If you’ve been through a financial audit, either an integrated audit required for filing an SEC annual report Form-10K or one done voluntarily per the direction of the board of directors and endorsed by the shareholders, you know how stressful this can be. Like many, you probably feel you are not ready, and the interaction with the auditors can be awkward at times. They ask questions and look for information that you simply don’t know how to respond to; the data is there, of course, but how to convey it to them in a meaningful way is another matter.
Then, there are these junior auditors, who due to lack of experience seem to have a hard time understanding your business – their questions appear to be irrelevant or insignificant, in short – it feels like a total waste of time, especially when you get approached by them with the same question more than once.
I’ve been through many types of audits and the financial statements audit seems to be the one I was having the most challenge with. Through experience as an audit client and as a consultant to our clients I gained the knowledge and insight I think is necessary to survive an audit and most importantly be prepared for one.
Auditors are people too
One of the most important aspects of the audit is building a rapport with the auditor. Your main goal is to convey to them that you run the accounting department with confidence and control over the processes. A good way to accomplish that is to have a candid discussion with them prior to the audit where you will convey to them the department culture, the internal control environment and the level of automation used in the processing of transactions.
I like to have simple and clear narratives explaining the basic processes, accompanied by flow charts. These documents should be reviewed at least annually and updated as needed. There should be evidence of the review and update. A collection of guidelines in each area is also going to be very useful
The importance of clear communication with your auditors
When you forward these documents to your external auditor you are communicating to them that you have clear and defined internal control over financial reporting. Although the external auditor cannot tell you how to run the accounting department or how to perform the various tasks, they can certainly tell you that you are on the right track and that the audit will be conducted taking into consideration some of these processes and guidelines.
Many of the management estimates, such as reserves, cannot properly be audited unless the auditor has some reference to the processes surrounding the review and calculation of such reserve balances. Your narrative or guidelines describing an inventory reserve for obsolescence will clearly convey to the auditor how you perform the analysis and how you determine that updates to the reserve are required.
If they agree with your methodology, all they have to do is audit the accuracy of the calculations.
Having clearly defined processes and knowing how to convey them to the auditors will make the entire audit experience less taxing on the company and its accounting and finance staff. The external auditors will repeatedly “catch” you doing good things, rather than point out flaws in the process, which are normally a major contributor to accounting errors.
When your external auditors are confident that you have a reasonably complete and accurate internal control environment, they will be able to proceed with the actual audit and usually this will result in them spending less time in your office, and doing less work in their office. Both of these will translate into lower audit fees. This will be evident in subsequent years’ audits, especially if your auditor can maintain the same audit team.
Although there are no perfect audits, by following these pieces of advice you will experience a much more pleasant external audit engagement, often with only minor exceptions discovered, some of which will not require any audit adjustments. You will also realize how good it feels when your auditors catch you doing something good.
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