Today’s Business Tax Topic – December 7, 2021

Are you ready for the upcoming audit season?

An external audit is less stressful and less intrusive if you anticipate your auditor’s document requests. Auditors typically ask clients to provide similar documents year after year. They’ll accept copies or client-prepared schedules for certain items, such as bank reconciliations and fixed asset ledgers. To verify other items, such as leases, invoices and bank statements, they’ll want to see original source documents.

What does change annually is the sample of transactions that auditors randomly select to test your account balances. The element of surprise is important because it keeps bookkeepers honest.

Anticipate questions

Accounting personnel can also prepare for audit inquiries by comparing last year’s financial statements to the current ones. Auditors generally ask about any line items that have changed materially. A “materiality” rule of thumb for small businesses might be an inquiry about items that change by more than, say, 10% or $10,000.

For example, if advertising fees (or sales commissions) increased by 20% in 2021, it may raise a red flag, especially if it didn’t correlate with an increase in revenue. Be ready to explain why the cost went up and provide invoices (or payroll records) for auditors to review.

In addition, auditors may start asking unexpected questions when a new accounting rule is scheduled to go into effect. For example, private companies and nonprofits must implement new rules for reporting long-term lease contracts starting in 2022. So companies that provide comparative financial statements should start gathering additional information about their leases in 2021 to meet the disclosure requirements for next year.

Minimize audit adjustments

Ideally, management should learn from the adjusting journal entries auditors make at the end of audit fieldwork each year. These adjustments correct for accounting errors, unrealistic estimates and omissions. Often internally prepared financial statements need similar adjustments, year after year, to comply with U.S. Generally Accepted Accounting Principles (GAAP).

For example, auditors may need to prompt clients to write off bad debts, evaluate repair and supply accounts for capitalizable items, and record depreciation expense and accruals. Making routine adjustments before the auditor arrives may save time and reduce discrepancies between the preliminary and final financial statements.

You can also reduce audit adjustments by asking your auditor about any major transactions or complicated accounting rules before the start of fieldwork. For instance, you might be uncertain how to account for a recent acquisition or classify a shareholder advance.

Plan ahead

An external audit doesn’t have to be time-consuming or disruptive. The key is to prepare, so that audit fieldwork will run smoothly. Contact us to discuss any concerns as you prepare your preliminary year-end statements.

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