How To Prepare For a Financial Audit

“To be prepared is half the victory.”

– Miguel De Cervantes

Yes, a financial audit can be intimidating. However, preparing for your financial audit should be a breeze. The key to preparing for an audit is to have good processes throughout the year to prepare and review the books. If you do not have good procedures in place and find yourself scrambling, do not worry. An audit is an excellent way to learn what areas of your business could use improvement.

This guide will give you the ten steps you need to take to be ready when the auditors arrive.

10 Steps to Prepare for an Audit

1. Month-End Close

You should be closing your books every month. Closing your books every month allows you to quickly identify errors so they do not compound. Ideally, you should follow a closing checklist with set procedures so the closing moves efficiently and you do not miss any entries. During a month-end close, you should be at a minimum reconciling all of your cash accounts.

2. Compile Documentation

Proper documentation is one of the keys to a smooth audit. You should be saving all of your receipts in either your accounting software or a cloud-based drive. Not having easy access to all of your invoices and receipts will lead to a more expensive and stressful audit. You should also be saving the following important documents:

  • Debt Agreements
  • Leasing Agreements
  • Lawsuits
  • Complex Transactions
  • Contracts with major customers and vendors

3. Establish Internal Controls

Auditors love seeing good internal controls because internal controls help protect the integrity of the financial statements. Therefore, before the auditors arrive, ensure that all of your stated internal controls are established, operating, and effective. An example of a control that auditors like to see is an access control that governs who can change financial information. 

4. Non-Recurring Transactions

Non-recurring transactions are transactions that only happen once or a couple of times throughout the year. They tend to have a significant impact on the business and include things like:

  • Sale or acquisition of property
  • Significant leases
  • New incentive plans for management
  • New revenue streams
  • A change in debt

Auditors will be sure to notice and ask about these transactions. Therefore, double-check that you have the correct documentation and that these transactions are recorded correctly.

5. Balance Sheet Reconciliations

These should be completed each month as part of your month-end close process from step 1. However, these are so important that we decided to discuss the reconciliations in more detail here.

A clean and reconciled balance sheet is a sign of a healthy company. All balance sheet accounts should have schedules that analyze their balances and agree to the trial balance. Once again, performing this procedure every month will allow you to find and correct any mistakes before they get too big to handle. Examples of balance sheet accounts you should be reconciling are:

  • Bank accounts
  • Accounts Receivable and Accounts Payable
  • Fixed Assets
  • Prepaid Expenses
  • Loan Liabilities

6. Customer and Vendor Aging Review

You should review the Accounts Receivable and Accounts Payable aging schedule each month for old and outstanding items. Doing so will allow you to uncover any payments you might have missed and allow you to set up a collections process for long overdue invoices. Additionally, adjust your receivable balance when you know you will no longer receive a payment from a delinquent customer.

7. Examine Your Revenue

As you go over your revenue transactions at the end of the year, there are two questions that you need to be asking yourself.

  1. Does your year-to-date revenue and gross margin make sense?
  2. Do you have a solid process to book sales in the correct period at the end of the year?

The auditors will look closely to see if your gross margin percentage makes sense and if you have been booking your revenue in the correct year. Additionally, make sure you can easily find all of your invoices. The auditors will ask to see some of your invoices, and you do not want to make the audit more expensive by wasting their time. 

8. Examine Your Expenses

At the end of the year, there are a couple of important things you need to look for to ensure that all of your expenses are complete and accurate:

  • Look for expenses that need to be accrued at year-end, like prepaid expenses and payroll.
  • Review your repairs and maintenance accounts to find any transactions that should have been capitalized instead of expensed.
  • Make sure that all fixed asset accounts have been depreciated.

Also, you should perform an analytical review of your budget to actual expense variances. This exercise may help you identify any missing expenses or expenses recorded improperly.

9. Track Your Physical Inventory

If you have physical inventory, you will most likely need to perform a year-end inventory count with your auditor present. However, to make the count more efficient, you may be able to count the inventory before year-end and provide a roll-forward schedule for your auditor.

Additionally, ensure you have robust cut-off procedures to recognize revenue and expenses in the correct year. Auditors love to test inventory cut-off as many companies tend to overstate revenue and understate expenses this way.

10. Analyze Your Asset Valuations

It is important to your auditor that the assets on your balance sheet are valued fairly and accurately. Some questions you will have to ask yourself are:

  • Are all of your receivables still collectible?
  • Is your allowance for doubtful accounts adequate?
  • Is any of your inventory obsolete?
  • Do any of your assets or lines of business need to be impaired?
  • Are labor and overhead allocations to inventory logical and supported?

Luckily, you can consider these questions throughout the year and make changes as needed so you will not have to scramble at the end of the year to make sure all of your assets are valued correctly.

What Does the Financial Audit Process Look Like?

Companies typically undergo audits because either regulators or lenders require them. Auditors will review a company’s financial statements and supporting documentation to provide reasonable assurance there are no material misstatements either due to error or fraud.

An auditor will often ask for a ledger containing every transaction you made during the year. From this ledger, they will select samples to test if the transactions actually occurred and if they were recorded correctly.

Auditors will also do their best to understand every aspect of your company. This understanding includes performing risk assessments, analytic procedures, and walkthroughs of your financial reporting processes.

If an auditor finds any inaccuracies in your financial statements, they are required to let you know. If you agree with the auditor’s findings, you must make the necessary adjustments so the auditor can issue a clean opinion. If you disagree with the auditor’s findings, they cannot sign off on your financial statements and will issue either a Qualified Opinion or Disclaimer of Opinion.

What Do Auditors Look For?

Auditors are looking for assurance that your financial statements are prepared in accordance with Generally Accepted Accounting Principles (GAAP). To do this, auditors will generally perform tests to ensure that:

  • Revenue and assets are not overstated
  • Expenses and liabilities are not understated
  • Inventory and assets are valued correctly
  • Proper procedures are in place for sales cut-off

Conclusion

An audit is nothing to be worried about. In fact, the insights gathered from an audit often increase the productivity and efficiency of the business. If you follow our 10-step guide throughout the year, you can rest assured that your business will be prepared to speed through an audit.

At Windstone Financial, we provide audit-ready bookkeeping to all of our clients. Additionally, we consult with business owners to clean up their bookkeeping nightmares and set up processes to prepare them for their audits. If you need help with your bookkeeping, click the button below to speak with a CPA today!

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Windstone Financial

Windstone Financial

We are a dedicated team of CPAs that work exclusively with small business owners to lower their taxes and grow their businesses. We will provide relief to all of your accounting headaches.

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