You may have heard that your business owner friend is going through his or her annual audit…and you may have wondered what that is but have been too shy to ask… well, no worries. You will now know why one would need an audit, what are the types of audits, what do auditors do and how to prepare for the audit. So, the next time you find yourself in a discussion about auditors you can weigh in.
Types of Audits: Financial Audit vs. Tax Audit
I’d like to start by clearing up the confusion between Financial Audits and Tax Audits. They are related, as they both are auditing your accounting records and transaction, but they are not the same.
Financial Audits are performed by accounting firms using Generally Accepted Auditing Standards (GAAS) to provide assurance that your company's accounting records are kept in line with Generally Accepted Accounting Principles (GAAP).
Tax Audits are performed by the IRS agents (Federal Income Taxes) using tax laws enacted for the year the taxes are being filed. Tax laws are legal rules and procedures that govern how taxes are calculated.
In many situations Tax Laws and GAAP may not be the same, however, your tax accountant will know how to translate your GAAP basis financials to tax basis.
Why Would a Business Need a Financial Audit?
Small businesses and especially family owned or closely held ones, do not need or require a financial audit. However, if your business is growing exponentially, or you are planning to sell, or you acquired a loan, or you're planning to go public then you will need or may be required to have an audit.
If any of what I mentioned is in your radar, I suggest you put down at least $20K in your budget for the audit and make sure you work with a reputable firm that undergoes their peer reviews. Actual cost of an audit will vary based on size of the company, it’s operations, complexity of transactions, multi-locations, etc….
What is the Purpose of a Financial Audit?
The “unqualified” opinion of the assurance service you receive by doing an audit is invaluable. Your company will stand out as good company, that has vested time and money to ensure that financials are presented fairly. When the time come for a valuation for sale, an IPO, or to obtain a loan, your company will be ready!
What do auditors do?
In general, financial auditors will get an understanding of your business operations and compare to competitors. They will perform analytical procedures and note any expected or unexpected variances. They will evaluate and understand your internal controls and will offer suggestions as needed. They may confirm cash, accounts receivable, accounts payable balances.
How can you prepare?
The checklist below is not all inclusive but a guide. Follow the checklist to prepare for you annual audit but additional support items will be requested with testing of transactions.
Ensure all account balances are reconciled at every month-end
Prepare a lead sheet for all your balance sheet accounts (which means put together all account reconciliations and or details)
Safeguard all payments have a proper invoice and authorizations (this should be done during the year)
Review all open receivables and evaluate if anything needs to be written off based on your company policy
Put together your financials and preform a comparison to your prior year financials; prepare any explanations for variances ahead of time.
Compile any current or new agreements
Prepare a lease schedule if applicable
Prepare a fixed asset roll forward
Gather invoices and support documents on any leasehold improvements done, purchases of any furniture and fixtures, computers and equipment, etc…
Assess or update internal control documentations
If you’ve tried to do this alone and you feel you need additional assistance, I can help you. As a past auditor I can do everything for you and manage the full audit on your behalf.