DOES MY COMPANY REALLY NEED AN AUDIT THIS YEAR?

By Jeffrey D. Solomon, C.P.A., C.V.A.
Today, even I shudder when I hear that the “auditors” are coming in – and that’s after almost 20 years in the business. However, audits should not be painful and, in many cases, can be a positive and rewarding experience. Recently, my client who sold his company in eight weeks informed me that having his financial statements audited was the “smartest money he ever spent”!!! He told me that because he provided audited statements to his acquirer, all questions about the accuracy of his financial statements posed by his acquirer were taken off the table. For this client, an audit expedited the sale of his company. However, in certain situations audited financial statements may not be necessary. This article explains what an audit is, the potential benefits of an audit, and alternatives to audits.
An audit of your company’s financial statements is a combination of numerous procedures performed by Certified Public Accountants (CPAs) to provide assurance that the financial statements are not materially misstated and that the numbers and disclosures comply with generally accepted accounting principles (GAAP) issued by the American Institute of Certified Public Accountants (AICPA). A CPA will perform certain procedures, such as (1) testing specific transactions and validating account balances, (2) testing internal controls, (3) confirming balances or agreements with customers or vendors, (4) examining supporting invoices and backup documentation for both sales and expenses, and (5) reviewing both internally prepared and externally prepared agreements and contracts. The auditor verifies that the historical financial statements are properly stated through these types of tests. The auditor will generally develop an audit work program, which identifies tasks to be performed.
An audited financial statement prepared in compliance with GAAP includes the following statements: (1) a balance sheet, (2) an income statement, (3) a statement of cash flows and (4) a statement of changes in owner’s equity. In addition, financial statements must include certain footnote disclosures to provide additional discussion or detail of account balances. Such disclosures generally include significant accounting policies, details of income tax accounts, fixed assets and debt instruments, summaries of stock option and employee benefit plans, and any other significant events affecting the financial statements.
Generally, the discipline needed to prepare for an audit forces the company’s accounting department to clean up their figures and deal with issues that would typically go unresolved on internally prepared financial statements. The costs of an audit vary based on the complexity of accounting transactions, the type of industry and the size of the company. An audit of a privately held company typically ranges from $10,000 to $75,000. Audit fees are usually much higher for publicly traded companies.
Typically, a privately held company undertakes an audit for several reasons, such as:
• Investor requirements
• Debtor requirements
• Owner’s “peace of mind”
• Government regulations
Most venture capitalists and smaller angel investors require audits for their portfolio companies to insure that their investment is secure. Banks and other lenders generally require an audit when the loan amounts exceed $500,000.
“If a Company is going out and trying to raise a large round and it has been in business for a while, then it is imperative that they get an audit of the financials preferably by a competent CPA”, states Charlie Cameron, a founding partner of Hub Angels, a small angel group located in Boston. He went on to say, “We have been burned before by a company that did not have audited statements, and when we drilled into the numbers, it was discovered that not only were the financial statements not in conformity with GAAP, but that the accounting was overall very sloppy”.
A business owner should have his or her financial statements audited if there is the possibility of an acquisition or merger, or an IPO in the near future. In addition, if you are a doing business with the government and have governmental contracts, you may also be required to have an audit. Finally, a privately held company should have an audit or review every few years, if the owners are not involved in the accounting for their company.
Another benefit of an audit is the management recommendation letter. This is a letter prepared for the audit committee (or owner in a privately held company) that provides recommendations that management should could use to improve internal controls and accounting and business processes. In the aftermath of the Enron fiasco and the new Sarbanes-Oxley Act, auditors are not only communicating directly with the audit committee on publicly held companies, but now on privately held companies as well. Today, we attend 50% more board meetings than two years ago.
A reviewed financial statement requires considerably less testing. It does not give an opinion or assurance as to the accuracy of the statements, but states that the financial statements are in compliance with GAAP. In a review the auditor performs analytical procedures and makes inquiries of management as to the reasonableness of the company’s various accounts. The cost of the review is generally 50-75% cheaper than an audit. In some cases, banks or investors will accept reviewed financial statements versus audited financial statements.
There are many obvious and hidden benefits to having audited financial statements. Your accounting books and records will be closely scrutinized, which insures that your accounting department will work harder to make sure that the numbers are accurate. It provides investors or lenders a peace of mind that their investments are secure. In addition, an audit could make it quicker and easier to sell your company, since it provides valuable, credible financial information to potential buyers.
ABOUT THE AUTHOR
Jeffrey D. Solomon, C.P.A., C.V.A., is a Partner with the Accounting and Business Consulting Firm of Levine, Katz, Nannis + Solomon, P.C. (LKNS), where he helps to head the technology and emerging growth department for the Firm. LKNS recently ranked as one of the 20th largest accounting firms in Massachusetts. Mr. Solomon can be reached at jsolomon@lknscpa.com.

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