Should Your Company Defer an Audit?
To audit or not to audit? When a company is faced with a shrinking cash flow, spending money on an audit may not be a top priority. Unless a company has a contractual, regulatory, or statutory audit requirement, the audit cost—a discretionary expense—is a prime candidate for elimination or deferment.
Deferring an audit is a valid business decision. And depending on your company’s specific circumstances, it may be the best decision. But all too often companies make this decision without considering how it may impact the business in the future. And, by choosing to defer an audit, companies miss out on the ancillary benefits of an audit, such as staying current with new and proposed accounting rules, possible introductions to financing institutions, and best operational practices.
Deciding whether to have an audit is not an all-or-nothing decision. Auditors offer a wide range of services—such as reviews, agreed upon procedures, attestation engagements, and general consulting services—that can be done without a full audit. These services can provide immediate validation of high-risk areas, address areas of concern to investors, or resolve historically problematic account balances. And auditors can provide advice on how to best preserve data for a future audit.
Before deciding to postpone an audit, companies should carefully consider whether the immediate cost-saving benefit outweighs the potential future costs, and should also determine what steps can be taken to minimize future costs and issues.
Deciding Whether to Defer
In deciding whether to defer an audit, consider the following questions:
- How does the Company view its auditors? Auditors should be viewed as the company’s trusted business advisors, rather than people who just want to poke around in your books and records. Take a look at how your company views its auditors. Your auditors’ valuable experience and knowledge of best practices can help your company improve operational efficiencies and reduce costs.
- Does the Company foresee a potential opportunity where audited financial statements would be required? If you’re already aware of a potential opportunity, then the audit will likely go forward as planned. But unanticipated opportunities present themselves when least expected, and often come with an audit requirement that must be completed quickly. In urgent, time-sensitive situations, your company’s internal and external costs often exceed the original cost of the audit. Because no one can predict what the future will bring, performing timely audits allows the company to take advantage of opportunities more quickly.
- Can the Company generate or reproduce historical records and information at a future date? This is one point that is seldom part of the initial consideration, but from an audit and cost perspective is probably the most critical. If the company cannot provide the auditors with requested schedules and supporting documentation—for example, because of system limitations (some reports can only be generated on a “real-time” basis), the accounting system has changed, the physical records and account reconciliations cannot be located, or the historical accounting personnel are no longer with the company—then the auditors may not be able to render an opinion on historical balances. Unfortunately, this is usually not discovered until deep in the audit process after the company and auditors have spent considerable time trying to identify alternative solutions. The costs of these efforts often far exceed the cost of the original audit.
- Does the Company have an effective internal control structure? In any company, those charged with governance are responsible for designing and implementing programs or controls to prevent and detect fraud. One of the required components in any audit is for the auditors to gain an understanding of a company’s internal control system and to evaluate the effectiveness of this system. Auditors then communicate suggestions for internal control improvements to ensure accurate financial statement reporting and to help guard against fraudulent activities. Studies have shown that an effective internal control system is the most effective fraud prevention and detection measure that a company can put in place. Additionally, surveys conducted by the Association of Certified Fraud Examiners have revealed that the most effective fraud deterrent for employees is the perception that someone is reviewing their activities.
- Does the Company maintain their records on a GAAP basis? A significant number of non-public entities rely heavily on their auditors for updates on new accounting pronouncements, changes to existing pronouncements, and how to implement these changes within the company. Companies typically gather this information in connection with the audit process. And auditors often assist their clients in indentifying and resolving accounting issues. If the company doesn’t have the internal resources to maintain their books on a GAAP basis, then the financial statements could become less meaningful to certain users.The company should also consider how users of the financial statements will react to a change in historical numbers and should be prepared to field these questions should they arise. Any proposed changes in future periods will also be reflected as a “true-up” adjustment in future income tax reporting.
- Does the Company have an unknown statutory or regulatory audit requirement? In addition to contractual audit requirements in connection with debt, investor, customer/donor, or vendor agreements, companies operating in multiple jurisdictions or countries may have additional audit and/or reporting requirements. And not-for-profit entities (including private foundations) operating in California, and meeting certain criteria, have a regulatory reporting requirement as mandated by the California Not-for-Profit Integrity Act of 2004. Falling out of compliance with this requirement could result in additional costs that negate initial savings.
Reducing Future Costs
Each company has its own unique set of facts and circumstances that will determine when to conduct an audit. Postponing an audit should be well thought out and structured to minimize the future impact. Towards this end, there are a few steps a company can take to mitigate the risks:
- Identify potential accounting issues that may require attention. Your company’s specific issues may include or be identified as follows:
- Identify any new or unusual transactions (for example, any business acquisitions, expansion into new areas of business, or other transactions).
- Review—and be sure that you have proper documentation for—the following areas, which are typically challenging for most companies:
- revenue recognition
- recognition of liabilities
- equity and option transactions (cash and non-cash), and
- non-standard debt agreements.
- Review prior period proposed audit adjustments.
- Review prior year management letter comments.
- Discuss accounting questions and issues with your auditors. Once you have identified specific areas requiring attention (as described above), discuss these areas, and any other concerns, with your auditors to brainstorm ideas on how to make sure these areas are adequately addressed.
- Generate reports. Identify the system information that is date driven and cannot be regenerated in the future. Create any reports that you or your auditors may need.
- Complete the normal year-end close process. Consult with your auditors and include a thorough analysis and reconciliation of all accounts (in other words, “keep the books audit ready”).
- Close the books. Physically close the books in the company’s accounting system to avoid entries being changed or posted to prior periods.
If, after considering all the available information, you decide to proceed with an audit, continue to work with your auditors to see if they are open to temporary fee reductions or “in-kind” exchanges of services.
One final thought: Deferring an audit should not be synonymous with deferring audit preparation work. Keep your books audit-ready to help maintain an effective internal control system and to allow the company to move quickly when an audit becomes necessary.