Focus Areas for Financial Statement Audit Preparation

For all of us who have gone through a financial statement audit, whether on the auditor or client side, we know how overwhelming it can be to keep up with the long list of requests and meet all deadlines.

It is important to know that auditors don’t treat every area within a business equally; they focus on the areas with higher risk. This can mean balances that are large, key metrics for financial statement users, or more complex when applying US GAAP accounting rules.

A critical factor in a company’s audit preparation is in prioritizing the many aspects within an audit that need to be addressed. As a former auditor, we hope this guide helps you focus on some of the key areas to avoid delays and headaches down the road.

Revenue

Unless you’re a pre-revenue startup, chances are that Revenue will be a top priority for the audit. It is one of the most important metrics for a business, can vary by product, and can be complex when evaluated under US GAAP. Make sure you have the following items ready:

• ASC 606 Policy Memo. Companies under US GAAP are required to account for their revenues in accordance with the recently revised ASC 606 standard. This includes a complex framework with many factors to consider. Having an accounting policy that outlines each revenue stream and/or customer contract type under ASC 606 is critical to ensure revenue is recognized properly.

• Revenue Scoping. Auditors want to know how you separate your revenues as a business. Whether by entity/subsidiary, product type, customer type, etc., laying out the differences and amounts for each revenue stream will help your auditors avoid scoping their procedures another way, which can lead to confusion and higher fees.

• Revenue Details and Support. Auditors need to have a detail of the amounts for your revenue streams, ideally by contract, so they can select a sample to perform their testing. You also need to have access to support for their testing selections, including contracts, invoices, payments, and proof of delivery/performance. Being unable to provide any of these within requested deadlines can become a major audit roadblock.

Acquisitions

If your company acquired any businesses or assets in the period under audit, auditors will focus on these for testing. For a first-year audit, they may even want to test large acquisitions in past years as well. The types of requests for these acquisitions include:

• Acquisition Technical Memo. Similar to revenues, acquisitions must be accounted for in a specific way under US GAAP. Having a technical memo that walks through the transaction and related accounting evaluation will help auditors quickly understand what has been done.

• Valuation / Purchase Price Allocation Report. Under US GAAP, acquired assets and liabilities are required to be recorded at fair value as of the acquisition date, and with certain intangibles recorded that were not previously. These generally are different than the carrying values on the closing balance sheet, and often require a valuation specialist to complete. Make sure you have this valuation work done, ideally prior to the beginning of the audit, or at least have a specialist ready to perform the work.

• Closing Balance Sheet. To complete the accounting, you need a solid balance sheet of the acquired business/assets as of the acquisition dates. The amounts within this balance sheet should be supportable, ideally by details/reconciliations, which auditors will likely test for key items. Make sure you have a clean/supportable balance sheet ready for the auditors, as well as the valuation specialist.

Debt/Equity

If your company has any debt or equity from external parties, auditors will focus on these items as well. Any major transactions during the audit period, as well as older transactions for a first-year audit, may fall in scope. Have the following ready:

• Technical Memo. Yep, you guessed it, there is specific US GAAP accounting for debt/equity, including how it is classified on the balance sheet and for the treatment of any costs related to the transaction. Make sure you have a technical evaluation completed for each major instrument/class of funding.

• Funding Agreements. In addition to the above, auditors will also ask for the underlying agreement of selected debt/equity. Have these agreements ready to provide early on.

Recent Accounting Standards

US GAAP accounting guidance is always changing, and there are recent major updates that auditors will want to make sure you are in compliance with. The most impactful recent updates include the following:

• Leases (ASC 842). Recently, guidance was released that requires specific accounting for any leases, including having any operating leases recorded on the balance sheet. Going through the exercise early to have the right accounting and amounts is important for any company with leases.

• Credit Losses (ASC 326). Beginning in FY2023 for nonpublic companies, there is new guidance for any assets/liabilities with credit risk. The impact varies; companies with significant loans (e.g. banks, lenders) will be hardest hit, but all companies with any credit risk, including trade AR and other receivables, need to do the exercise for any impact and adjustments to reserves.

Reconciliations/Support

While more of a general topic, auditors will review a company’s financials and select various accounts/balances for testing. One way to prepare for this is to have year-end reconciliations and related details ready for your balance sheet accounts:

• Assets. Auditors normally focus on the large/material assets, so have any large accounts supported with a recon. Common areas include AR, Fixed/Intangible Assets, and large prepaid or receivable amounts.

• Liabilities. These are trickier; audit scoping depends less on the size of the amount. Common testing areas include AP, payroll accruals, and deferred/unearned revenue.

Conclusion

Audit preparation involves a combination of technical accounting knowledge and information gathering. Because of this, it is likely best to adopt a divide-and-conquer approach to avoid overwhelming a single person or small accounting team. This may include other departments in the business, such as the Ops and Legal team for key documents, or external specialists for complex valuation or technical accounting under US GAAP.

If you feel like you or your team may need assistance in tackling your upcoming audit, please reach out to our team. An initial consultation can go a long way in helping your audit preparation, and avoiding delays, headaches, and costly audit overruns.