Most owners or executives of mid-sized companies would be quick to agree that preparing for an annual audit can be about as much fun as:
• Getting a root canal
• Eating vegetables you really don't like
• Taking a coast-to-coast red-eye flight
• All of the above
Still, like vegetables and dental work, a regular audit is good for the long-term health of your business. And, experts say, you can make the process far less stressful with some upfront planning, careful scheduling and a commitment to evaluation.
"When management is preparing for an audit, it really pays to develop clear expectations and to be able to talk about them in an open way," says John Morrow, a vice president of the American Institute of Certified Public Accountants (AICPA). "That way, when the staff or external auditors come out of meetings and check notes on their action items, there really should be no surprises."
While longevity in a relationship normally minimizes surprises, experts disagree on whether it leads to better audit results. For example, a 2003 study by the General Accounting Office found that the average auditor tenure for companies in the Fortune 1000 was 22 years. The report noted that stability in an audit relationship usually translates into process efficiencies and cost savings. On the other hand, a recent study published in the Journal of Accounting Research noted that two-thirds of partners from international auditing firms commonly negotiated their audit report findings with more than 50 percent of clients — a sign that audit results may not be as clear as possible.
Still, regardless of whether a company’s management team and its audit partner have worked together for years or just weeks, one of the cornerstones to success is open and honest communication. In private companies without a board-level audit committee, Morrow says good communication is particularly vital between the auditor and the company’s top finance staff, such as the CFO and controller.
“While this is an especially important point in a new relationship, the “shorthand communication” that once worked with a longstanding audit partner can sometimes change as people change,” he says. “That’s why both existing and new relationships need to pay close attention to the communication process.”
One way to enhance the communication process is for management to think about what they want from the auditor and clearly communicate those expectations. While communication is key, experts agree that mid-sized businesses can take additional steps to help build a solid, troublefree relationship with an outside auditor. Whether or not your annual audit delivers more than its share of headaches, consider the following tips:
Develop respect for perspective. In the discovery phase of an audit, the outside team often seeks management’s position on key issues such as internal controls and oversight. It’s the auditor’s responsibility to ask questions and follow up on the responses. They can’t just take management’s response at face value, but must consider supporting evidence. In order to maintain objectivity, the auditor typically cannot take a position on management issues. This sometimes causes unnecessary friction which everyone can help alleviate by taking a big-picture view of the roles.
“This may be more of a public-company issue, because of how Section 404 of Sarbanes-Oxley changed the nature of relationships between management and audit firms,” Morrow says. “But in either a public or a private company, there needs to be a willingness to understand and respect how the [management and auditor] roles need to work if the process is to succeed.”
Deliver on promises. When it comes to an outside audit, time is quite literally money. The audit partner will schedule its resources to accomplish key tasks in the most efficient manner possible, meaning that company management needs to deliver requested documents on schedule. Just as important, key executives need to accommodate meetings with the auditor so that the process can proceed on time and within budget.
“If the audit team gives you a list of schedules, and you agree they will be ready by a certain date, you need to meet that. Otherwise, the audit firm will allocate the people to do the job, and the company will be paying for nonproductive time,” Morrow says. “And, when an auditor needs to talk with management about some issue or concern, saying ‘I’m not available’ is not a good response, because it just extends the timeline and costs your business more money.”
Upfront planning will help keep the audit on schedule. Prior to beginning the audit, management should compile an inventory of the “new things” the company has taken on this year. This may include large contracts of any type (customer contracts, debt arrangements, leases, guarantees and supplier contracts), new lines of business, additional personnel, significant procedural changes, revisions to employee benefits, and so on.
Experts say the best practice is to inform the audit team as these changes come up during the year, but it’s still a good idea to re-inventory everything before the audit begins. Auditors can then plan their time accordingly and avoid surprises.
Evaluate with a post-audit review. Once an audit is complete, experts say it’s wise to evaluate initial goals by using a post-audit review. This structured conversation between the outside audit team, management and a board audit committee (if applicable) should focus on important financial-management issues, including:
• Any significant variances that appeared on financial statements from one fiscal year to the next, or changes in accounting standards or rules that affected the company's financial statements.
• Any significant accounting accruals, reserves or estimates that had a material effect on financial statements.
• Any income-tax issues that the IRS has or might dispute. If such issues exist, the audit committee should determine the status of related tax reserves.
• Any substantial financial reporting issues and how you resolved those problems.
Besides financial discussions, a post-audit review is an important place for candid conversations about process and people issues. This may include the auditor's opinion on the quality of the company's internal financial procedures, or management's view of how effectively members of the audit team worked with executives or staff. "The time to do this is perhaps a couple of weeks after the audit, when both the emotion and the time pressure are gone," Morrow says. "That way, the parties can put the issues on the table, figure out what went right and what went wrong, and move that into a plan going forward."
Place the audit business up for periodic review. Even if you have a solid relationship with an existing partner, occasional reviews are a healthy way to minimize personal aspects of the relationship and ensure good business practices. To build goodwill, experts suggest communicating the review process up front and completing it on a regular schedule (ideally every five years). Regular reviews allow the existing firm to showcase its accomplishments and “insider’s knowledge” against competitors who may bring a new, value-added approach to the table.
“When there’s a periodic competition for this business, you might discover that you can get a whole new level of service from another firm, or get validation that your existing partner is still the best choice,” Morrow says. “Regardless of which way it goes, a regular review ensures that the work will be done well and the fees will be competitive.” IBI
• Getting a root canal
• Eating vegetables you really don't like
• Taking a coast-to-coast red-eye flight
• All of the above
Still, like vegetables and dental work, a regular audit is good for the long-term health of your business. And, experts say, you can make the process far less stressful with some upfront planning, careful scheduling and a commitment to evaluation.
"When management is preparing for an audit, it really pays to develop clear expectations and to be able to talk about them in an open way," says John Morrow, a vice president of the American Institute of Certified Public Accountants (AICPA). "That way, when the staff or external auditors come out of meetings and check notes on their action items, there really should be no surprises."
While longevity in a relationship normally minimizes surprises, experts disagree on whether it leads to better audit results. For example, a 2003 study by the General Accounting Office found that the average auditor tenure for companies in the Fortune 1000 was 22 years. The report noted that stability in an audit relationship usually translates into process efficiencies and cost savings. On the other hand, a recent study published in the Journal of Accounting Research noted that two-thirds of partners from international auditing firms commonly negotiated their audit report findings with more than 50 percent of clients — a sign that audit results may not be as clear as possible.
Still, regardless of whether a company’s management team and its audit partner have worked together for years or just weeks, one of the cornerstones to success is open and honest communication. In private companies without a board-level audit committee, Morrow says good communication is particularly vital between the auditor and the company’s top finance staff, such as the CFO and controller.
“While this is an especially important point in a new relationship, the “shorthand communication” that once worked with a longstanding audit partner can sometimes change as people change,” he says. “That’s why both existing and new relationships need to pay close attention to the communication process.”
One way to enhance the communication process is for management to think about what they want from the auditor and clearly communicate those expectations. While communication is key, experts agree that mid-sized businesses can take additional steps to help build a solid, troublefree relationship with an outside auditor. Whether or not your annual audit delivers more than its share of headaches, consider the following tips:
Develop respect for perspective. In the discovery phase of an audit, the outside team often seeks management’s position on key issues such as internal controls and oversight. It’s the auditor’s responsibility to ask questions and follow up on the responses. They can’t just take management’s response at face value, but must consider supporting evidence. In order to maintain objectivity, the auditor typically cannot take a position on management issues. This sometimes causes unnecessary friction which everyone can help alleviate by taking a big-picture view of the roles.
“This may be more of a public-company issue, because of how Section 404 of Sarbanes-Oxley changed the nature of relationships between management and audit firms,” Morrow says. “But in either a public or a private company, there needs to be a willingness to understand and respect how the [management and auditor] roles need to work if the process is to succeed.”
Deliver on promises. When it comes to an outside audit, time is quite literally money. The audit partner will schedule its resources to accomplish key tasks in the most efficient manner possible, meaning that company management needs to deliver requested documents on schedule. Just as important, key executives need to accommodate meetings with the auditor so that the process can proceed on time and within budget.
“If the audit team gives you a list of schedules, and you agree they will be ready by a certain date, you need to meet that. Otherwise, the audit firm will allocate the people to do the job, and the company will be paying for nonproductive time,” Morrow says. “And, when an auditor needs to talk with management about some issue or concern, saying ‘I’m not available’ is not a good response, because it just extends the timeline and costs your business more money.”
Upfront planning will help keep the audit on schedule. Prior to beginning the audit, management should compile an inventory of the “new things” the company has taken on this year. This may include large contracts of any type (customer contracts, debt arrangements, leases, guarantees and supplier contracts), new lines of business, additional personnel, significant procedural changes, revisions to employee benefits, and so on.
Experts say the best practice is to inform the audit team as these changes come up during the year, but it’s still a good idea to re-inventory everything before the audit begins. Auditors can then plan their time accordingly and avoid surprises.
Evaluate with a post-audit review. Once an audit is complete, experts say it’s wise to evaluate initial goals by using a post-audit review. This structured conversation between the outside audit team, management and a board audit committee (if applicable) should focus on important financial-management issues, including:
• Any significant variances that appeared on financial statements from one fiscal year to the next, or changes in accounting standards or rules that affected the company's financial statements.
• Any significant accounting accruals, reserves or estimates that had a material effect on financial statements.
• Any income-tax issues that the IRS has or might dispute. If such issues exist, the audit committee should determine the status of related tax reserves.
• Any substantial financial reporting issues and how you resolved those problems.
Besides financial discussions, a post-audit review is an important place for candid conversations about process and people issues. This may include the auditor's opinion on the quality of the company's internal financial procedures, or management's view of how effectively members of the audit team worked with executives or staff. "The time to do this is perhaps a couple of weeks after the audit, when both the emotion and the time pressure are gone," Morrow says. "That way, the parties can put the issues on the table, figure out what went right and what went wrong, and move that into a plan going forward."
Place the audit business up for periodic review. Even if you have a solid relationship with an existing partner, occasional reviews are a healthy way to minimize personal aspects of the relationship and ensure good business practices. To build goodwill, experts suggest communicating the review process up front and completing it on a regular schedule (ideally every five years). Regular reviews allow the existing firm to showcase its accomplishments and “insider’s knowledge” against competitors who may bring a new, value-added approach to the table.
“When there’s a periodic competition for this business, you might discover that you can get a whole new level of service from another firm, or get validation that your existing partner is still the best choice,” Morrow says. “Regardless of which way it goes, a regular review ensures that the work will be done well and the fees will be competitive.” IBI
