No finance team looks forward to an audit. Luckily, while they can’t be avoided all together, there are certain processes that can be put into place to ease stress and ensure the lowest possible risk of errors.
A smooth audit process starts with a solid foundation of well-documented transactions and accurate balances. Throughout an audit, your auditor will gather evidence to substantiate the effectiveness of your accounting and reporting processes, so well-documented and organized financial statements will make everyone’s life easier.
However, implementing effective internal controls long before you begin an audit is crucial for ensuring accuracy and compliance when the time comes. Below, I discuss three areas where organizations often have the greatest accounting and process deficiencies when it comes to being consistently audit-ready and how to address them.
Having effective internal controls reduces the risk of errors in these areas and makes for a smooth audit process. However, there are three areas where organizations often have the greatest accounting and process deficiencies: revenue, receivables, and consolidation. Pay special attention to these aspects of your financial statements in order to consistently be audit-ready.
Loosely defined regulations and evolving interpretations make GAAP-compliant revenue accounting highly complex. The timing of revenue recognition often receives the greatest scrutiny, especially if you have multiple elements that are bundled into a single contract yet accounted for separately, such as with software implementation and ongoing technical support. Your auditor wants to see that each element in the bundle is separated, valued, assigned timing and amount for recognition, and reconciled back to source documents. Revenue recognition also involves subjective judgments and estimates on your part, which your auditor will always investigate.
To make your revenue recognition audit-ready, ensure your accounting system effectively automates, manages, and documents your revenue accounting treatment, with the ability to define separate revenue recognition schedules and rules for each individual contract and line item.
Auditors care mostly about your assessment of the realizable value of receivables. Therefore it’s essential that your judgment of collectability be well-founded and defensible. To establish an auditable basis for assessing the value of receivables, your accounting software must track complete transaction details “forever” and maintain secure access to complete customer histories.
In addition to the value of receivables, the timing also matters to your auditor. If customers simultaneously pay multiple invoices covering multiple accounting periods, you must properly allocate the payment to the right invoices and periods, which means matching all cash receipts to specific invoices in a straightforward, documented, and traceable way. To be audit-ready, your accounting software should automatically apply cash receipts to outstanding invoices, starting with the oldest invoice and taking into account any payment penalties and partial balances.
Organizations that report a single consolidated set of financial statements for multiple entities are at a greater risk of a misstatement if they manage consolidations using a massive, complex spreadsheet workbook. Any experienced auditor will tell you that these massive spreadsheets either contain formula errors, are missing some general ledger accounts, or are impossible for the auditor to untangle and follow.
To be audit-ready, ensure your accounting software can automate a complete and accurate financial consolidation, including calculating currency conversions and translations and managing allocations for minority interests. Ideally, the system should provide a full set of consolidating and eliminating journal entries and let the auditor see the details behind each entry.
The Need for Speed
It’s one thing to have your accounting well-documented and accurate, it’s another thing to quickly prepare your financial reporting and audit package. By being more responsive to an auditor’s requests for information—and reducing the time an auditor spends on fieldwork and testing—you might even have your audit fees reduced! In part 2 of this blog I’ll share some ways to speed up your audit preparation process.
Another great way to accelerate your audit readiness is to keep separate sub-ledgers. For example, having a separate receivables sub-ledger lets you can close the sub-ledger before completely closing the general ledger, allowing the auditor to start testing accounts receivable while you continue your overall financial close process. To do this, your accounting system should support multiple sub-ledgers for each entity in your organization.
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