organization can take throughout the year to effectively plan for an audit. A great first step would be to establish an audit committee. An audit committee’s responsibilities include oversight of the audit and the financial reporting process, monitoring accounting policies and principles, as well as the organization’s system of internal control. If your organization is a nonprofit, each state has requirements for the constitution of the audit committee and related responsibilities. For instance, in the state of California, an audit committee must be established for all audits of nonprofit organizations, and the committee cannot include the CEO, Treasurer, Finance Committee Chair, any employee of the organization, or any person with a material financial interest in an entity doing business with the organization.
Once an audit committee is established, an organization should go through four main steps to prepare for their audit.
Risk Assessment & Internal Control Environment
An audit will always start with a review of their client’s system of internal control and perform a risk assessment. To prepare for this process, organizations should perform their own annual risk assessment. Performing an annual risk assessment is a great way to identify weaknesses in internal control, as well as accounting processes susceptible to error or even fraud. By documenting and updating a narrative of your processes, you are taking the first step to evaluating your internal control environment. If you happen to identify an error or weakness during this process, you will have the ability to implement new or improved processes to mitigate these issues in advance of your audit.
Accounting in Accordance with U.S. GAAP
Accounting throughout the year should be prepared in accordance with accounting principles generally accepted in the United States of America (“U.S. GAAP”). Make sure that you have researched and understand accounting standards updates issued to determine if there are new standards that you should be following. Following an old accounting standard that has been recently updated could lead to a misstatement in the financial statements, audit adjustment, and if large enough, a management letter addressed to those charged with governance describing this significant deficiency or material weakness in the organization’s internal control.
Maintaining proper documentation to support accounting transactions is imperative. Auditors will issue a request list for support to substantiate specific transactions during an audit. This means that they will be looking for “verifiable audit evidence” to support that the transaction meets audit assertions. Having a well-maintained system for retaining and filing this documentation will not only substantiate the transaction, but will help you to do so in a timely manner.
Year End Financial Statement Close
Closing your organization’s books is usually a task performed monthly. The annual financial statement close is a similar process, yet this process can get more involved for a period-end under audit. Where should you start? The Balance Sheet. Each account balance should be reconciled to the underlying accounts and supporting detail. Preparing rollforward schedules or annual reconciliations is a great way to ensure that your ending account balances are correct and in accordance with U.S. GAAP. Investigate significant or unusual items and unreconciled differences; propose adjustments as appropriate. Assess the need for adjustments to the financial statements related to management’s estimates such as reserves, write-offs, commitments, contingencies, fair value, accrued liabilities, and many others. Auditors will test these year end account balances, so be prepared to provide to them these schedules, reconciliations, and other support.
The key to a successful audit is preparation. For assistance in preparing for an audit, please contact your L&B professional at (858) 558-9200.